Why Netflix changed its pricing plans

Reed Hastings

Netflix updated its pricing Tuesday, removing the ability to combine DVD-by-mail and streaming plans and effectively forcing subscribers to choose one or the other. For those that wish to continue using both services, the change effectively raises the price of a combined plan by 60 percent, which has already caused some subscriber unrest on the blog post announcing the change and around the Internet. But why did Netflix make the change?

Ultimately it comes down to money, as Netflix VP of Marketing Jessie Becker acknowledged in the company’s blog post. “Given the long life we think DVDs by mail will have, treating DVDs as a $2 add on to our unlimited streaming plan neither makes great financial sense nor satisfies people who just want DVDs,” she wrote.

The cost of its DVD-by-mail operations isn’t supported by the $2 per month in additional revenues that Netflix gets from the previous add-on plan. While much of the infrastructure investment is a sunk cost and has been amortized over the years, supporting ongoing DVD operations isn’t a winning strategy for a company that is betting big on streaming. The cost of postage alone argues against such a heavy discount for a continued DVD-by-mail plus streaming offering.

But there’s another reason why Netflix is making this change: By forcing subscribers to choose, it’s likely betting that most will go streaming-only, thereby lowering the infrastructure costs of supporting them. As we wrote last year, the real cost of its streaming service isn’t defined by video storage, delivery or other infrastructure, but in the acquisition costs that come with it. That gives Netflix the ability to better manage its costs as it decides which content to invest in.

From an investor standpoint, splitting up Netflix’s operations more clearly into streaming and DVD-by-mail services could also give further transparency into its business. Doing so would enable it to break out operational costs from its DVD and streaming units, something that it has been unable (or at least unwilling) to do so thus far. With a management and organizational structure that clearly defines operations into separate units — streaming, DVD and international — financial analysts and investors will get a better idea of what’s driving revenues and costs. This could happen as soon as the fourth quarter of this year, once subscribers have been moved into one plan or another.

And finally, while Netflix weens subscribers off the combined plan and onto either a DVD- or streaming-only plan, there’s a side benefit to breaking up its plans and effectively raising rates for those who subscribe to both: In the short term, at least, we’re likely to see those who subscribe to both plans effectively subsidizing content acquisition costs for its streaming-only plan — except they’ll be doing so at a higher rate ($7.99 versus $2 a month) and with more transparency.

If Netflix does break out financial operations in the coming quarters, as we suspect it will, we could see whatever profits might come from a combined plan or DVD-only being shuffled to support content acquisition, as Netflix invests ahead to support more aggressive subscriber growth, both in the U.S. and internationally.

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