July 20, 2016

Netflix Growing Pain a Good Omen for Content Producers

SMITH BRAIN TRUST — Netflix stock plummeted about 16 percent earlier this week upon word of a second-quarter shortfall of about 800,000 new subscribers internationally. The developments followed a monthly rate increase from $7.99 to $9.99, initially for new customers and now for all renewing subscribers. The hike is not surprising, given the slow customer base growth coupled with the increasing cost for Netflix to acquire content, says P.K. Kannan, the Ralph J. Tyser Professor of Marketing Science at the University of Maryland’s Robert H. Smith School of Business.

Nonetheless, Netflix should be able to withstand the downtown and emerge strong a few years from now amidst intensifying competition in a market where viewers will pay considerably more than they do now to select from and stream a broader and richer selection of content, Kannan says. HBO, CBS, Hulu, Amazon and other competitors are saturating a maturing market and causing Netflix’s customer base to grow increasingly slower, Kannan says. Netflix has relied on a large customer base paying a fixed monthly subscription to absorb the significant costs it incurs to acquire (and now produce its own) content.

Kannan says this recent Netflix activity sheds light on a chain of significant developments in the video streaming industry. As Netflix and its growing number of rivals increasingly compete and spend for content, creative content producers are finally getting paid what they feel they deserve. This will increase content production and viewing options for consumers.

The content cost uptick will lead to price increases for streaming services, overall, with the price differentials signaling the differences across services. Netflix and its rivals also may resort to tiered pricing, similar to mobile phone services pricing, to extract value from customers. Look for unlimited streaming at a higher price and lower prices for limited streaming and content access.

Subscribers will pay more, even with increases in content and competition. “Customers have had it good so far, but binge watching is likely to cost a bit more,” Kannan says. “I will not be surprised to see subscribers paying between $15 and $20 per month in a year or two from now.”

In Netflix’s case, they will be looking “to ensure that they are providing high quality content, which the customer base will care for,” he says. “Retaining customers becomes more important now, and increased content and content acquisitions costs are necessary to retain their customers.”

“From the customers’ viewpoint, they are still getting a good value at these prices, so they should enjoy themselves while the party lasts,” Kannan says. "If you consider the cost of cable services or streaming of HBO content alone (which are substitutes), Netflix even at the increased prices is a good value." Given Netflix provides more original content than Amazon or Hulu, it maintains a positive differentiation over those rivals, and that can translate to increased pricing power, Kannan says. 

Ultimately for Netflix, any loss of customers will be temporary. "They could soon return, paying the increased prices, similar to what happened when Netflix decoupled its streaming and DVD services a few years ago," Kannan says.

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About the University of Maryland's Robert H. Smith School of Business

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and flex MBA, executive MBA, online MBA, business master’s, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

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