Thursday, July 14, 2011

Culture Shock 07.14.11: Rate hike will test Netflix surplus

It really is amazing sometimes how something can go from not existing at all to being such an essential part of daily life that any change to it is met with anger, frustration and uncontrolled sobbing.

Netflix didn't exist before 1997, and it only really became virtually ubiquitous just a few years ago. But when the video-on-demand and DVD rental company announced a new, less user-friendly rate structure this week, you'd have thought the Spaceballs had landed and said they were going to start charging us to breathe.

Basically, if you only want streaming movies and TV shows, or if you only want DVDs delivered to your home, Netflix is willing to cut you a deal. But if, like most Netflix subscribers, you want both, you're going to have to pay more. How much more? In the neighborhood of up to 60 percent more, in some cases.

If, for example, you currently have a subscription that gives you two DVDs at a time and unlimited video streaming, you can expect to pay about $5 more per month, roughly a 33 percent increase, starting Sept. 1.

The reaction to Netflix's price-increase announcement was instructive.

The Netflix blog and Facebook page quickly filled with complaints and threats to cancel subscriptions, with formerly loyal and suddenly outraged Netflix customers threatening to jump to competitors like Hulu Plus (cheaper, but you have to put up with ads) or Amazon Prime (also cheaper, but with a smaller selection of streaming titles overall, although Amazon is arguably better when it comes to recent TV shows).

If you take the angry customer reaction at face value, then you're probably thinking Netflix has just made a huge, possibly fatal mistake. Netflix is about to lose so many customers it will earn less money than before the rate hike.

That conclusion, however, is probably wrong. And Netflix knows it, otherwise it wouldn't be risking this customer revolt in the first place. (And if you want to know why Netflix is doing this, look to Hollywood. The studios are demanding more money for the right to stream their movies and TV shows, and Netflix is passing the cost along.)

Before this week's bombshell, it seemed like most Netflix customers were thrilled with the company's offerings and service. To hear most of its customers talk, Netflix was the greatest thing since the invention of moving pictures. Simply put, the vast majority of Netflix customers, based on their own reported satisfaction, seemed to enjoy a rather large consumer surplus.

"Consumer surplus" is what those of us with economics degrees call the difference between what you pay for something and what that something is actually worth to you. If I pay $5 for a double mocha latte with whipped cream but would be willing to go as high as $10 for it, my consumer surplus is $5. You may think I'm crazy, but I'm getting a 100 percent consumer surplus. That's a steal.

Netflix is betting most of its customers have been getting enough of a consumer surplus that they'll absorb the rate hike, even if they have to vent about it first. That's probably a safe bet, because all of those angry Netflix customers wouldn't have been so upset if they didn't really love their Netflix.

And that means a lot of Netflix's customers are dirty, dirty liars.

Either they were lying just a few days ago when they were saying how great Netflix was, or they're lying now when they say they're going to cancel their accounts because Netflix suddenly turned into a greedy, profit-maximizing corporation with bills of its own to pay, which it totally wasn't just last week.

You can't believe what people say. But when they actually put their money on the countertop, that's when they're telling the truth.

When it comes to Netflix, we'll find out the truth sometime in September.

1 comment:

  1. Anonymous5:37 PM

    Elasticities and consumer surplus are cute and all, but this is a case study in theory of the firm, not theory of the consumer.

    Netflix made this change, not because it could, but because it HAD TO. As many as 80% of (paying) subscribers are on disc+ streaming, and Netflix LOSES MONEY on many if not most of them at the current price points.

    At one disc per month, for example, a subscriber can easily receive as many as 7-8 discs a month. Estimates of round-trip mailing cost are usually around $1.20 per disc (BEFORE content costs). At $10/month, and adding in streaming costs, the company was, literally, operating below its marginal cost.

    Netflix is not "betting" on anything except the fact that it cannot survive on negative margins. "Lying" consumers are simply not part of the equation.