Netflix admitted price hikes hurt growth in the US, and its pricing power will face an even greater test as new rivals launch (NFLX)

Business Insider Entertainment 1 month ago

There was a dull mark on Netflix's third quarter, which otherwise helped reassure Wall Street it could defend its streaming empire from soon-to-be rivals like Disney and Apple: Subscribers in the US were still canceling the service in higher numbers than before.

Netflix added about 280,000 fewer paid subscribers in the US than forecasted during the third quarter, after losing paid subscribers in the country the prior period. The company blamed its latest misfire on churn, or the rate cancellations which rose slightly after Netflix hiked prices in the US earlier this year.

The streaming giant squeezed in one last big price hike in 2019 before forthcoming streaming services like Disney Plus, Apple TV Plus, HBO Max, Peacock, and Quibi try tried eat its lunch. It announced in January, across its US plans, rate increases of $1 to $2, which were still rolling out to existing subscribers through the second quarter.

Netflix's struggles since, in its largest single market, has Wall Street analysts and investors questioning how much the service can continue growing domestically, and what the limits are to its pricing power.

"It basically says they have some limits on their pricing power, at least for now," James Wang, analyst at investment manager ARK Invest, which runs two exchange-traded funds that include Netflix, told Business Insider. "That's what caught me on the more cautious side," he said, noting that the report was quite strong overall.

Netflix's frequent price hikes may evoke the worst of cable TV for some customers

Netflix's pricing power will be tested more during the fourth quarter, and into 2020, when its new competitors take hold.

So far, none are positioning themselves as direct threats. Disney, Apple, and WarnerMedia are all tiptoeing around "800-pound gorilla in OTT," as Brett Sappington at entertainment research firm Parks Associates said. "Those other services have content that's unique and are seen as an add ons," he said.

Disney Plus, for example, will be more family oriented. Apple TV Plus is launching with nine original series, and no licensed or library content.

Netflix, meanwhile, is still trying to be the home for nearly everything. It wants to make your favorite show, be it a  guilty pleasure or prestige drama, and movie, from indies to blockbusters, and have your beloved TV repeats like "Seinfeld." In that sense, Netflix has become the equivalent of broadcast or cable TV to some cord-cutters.

It's also the only major streaming service that is profiting entirely from subscriptions. Amazon, Apple, and Disney-controlled Hulu can afford to undercut Netflix on price, as they are, because their streaming services are backed by other profitable businesses, such as Apple's iPhones and Disney's movies and parks.

As such, Netflix has had to raise prices in the US more regularly than most of its peers — about every two years or less. Hulu, by contrast, lowered the price of its cheapest plan this year, right after Netflix raised rates. And HBO Now, which charges more than Netflix does for its standard plan, hasn't raised prices since its 2015 launch.

Yet people in the US, scarred by constantly raising rates for cable TV, worry about being tied to services with ever-rising rates. Netflix's pricing power may be limited not by its actual prices, but the frequency with which its raising them.

"I don't think the price itself is the issue," Eric Haggstrom, forecasting analyst at eMarketer, said. "It's purely psychological. The main reason people cut the cord in the first place is the consistent price increases they're subject to ... Netflix is the one streaming service that has been consistently raising prices so far."

The streaming giant is hoping higher-caliber films and other new content will make its service more valuable

Many industry watchers still agree Netflix is a good value at $13 per month for its standard plan. But the company is also looking at other ways to round out its content lineup and make itself indispensable to streaming users. Netflix has been spending heavily on animated originals, ostensibly to replace some of the movies and shows it is losing as Disney shifts its library to its own streaming service. 

Netflix has also been investing in big-budget movies, the kind you'd expect to watch in theaters or ignite Oscar buzz. The company called out during earnings movies including Martin Scorsese's "The Irishman"; "Marriage Story," with Adam Driver and Scarlett Johansson; and Michael Bay's "Six Underground" that will hit the service later this year.

"What we have to do is just give it a pause and really focus on the value," Reed Hastings, CEO of Netflix, said in the third-quarter earnings interview when asked about pricing and churn. "If you think about it, we haven't had many big movies in the past, and movies are very valuable. People are used to paying for a lot of that."

Introducing a greater caliber and breadth of movies on top of the indies and so-called "TV movies" on Netflix now may also help replace some of the content from outside studios that the streaming company can no longer rely on licensing year after year. 

But it's harder to tell how films, a newer endeavor for Netflix, will drive or retain subscribers. Netflix lowered its subscriber forecast for the upcoming fourth quarter, in part because of new releases that are harder to predict the the audience for than returning seasons of existing series.

Whether Netflix will be able to match the hit ratio of movie studios that have been releasing films for decades also remains to be seen. 

"If you think about how long Disney has been doing this compared to Netflix as a studio, Netflix is a startup," Jeff Galak, associate professor of marketing at Carnegie Mellon University's Tepper School of Business, said. "They're still figuring out the right formula."

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