Netflix's price hikes help explain its terrible quarter and Wall Street analysts say it needs to be careful as new competitors spring up

Netflix's price hikes help explain its terrible quarter and Wall Street analysts say it needs to be careful as new competitors spring up

FILE PHOTO: The Netflix logo is seen on their office in Hollywood, Los Angeles, California, U.S. July 16, 2018. REUTERS/Lucy Nicholson/File Photo

  • After a rough second quarter and with new competitors on the way, Netflix's pricing power in the US may be called into question.
  • Customers will be gauging the value of Netflix against its competitors, as more options become available to them.
  • Wall Street and industry researchers haven't lost faith in Netflix, but they're keeping a close eye on subscriber growth in the quarters to come to evaluate how much runway Netflix has in the US.
  • "They will need to be more careful moving forward," one analyst said.
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Netflix rolled its latest price hike out to existing subscribers in the US during the second quarter, and lost more than 100,000 paid subscribers in the country. It was the first time since 2011 that the company lost subscribers in its biggest market.

Wall Street analysts are hesitant to place too much weight on Netflix's subscriber miss, because the second quarter is usually a slower period for the streaming company; it fell short of expectations during the second quarter last year, too, and quickly recovered.

But with new subscriptions on the way from big brands like Disney and WarnerMedia, the weak quarter is raising questions among Wall Street analysts and industry researchers about how much pricing power Netflix has left.

"It's pretty clear there's some price sensitivity," Tuna Amobi, who covers Netflix for CFRA Research, which has kept its buy rating on Netflix, told Business Insider. "The question becomes, when companies like WarnerMedia and Disney Plus, and Comcast begin to launch their own offerings in the next year or so, how will it affect Netflix?"


Read more: Netflix plunges more than 10% after a huge miss on subscriber growth during Q2

The second quarter slowdown

Netflix blamed the weak quarter on seasonality and a content slate that pulled in fewer signups than expected following a surprisingly strong first quarter, but said pricing played a factor, as well.

The company said it had "elevated churn rates and lower retention," - basically, more cancellations - during the quarter in places where it hiked prices. That would've included the US, where a $1-$2 price bump for each of Netflix's three plans rolled out to some existing subscribers. Netflix raised prices for new subscribers to all its plans in January.

"When you raise your price, you have now triggered all of your subscribers to think about whether it's worth it or not," said Brett Sappington, senior research director and principal analyst at entertainment research company Parks Associates. "Subscribers make a decision - do I still like it at this price? There's always going to be greater churn, but typically it settles out over time."

Netflix said it's already seeing that leveling off in the first few weeks of the third quarter. It's projecting a strong, 7 million paid subscriber additions globally next quarter, including 1 million in the US, which would be more members than it pulled in this time last year.


The company also said the additional revenue it gets from price hikes are a good thing.

"While there may be some short-term slowdown in subscriber growth because of pricing, that increased revenue is very good for our business and ultimately for our members, because we reinvest the bulk of that back into great content and great product experience for our members," Spencer Wang, vice president of finance, investor relations, and corporate development, said in the company's earnings interview.

The value equation

But the value equation is going to get more complicated for people in the US in the next 18 months or so, when services including Disney Plus, HBO Max, and NBCUniversal's upcoming platform will launch. People will have more barometers to gauge whether their Netflix subscriptions are worth it, and more options to switch to if they decide they are not.

Netflix subscriptions now cost between $8.99-$15.99 per month in the US. At that price, Netflix's cheapest plan is on par with competitors like Hulu's on-demand service and Amazon Prime Video, and its most expensive is slightly more than HBO Now.

It costs more than the $6.99 per month Disney Plus will, come November. But it's likely less than HBO Max will cost. (WarnerMedia has not announced the price of the service, but it is expected to be more expensive than the $14.99 HBO Now costs.)


That means, next time Netflix raises prices, which it typically does every 18 months or so in the US, it'll need to prove its service is magnitudes more valuable than its cheaper competitors.

About 40% of people who said they canceled Netflix in the last year said they did so to cut back on spending, according to an April survey conducted for Business Insider by the on-demand insights firm, AlphaHQ. Another 23% of respondents said they canceled because Netflix wasn't worth the price.

Cost is the reason that most people typically cancel services, Sappington at Parks said.

The bottom line

Netflix isn't going to stop raising prices, the experts say. But it'll have to be more cautious when it does so, and bank on its original content slate to keep people around.

"Consensus across the industry was that Netflix was the base package," said Eric Haggstrom, a forecasting analyst at eMarketer, explaining that people may sign up for other services like HBO Now to watch one or two shows throughout the year, but that Netflix was viewed as the subscription service people stuck with. "This quarter kind of disproved that whole idea, where Netflix had a relatively weak content schedule and some people churned out ... They will need to be more careful moving forward."


That may mean smaller price bumps at Netflix in the future, or hikes that only hit certain packages, so that the barrier of entry remains low. Netflix has raised prices on its more expensive plans in the past, and left the cost of its starting offering alone.

But if Netflix can turn its free-cash-flow deficit around, as it plans to start doing by 2020, it may be under less pressure to raise prices, Amobi, at CFRA Research, said. "My sense is they might not be compelled to raise prices as frequently as they might've needed to before they turned cash-flow positive," he said.

Investors are also encouraged by Netflix's inroads with pay-TV providers like Comcast and, most recently, AT&T. Being included in the pay-TV bundle is helping Netflix reach subscribers who wouldn't typically sign up for its streaming service. Traditional pay-TV customers also tend to spend more on their video subscriptions than streaming-only subscribers, Sappington said.

Those deals could help Netflix extend its runway for subscriber growth in the US, where the company seems to be approaching a plateau. Netflix has said it has a longterm goal of 60 million to 90 million US subscribers, and it now has 60 million paid members.

Next quarter will be the real test to see whether Netflix's subscriber troubles are a blip, or a worrisome trend.


"We don't take the Q2 miss lightly, but history tells us it's a difficult quarter from which to extrapolate Netflix's trajectory," analysts at J.P. Morgan wrote, in note on Thursday.