Netflix Cuts Subscription Rate to Further Grow Market Share; Kills Poison Pill Provision

By Bob Cramer on Dec 31, 2013 at 6:22 am EST


Netflix continues to drive success through growth in its subscriber base by using better pricing options and motivating management with higher compensations

Netflix (NFLX) is currently the king of the hill when it comes to the online media streaming service industry. The company has a subscriber base of nearly 40.3 million, and has networks in over 40 countries. Netflix also enjoys the first mover advantage with regards to production of original content and is also extremely popular because it prices its services much lower than cable TV. Its ability to price its services cheaper than traditional sources and the provision of original content have been primary drivers for the company’s growth so far.

Netflix’s subscribers have increased from around 29.4 million to nearly 40.3 million over the last one year alone, and its stock price has rallied by almost 300% year-to date.

However, this is a highly competitive industry. Hulu, Amazon Prime and smaller regional players are constantly trying to encroach on Netflix’s market share. The market leader is now trying a new pricing plan based on the number of account users.

Currently, the company’s standard steaming service costs $7.99 a month and allows content to be streamed on two separate devices simultaneously. Under the new plan, users will have the option to pay $6.99 a month in exchange for access to movies and shows in standard definition. The caveat is that streaming will be allowed on only one device per account.

Demand for Netflix’s streaming services is highly price sensitive, which is evident from the decline in subscribers when the company increased subscription rates by almost 60% in 2011 for its DVD plus steaming plan. The increase in pricing led to a loss of 800,000 subscribers during the third quarter of 2011 (3QFY11). Based on this track record, it is safe to assume that a price cut of about 12.5% for the standard service should result in subscriber growth.

However, there is the possibility that some existing subscribers might also shift to the cheaper option. In that case, revenue growth may suffer if the loss of revenues due to lower pricing more than offsets the impact of new subscriber additions. The plan is still in its testing phase, and it is assumed that Netflix’s management will only extend the plan to all subscribers only if the test produces favorable results.

Reed Hastings, CEO Netflix, has been one of the key players behind Netflix’s success. The company’s board realizes the importance of having a strong management lead and continues to motivate key employees with higher compensation. In a SEC filling on December 30, 2013, the company announced a 50% increase in Reed Hastings’ salary to $3 million for 2014. The company also increased the annual stock option allowance by the same proportion. Other top executives including Chief Content Officer Ted Sarandos, and Chief Financial Officer David Wells, will also receive raises in 2014.

Netflix has also killed the ‘poison pill’ provision, which was set up in November 2012, to avoid a possible hostile takeover when hedge fund manager, Carl Icahn acquired a 9.5% stake in the company. The provision had been originally scheduled to expire in November 2015, but the shareholder rights plan was amended to accelerate the date to December 30, 2013. Carl Icahn had disclosed in October that he had reduced his stake in the company to 4.5%, realizing a profit of $825 million after the sale.

The early termination reflects the management’s optimism about the company’s performance. Netflix’s business model has proved to be quite successful, and therefore, investors are no longer pushing the management for a buyout.

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