Q. 1 Why did investors bid up Netflix shares so dramatically in the early 2011?

Ans: : Bidding up is the process of increasing the price at which an investor is willing to but the
share. This is generally used when the market is growing. When the market is growing, the investors
are not ready to sell the shares so by bidding up the price, the buyer increases the probability of
selling of shares by investors. This in turn also increases the share price.
In case of Netflix, the company’s net income was growing steadily till 2010 which is shown in the bar
chart below. In first quarter of 2011, also it showed a fairly good net income of 65Mn dollars which
was much higher than the net income in the same quarter of 2010. These trends show that the
company was growing steadily. In addition to this, the streaming business of Netflix was in full swing
and the subscribers were increasing rapidly. This increased the internet traffic. By May,2011 Netflix
alone was responsible for 25% of total internet traffic in North America. This shows the growth that
Netflix was having in early 2011. Since there was growth in the company, the investors may not be
interested to sell their shares so there might be bidding up of shares.
 Net income (USD Mn) Revenues (USD Mn)
180 2500
161 2163
160
2000
140 1670
116
120 1365
1500
100 83 1205
80 67 997
1000
60 49
40 500
20
0 0
2006 2007 2008 2009 2010 2006 2007 2008 2009 2010

From above graphs, we can conclude that the

Netflix was a growing company, so the bidding up of shares might be done to ensure that the shares
get sold.

Q. 2 How did Netflix cost structure change as the company moved from movies on disk-
though-mail vs streaming?
Ans :

Cost Structure

Acquiring Cost per DVD $ 7.99 $ 17.99

No of use 24  
Per person cost per movie $ 0.33 $ 0.75
Average view per month 2 11
Per person cost per month $ 0.67 $ 8.25

DVD only (2007)

1 Movie $ 9.99

2 Movie $ 14.99

3 Movie $ 17.99
Subscription plan in 2007

Revenue 2007
Revenue from DVD $ 1205000000
Total Subscriber $ 7500000
Revenue per person per month $ 13.3888889

Cost components (2007)

Round-trip postage $ 0.80
Envelope and inner sleeve $ 0.10
Per person cost per movie per month $ 0.33 - $ 0.75
Per person cost per month $ 0.67 - $ 8.25
   
Other Costs  
Content acquisition -
Fulfilment expense -
Customer Service -
Credit Card Fees -
New Customer Acquisition Cost $ 40.88
Technology and Development -
Costs of developing machinery of the shipping centres -
Marketing -
General and Administrative costs -

2011
Total Subscribers 23800000
Online 21400000

DVD 2400000

Revenue (2011)
January – September $ 2,32,90,00,000.00
January - December* $ 3,10,53,33,333.33
Revenue from DVD** $ 2,79,21,90,476.19
Revenue from Online Streaming** $ 31,31,42,857.14
Revenue per person per month $ 10.87

Cost components (2011)

Right to stream $ 20,00,00,000.00
Content Streaming library $ 8,05,00,000.00
Cost per Online user per month $ 0.98
 Other Costs -
Content acquisition -
Streaming Cost $ 0.05
Customer Service -
Credit Card Fees -
New Customer Acquisition Cost $ 18.00
Costs of the streaming server  

2007

DVD + Online Streaming Online streaming Only

Earlier 15.98 7.99
Later 11.99 - 13.99

 The shift of users from DVD only subscription to DVD + Online streaming users
had not affected the revenue generated per user to a great extent until the prices
were increased even though there was a change in the cost structure. The increase
in the subscribers had decreased the Acquisition cost but there was also an increase
in the content licensing cost which was balanced by reduced fixed and variable
cost.
 Decrease in customer base by 800,000 users was due to the increase in the
subscription charges. The best possible was of promoting both the platforms was
bundle pricing. Abandoning “unlimited” for streaming was a viable choice for
users who watched less number of movies per week.

Q. 3 Customers had a bad reaction to the announcement of monthly fees for streaming
video; compared to previous prices for movies on disk- why was there a backlash?
Ans: As movie studios began to realise that there would be a loss from the income of Cable TV due
to the unlimited streaming services provided by Netflix, they increased the prices for Netflix. This
resulted in increased spending $805 million against $115 million in the prior year. The company was
facing a huge increase in cost to provide streaming content and it was ever increasing. Netflix realized
that it was time to charge people for streaming content. To counter this, Netflix announced that the
two services were to be split into separate charges for DVDs and streaming. Subscribers who were on
the one-disk-at-a-time program would see their monthly rate change from $9.99 down to $7.99—a
price decrease. But to continue to view movies online, they would now have to add a separate
streaming subscription, an additional $7.99 a month. This was a drastic increase of 60%, the
customers saw this sudden and unexpected increase in the price of subscription to be absurd. Netflix
management tried communicating to the customers that they were getting “terrific value” on the
subscription plan but ended up receiving backlash from the customer base which also included
consumers who threatened to quit the service entirely. Throughout the summer after the
announcement the backlash was visible in form of complaints on blogs and social media.

The reason for this backlash was that the customer did not expect a sudden price increase for a service
that they have been availing for free of cost over the past two years. This sudden move failed to
generate value in the eyes of the customer. Reed Hastings realised his mistake that the new pricing
was not communicated properly and thus was receiving a lot of backlash. To Solve this issue Reed
Hastings wrote an apology to the customers saying “sorry you’re so upset” The apology was aimed at
affirming the two-price plan and clarifying that there would now be two separate websites, two
separate subscriptions and two separate queues for customers to manage. It further added that, The
DVD service would be renamed “Qwikster” and the original Netflix site would be streaming only.

Q. 4 While formulating a pricing strategy, which of the three specific pricing

alternatives laid out at the end of the case would you recommend? Why?

Ans: We would recommend “Option 2 : Make a single lower bundle price” . Subscribers had more
than two years of experience of free streaming and were unprepared to pay for it. The rise was of 60%
from $9.99 to a total of $15.98 a month. During that scenario Netflix failed to understand it
customers. The right decision would have been to provide a DVD/streaming combo option that
offered a limited amount of streaming per month for a little more than $10 fee and then up-selling
them on the value of the upgrade. This would have made Netflix retain a lot of these customers that it
lost due to sudden price change. Netflix lost 1 million more customers than anticipated and
experienced a hit on Wall Street, sending the stock price down almost 50 percent, from $300 to $155.
Although online streaming was the future and a booming industry but at that point people still
preferred to buy DVDs and there was no clear distinction of soon the shift from DVD to online
streaming would happen.
Opting for option two would have increased Netflix’s overall revenue and had given the start to
eventually increase price up to $15.98 Also value addition would have been highlighted and Netflix’s
major issue of offering streaming service free from last two years would have resolved.
Option 3 is also not viable because it removes the competitive advantage of unlimited streaming that
Netflix had over it competitors. It would have lost it brand identity. Also there is no clarification
about the operation of DVD model along with this.
The objective of price change is to :
• Maximize Profit
• Cover acquisition and distribution costs
• Align price with perceived customer value
• Maintain competitive edge
Selecting option 2 will achieve all the objectives.