Netflix Isn’t NY Times, Apple, or In-N-Out

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ForbesForbes – @Forbes
The Price Isn’t Right: What New York Times, Apple and In-N-Out Could Teach Netflix

In this recent Forbes article, Netflix gets called out for not understanding pricing in the marketplace. But the argument falls flat (at best) and makes some pretty wacky assumptions (at its worst).

A little while ago, I wrote a post that stated that Netflix’s moves were anchored in a “startup” mentality – and I’m still sticking by that piece. For the Forbes article, author Trish Gorman starts off her piece with a rather ominous declaration:

What happened was more than a minor public-relations snafu. Netflix stumbled in its pricing—a minefield for any business and the last place you want to make a misstep.

So the premise is that Netflix has committed a cardinal business sin – the “last place” they can make a mistake. But like I argued in my previous piece, this really isn’t a pricing issue. Fundamentally, Netflix restored it’s original business – at a 20% discount (from $10 / month to $8 / month) of DVD-by-mail. They’re simply splitting their operations because the two businesses are different businesses that serve the same need. But that’s not what I want to focus on (just yet).

The Forbes article tells us that Netflix should learn from New York Times, Apple, and In-N-Out. 3 iconic brands, to be certain, with rabid fans and outwardly-successful business models that Netflix could use a case-study in pricing minefield avoidance. So what’s the takeaway? Uhm…

Her first example of how the New York Times has succeeded concludes with:

…the Times earned $83 million in the second quarter of this year, down from $93 million in the second quarter of 2010. But that the company managed the enormous price hike with just a few murmurs of complaint from its readers was extraordinary.

The only thing obvious from this example is that the NY Times is losing money. Hooray for their savvy pricing decision! Ultimately, the NY Times suffers much like Netflix: Premium content is blended in with commodity content, driving the price down to some sort of mean value that is averaged across the whole array. Would I need to read the New York Times for coverage of a national news story? Of course not – they’re likely getting their information from the same wire service that AP, Reuters, and every other news outlet is using. And in the case of the East Coast earthquake this past summer, I was getting news on the quake from people I follow on Twitter about 5 minutes before the Washington Post website.

Unlike the NY Times, though, Netflix is not a production business (yet), they’re simply a distributor. The NY Times suffers because it’s premium content (self-produced, high-cost) simply can’t yield a high enough advertising revenue to offset the cost of premium production. So they added a “premium” tier. The funny part about Mrs. Gorman’s article is that she states there were “… just a few murmurs of complaint from its readers…” I’ll guess why: Because most people don’t care. There are literally hundreds (if not thousands) of alternatives to news. Certainly there is a degree of price elasticity that people will be willing to consume premium content from NY Times, and that’s why they created a premium tier – to earn revenue from those customers willing to pay for it. But, as the article pointed out – this hasn’t been the saving grace for the news room. A $10-million dollar YTD quarterly decline definitely doesn’t suggest that they’ve nailed their pricing problem. So what lesson should NFLX be learning here?

Moving on to the next lesson: Apple. Apple is the financial aberration of the decade – a premium technology company building high-end iDevices that consumers crave and rave about. It’s an easy choice to include in an article like this, because obviously Apple’s strategy has been effective. They’re the most valuable American company, after all, so why isn’t Netflix using their pricing philosophy? Steve Jobs! (I’m not quite sure what the argument is):

… he developed his more user-friendly, sexy iMacs, and charged a premium for them. Don’t like Apple’s prices? Tough. There were no Macintosh clones.

Get it? Me neither. This argument spans a paragraph, which I think may be a paragraph longer than it should have been. Netflix is in the movie distribution business. Maybe at some point they’ll be in the business of premium exclusive content (think HBO or Showtime, or any cable network), but they aren’t right now. So what premium can they command? Their DVD-by-mail business was innovative, but followed closely by Blockbuster. Who charged more. Blockbuster countered by striking (expensive) licensing deals with studios to get some new releases 4 weeks before Netflix. And Blockbuster went bankrupt, and now Dish is just riding the last vestige of brand loyalty and name recognition in an effort to flank cable companies’ streaming options (which are here, and/or coming).

The real story of how Netflix can follow Apple in terms of pricing literally is command a premium and raise prices. And they’ve done that. So, uhm. There you go. The simple reality is that Netflix is leveraging their superior distribution capabilities (in both streaming and plastic disc businesses) and their licensing deals to command a better price point from consumers. That’s because, though there are lots of alternatives for entertainment, Netflix is essentially the only subscription service in the game. Hulu Plus comes a close second (in terms of content) and even they charge $10 / month – 20% more than Netflix, for less content. Hulu may have some deals for better or fresher content, but that’s part of the TV / movie marketplace. There are no Netflix clones

So how about In-N-Out? They sure do have some tasty burgers. But what should Netflix know about In-N-Out pricing?

It’s common to hear fanatical In-N-Out customers insist they’d happily pay more. But a $5 In-N-Out burger would break the company’s implicit contract with its customers—and that’s what a price ultimately is. A contract of what you will sell and what I will pay, and why.

Netflix split its business specifically because cost-plus pricing doesn’t work in streaming licensing deals. It works fine with DVD’s, because the licenses were set up ages ago. The deal is – you buy a DVD as a rental agency and you can rent that single disc as many times as you want. That is perfect for a company that can nail the distribution and operations cost, and operate at scale. Netflix essentially runs their business like a fitness club. A fitness club wants you to pay for it and not use it – and if everyone used it as frequently as possible, the business model falls apart. The foundation of the DVD-by-mail business is anchored in the hope that your customers will rent DVD’s and keep them rather than watch immediately and go back through the process. I’d venture to guess only 5-10% of Netflix’s (err, Qwickster’s) users are “heavy” users – costing the company more than the profit they generate from the monthly subscription. Everyone else is choosing not to ride the treadmill on a daily basis.

But going back to the point – the streaming business doesn’t have a foundation for cost-plus pricing yet. The studios, producers, and distributors are all busy scrambling trying to figure out the right deals to make. Starz is playing a game of chicken with its content with Netflix – and that won’t be the last licensing deal that makes the streaming business complicated. Costs for long-tail content (once digitized) are no longer physical. A copy of Titanic on DVD has some sort of actual cost – and exists only once. A stream of Titanic costs virtually nothing (maybe $0.03 of actual transmission cost), and can exist in virtually unlimited instances. So what’s the right compensation for James Cameron, Kate Winslet, and Leonardo DiCaprio? That’s the challenge of suggesting that cost-plus pricing is appropriate for the streaming business – which is clearly the focus of Reed Hastings, Netflix, and honestly the bulk of the entertainment industry. Physical media provided theoretical constraints – digital media does not.

So, that’s my rant. I know there is a “vocal” part of Netflix’s customer base who are upset about the split of services. But the reality is, without splitting the services and without isolating pricing factors, Netflix (the streaming business) would be throttled by the limitations of the DVD-by-mail business. I made the argument in my previous article that the businesses are fundamentally different – from core activities, to assets, to employees & management. The same is true for pricing. In-N-Out is not in the business of selling spaghetti. It’s another form of food, right? So why not? The promise In-N-Out made is that they’ll sell burgers, fries, and shakes. That’s Qwickster now – and it’s cheaper than before. The promise Netflix is making is that they’ll sell a subscription “all-you-can-eat” entertainment service for the lowest possible cost with the widest possible selection. TV shows & movies aren’t all the same (though they ultimately serve the same end) – any more than a cheeseburger is the same as spaghetti.