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Killing the Golden Goose

October 2011 Marketing, Pricing 5 Comments

In a marketing blunder that rivals Coca Cola’s (temporary) abandonment of its original formula in favor of the sweeter “New Coke,” Netflix (NFLX), despite its incredible success and customer affection, decided to raise its prices 60 percent and sent its stock tumbling 19 percent.

Was it incredible greed, stupidity or just plain ignorance that caused Netflix to  take this action from which it will be difficult to recover and which will open the door to major competition.  One million customers instantly abandoned Netflix.

Quick to retrench, Netflix might have compounded its problems with a move to separate its DVD and streaming services.  Acknowledging his mistake, Netflix CEO Reed Hastings released a lengthy and highly apologetic blog by saying, “I messed up…I owe everyone an explanation.”  He further added, “In hindsight, I slid into arrogance based on past successes.”

Hubris

The Greeks have a word for such action.  It is hubris and it means extreme arrogance based on an overestimation of one’s own competence or capabilities, especially when the person exhibiting it is in a position of power.

Perhaps there are factors at work that are invisible to anyone but those in power at Netflix,  but this company has had a remarkable history of financial success.  Top-line revenues have increased steadily from $996 million in 2006 to $2.162 billion in 2010.  Bottom-line net income has gone from $48.8 million in 2006 to $160.8 million in 2010. Basic earnings per share have gone from $0.78 in 2006 to $3.06 in 2010.

Does this kind of performance warrant a decision that threatens the future of the company?

The Price Increase

What Netflix did in its original announcement was effectively raised its monthly charge for many subscribers from $10 to $16.  In the latest action, it will unbundle its DVD mail service from its on-line streaming service.  This, no doubt, will cause chagrin from other subscribers who enjoyed the balance – and value – of the DVD mail service with the on-line streaming service.

Why, then did a heretofore intelligent, creative company do something so stupid? It is my opinion that the decision was made in a vacuum.  It was an ivory tower decision made by a highly successful entrepreneur who simply felt that the customer would pay the increase.

Why did Netflix not do any market research?  All they would have had to do was spend a little money and interview a random sample of their customers and ask them how they would react to a 60 percent increase in their monthly rates.  Had they done that , there is no question that customers would have told them what the financial markets told them – bad idea.

There is another more intangible variable, customer loyalty and perceived betrayal.  As the Wall Street Journal reported: “Some customers said an apology didn’t lessen their anger.  ‘I am still a customer but no longer a fan – I feel betrayed.’ “

Interestingly enough, when Coca Cola  (CCE) embarked on its adventure, it had conducted some 200,000 taste tests before they embarked on the New Coke.  However, in none of those taste tests did they ask loyal Coke drinkers whether they would be willing to give up the traditional taste of Coca Cola in favor or the sweeter New Coke taste.  Coca Cola didn’t want to reveal in its research that it was thinking of replacing its traditional formula with the New Coke.   When they did there was such a backlash, that Coca Cola quickly re-branded its original formula as “Coca Cola Classic.”

For a short period, Coke had two flagship brands and, in effect, gained market share against rival Pepsi.



  • MBH

    It seems you’re missing several important details (i.e. what Starz really wanted, future of dvd’s, production companies asking price).

    A little lack luster journalism here. Move along folks, nothing to see here.

  • agreed

    Why is no one pointing out that losing 1 million customers after a 60% increase in cost is actually profitable when youhave 25million of them?

  • Daniel Parmet

    I feel you guys are being too harsh on this article.
    Do you not realize that losing ONE million customers in a single day is a huge blow? You are not accounting for the negative word of worth and the potential growth lost. I for one was a previous borderline potential customer that now has zero interest in ever becoming a customer. This article touched on some important issues. It did not claim to give a 100% industry evaluation of netflix. However, face it, netflix could have done a much better job of communication.

  • Daniel Parmet

    In fact look, Netflix itself admitted a mistake after a 65%(!!) drop in the stock market share price they announced today a reversal of their decision to split their services.

  • Steve from Pricing

    Don’t confuse stock market changes with real fundamentals. A sudden drop in the stock price was pure speculation based on perception, not based on a sudden change in cash flow.

    If 96% of customer paid 60% more, and 4% of customers dropped, my math says that’s an increase in profits. Worried about growth? A 50% growth in revenues from price wouldn’t be that bad in the end.

    However, there is an important reference price issue here. Anytime you increase price by 60% you need to be careful. People hold that reference price like an anchor. Companies that successfully make pricing changes like this need to break that reference price by creating another. For example, you could compare this explictly to the entertainment value – with streaming, if you download a movie a night, at the old videostore rates of $5 a movie, that’s like $150 in value. What’s the value of access to a library of 10 million movies, or whatever Netflix holds, compared to the 18 in Redbox?

    Some simple comparisons here could have shown $16 to be a tremendous value, and broken the old reference price.

About the author

James T. Berger, Managing Editor of The Wiglaf Journal, through his Northbrook-based firm, James T. Berger/Market Strategies, offers a broad range of marketing communications, research and strategic planning consulting services. In addition, he provides expert services to intellectual property attorneys in the area of trademark infringement litigation. An adjunct professor of marketing at Roosevelt University, he previously has taught at Northwestern University, DePaul University, University of Illinois at Chicago and The Lake Forest Graduate School of Management. He holds degrees from the University of Michigan (BA), Northwestern University (MS) and the University of Chicago (MBA). Berger is an often-published free lance business writer who has developed more than 100 published articles in the last eight years. For more information, visit www.jamesberger.net or telephone him at (847) 328-9633.

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