Sunday, July 17, 2011

Netflix raises prices...This has to kill their revenues, doesn't it? Look at the numbers and see if they can STRETCH revenues like an elastic

Netflix recently announced a new pricing plan for its online streaming and DVD service.  People understandably are upset about this. Is this going to hurt their revenues as people follow through on their threats to discontinue the service?  Let's perform a total revenue test to see if this is going to hurt their revenues.

 I am going to use some easy numbers to illustrated what might happen to Netflix revenue as a result of this change in pricing policy.

I currently subscribe to the $9.99 plan (round to $10 so the math is easy) where I can stream online and get 1 DVD at a time through the mail. This plan will increase in price to $15.98 (round to $16 so the math is easy).  This is a 60% increase in the monthly price. Right now, Netflix has approx 23.6 million subscribers. Assume that because of the negative publicity 10% of their customers drop the service completely. I don't think that many will, but lets see what happens.  This means monthly subscriptions will be 21.2 million now (a loss of  2.2 million subscribers).  That can't be good for the bottom line, can it?

Revenue before the change in plan: $10 X 23.6 million = $236 million.  Revenue is actually higher because they do have more expensive rental plans, but we will leave that aside for now.

Of the remaining 21.2 million customers, assume only 40% decide to maintain the streaming and 1 DVD at a time plan for the higher price of $16---8.48 million X $16 = $136 million.  Assume the rest are split 50/50 between online only and DVD only plans---12.72 million X $8 (either plan costs $8) = $102 million. Total revenues now are $238 million---$2 million MORE than before the change.

Performing the Total Revenue Test for Elasticity of Demand, we found that the increase in price and corresponding decrease in quantity demanded actually increased their total revenues. This means overall not enough people were sensitive to the change in price to discontinue the service and cause Netflix total revenues to decrease.

The percentage change in price for Netflix (+60%) was greater than the percentage decrease in quantity demanded for their service.  If this remains the case, then we can say the demand for Netflix is relatively INELASTIC.

Netflix will weather the storm of negative publicity. Eventually the DVD part of the business will disappear and so will the postage and all the other costs associated with running a mail order business. A broader offering of content will be available for online streaming in the near future and everyone will forget the day Netflix raised prices.
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