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Netflix (NFLX) has just announced a price increase. The nuts and bolts of the change is a “separation” of the unlimited by mail and unlimited streaming plans, so that customers with the lowest plan would have to pay $7.99 per month for unlimited mailed DVDs, one at a time, and $7.99 for unlimited streaming. Previously, the company offered a $9.99 plan that allowed unlimited mailed DVDs, one at a time, and unlimited streaming. A separate digital only plan was available for $7.99.

When the old plan was put in place, it was an obvious statement that the company wanted customers to shift toward digital only delivery. However, the cost differential was so small that many were willing to pay an extra couple of bucks for the option of getting a DVD in the mail. This option was almost a necessity in some customers’ minds, since many recently released movies are not available via streaming on Netflix. And therein lies the problem.

Clearly, the company is seeking to push customers toward digital delivery. However, without many recent releases being streamed, Netflix could wind up alienating its core audience. Many will likely find a happy medium of using Netflix for most of their watching desires and supplementing by renting movies for a dollar a night from kiosk-based rental services such as Coinstar’s (CSTR) Redbox. With the demise of Blockbuster, there aren’t currently many other options—unless there happens to be one of the very few remaining “mom and pop” movie rental shops in close proximity.

The outcome of Netflix’s price change is important because it is a major test of what customers are willing to pay for digitally delivered content. Netflix, however, isn’t alone in its attempts to figure out the right pricing model for a given market. Indeed, price testing is a basic part of doing business in just about every market.

Consumer goods companies, for example, use price changes successfully (and unsuccessfully) to shift pricing. One favorite trick of giants from Procter & Gamble (PG – Free Value Line Research Report on Procter & Gamble) to smaller fry like B&G Foods (BGS) is to raise prices on products while simultaneously putting them on sale or providing coupons so that the cost of purchase remains at the old price. After a period of time, the coupon or sale goes away and the new price takes effect. Most customers don’t notice. (Read Value Line’s Coverage Initiation article about B&G Foods.)

The well-practiced pricing habits in the grocery and other consumable spaces, however, are a far cry from the muddled models that are being tested with digital products. Indeed, digitally delivered media wasn’t even a reality just a few short years ago—though that may be hard to believe since the medium has so quickly become a ubiquitous option. As recently as 10 years ago, in fact, the big question was the amount that cable networks such as Comcast (CMCSA) could charge for advertising time versus the broadcast networks, such as Disney’s (DIS) ABC or CBS Corporation (CBS). In fact, a consortium of media companies has teamed up to fight Netflix with an online service of their own (Hulu) which itself is struggling with the subscription pricing issue.

Video, though, isn’t the only area that digital delivery is upending. Newspapers have been particularly hard hit. The New York Times Company (NYT) recently launched a convoluted pricing model for its flagship product, The New York Times, which has left many scratching their heads as it seems to push customers to print rather than digital delivery by charging less for print plus digital than for digital only deliver. Worse, the cost of a subscription increases based on the number of devices (web browser, mobile phone, tablet computer) on which you consume the material—despite the fact that it wouldn’t seem to cost materially more to deliver photos and text across different digital mediums. This is just one example, as old-line media companies from magazines to newspapers have locked horns with Apple (AAPL) over the company’s dominant iPad tablet and how content is priced and customer data controlled.

These examples, though, are of companies delivering “old” products. There are pricing issues in the online area that go well beyond movies and print. Take, for example, a service such as recently public LinkedIn (LNKD) or still private companies like Twitter and Foursquare. Clearly, people enjoy the services these companies provide, but how do they make money without alienating customers? Advertising that is too intrusive can backfire and web consumers are so used to getting web-based services for free that a fee model is hard to implement.

Obviously, there is no right answer to charging for digital products or content. The issue also goes far beyond the examples noted herein to include many other industries and products. Netflix’s move is somewhat bold and could have negative repercussions for its business, creating a dent in its seemingly impregnable armor for competitors to attack. Indeed, many don’t realize that Amazon.com (AMZN) is also a player in the streaming media space.

That said, the company is clearly the online video delivery giant and can likely take a few hits in what appears to be its goal of exiting the mail delivery business. This follows intriguing moves the company has made of late to purchase original content—much like a broadcast network might. This move, too, is bold in that it appears to pit the company against the very entities (networks and movie studios) that provide it with the bulk of its current content.

There are some that believe the company is looking to create an alternative to the broadcast network/cable stranglehold on consumers. There are others who would suggest the company has already created that alternative, as some early adopters have chosen to forgo cable television and broadcast networks to rely solely on Netflix and other online services for their media consumption desires. Shifting customers away from mail delivery and toward digital only delivery could clearly be viewed as another step in this direction.

Netflix shareholders should keep a close eye on the company’s subscriber rolls. A slowdown in this metric’s rapid growth or, worse, a drop, could present a serious headwind for the stock price even if it doesn’t derail the company’s long-term prospects. Media industry watchers, from print to video, should also keep a close eye on this pricing experiment, as it could help to set a trend for the digital delivery space for years to come.


At the time of this article's writing, the author held a position in B&G Foods.