Netflix Evolves in the Choice Game

Dear Friends,

In the latest installment of the Expert Interview Series for Game Changer, pricing expert Cesar Torres explores how companies can win the Custom Game by understanding customer needs at the individual level and designing offers and price points that address those needs. You can watch the video here.

In case you missed them, here are some posts since last week’s newsletter.

Restaurants and tipping: I recently discussed the future of restaurant pricing and tipping with Roger Beaudoin on the Restaurant Rockstars podcast. In challenging economic times, understanding and innovating pricing strategies becomes essential in the restaurant industry. You can listen to the podcast here.

Meat products: The midpoint in a range is not always the optimal place to be, as the market for blended meat products shows. You can read the full post here.  

The sub-title for Game Changer sums up the power of having the right pricing strategy: it can shape a business, a market, and society. The current and future strategic decisions of major streaming companies such as Netflix will demonstrate how implementing a new pricing strategy can also reshape a business and a market. This week, my co-author Arnab Sinha and I explore the challenges that companies such as Netflix face when they refine their pricing strategy within their existing pricing game.

Netflix Evolves in the Choice Game

Netflix finished the first quarter of 2024 with almost 270 million subscribers, which was larger than expected and roughly 11 times as many customers as the company had in 2011. In its communications to investors, however, Netflix said it will no longer report how many customers it has.

This decision signals more than a shift in communication strategy. It also indicates that Netflix is now more focused on serving customers lucratively than acquiring customers. The two are not mutually exclusive, of course. The challenge for Netflix is how to evolve its business model within the Choice Game, which it has played successfully for well over a decade. The natural steps in that evolution are to develop a much finer segmentation of its customers and continue to focus on clear communication, all while maintaining the integrity of its portfolio.

Maintaining the integrity of the portfolio

In Game Changer we emphasized three aspects of portfolio design for players of the Choice Game. The portfolio should be balanced, with features and prices forming an integrated system that aligns with customers’ value perceptions. It should also be simple, so that customers can self-select an offering or choose with limited guidance. Finally, the portfolio’s individual offerings should have fences that create or reinforce the price-value separation.

In the United States, Netflix currently has three core offers in its portfolio: premium, standard, and standard with ads. Premium ($22.99 per month) and standard ($15.49 per month) differ in terms of quality, resolution, and the number of users allowed. If a customer accepted ads with their standard package, the price drops to $6.99 per month but the other features remain the same.

The portfolio is balanced, simple, and fenced, but is it sufficient to deliver ongoing strong revenue and profit growth? One essential input to answering that question is the company’s segmentation.

The critical role of segmentation

When a company and its investors measure success based primarily on the number of subscribers, they effectively reduce those customers to one data point along an upwardly rising curve. The truth is that Netflix Nation now has a population that would rank it as the world’s fifth largest nation, trailing only India, China, the United States, and Indonesia (barely).

The odds are long that all 270 million people have similar viewing habits, tastes, disposable income levels, and willingness to pay. A much better bet is that Netflix can find large segments that have more in common than whether they like a higher quality feed or dislike ads. The challenge is to find the most valuable differentiators within that mass of subscribers, create a small number of segments, and design offers that will allow these segments to trade up or customize how Netflix serves them.

But the quest for a segmentation can veer out of control and cause companies in the Choice Game to lose their balance and discipline. That can happen if they pack their offerings with too many features in an effort to add value, whether to meet customer needs or address a competitive threat. It can also happen if they end up with a large number of microsegments or make too many bespoke offers, as if they were playing the Custom Game.

We can imagine that Netflix revamps it portfolio without losing its balance and simplicity by using tactics such as loyalty programs, exclusive access, a small menu of add-on features, or other differentiators to create greater value for subscribers who are willing to trade up and pay for it. Netflix has already added an option for a subscriber to add an extra member outside the household for $7.99 per month.

The essential role of communication

Imagine that you could implement a price increase of 60% and lose only around 3% of your volume. For a widget maker in a classical economic course, that microscopic price elasticity would make the decision a no-brainer. But when Netflix achieved that outcome in real life in 2011, its share price fell by over 25% and launched the stock on a downward trajectory that would eventually erase around two thirds of its market capitalization.

One reason behind the decline was that the market evaluated Netflix primarily on subscriber growth, not the size and quality of its subscriber base. After the 2011 price increase, Netflix lost 800,000 subscribers (on a base of 24 million) and that was the number that grabbed the headlines.

Successful evolution within the Choice Game involves more than math and mechanics. It also depends heavily on how Netflix communicates its future strategies and how its resulting actions contribute to strong growth. This is unchartered territory for Netflix, which needs to retrain investors on how to measure the company’s success.

As always, please continue to share your thoughts and questions with us. If you haven’t ordered your copy of Game Changer yet, you can do that HERE. Thanks for your interest and support.