Watch Out for Netflix As You Watch Netflix

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Watch out for Netflix’s (NASDAQ: NFLX) business if you’re an investor of the company, even as you watch movies and shows on as a customer of the company. Netflix is seemingly stuck in the slower growth of customer subscriptions -- the sole source of its revenue, and the fastest increase of content costs -- a large part of its operating expenses. This has been a consistent trend for all three quarters so far this year. While there is not much that Netflix can do to rein in content costs charged by studios, it is up to the company to best structure its service offerings and attract more customers for the long run.

Started as a DVD-by-mail service, Netflix has become the most recognizable name in the video-streaming service. Many customers see Netflix as the streaming destination for movies and shows, and most recently activist investor Carl Icahn invested a large stake in Netflix partly because he also believes in the company’s strong position in the online-video market.

However, no one seems to have taken a closer look at what content customers can actually stream using Netflix. Out of the company’s total content selections, not all are available for streaming, while everything is on DVD and can be ordered by mail for an additional charge. In other words, you may find many of your favorite movies or shows after browsing through Netflix’s content selections, but with a streaming subscription, you can watch only a small portion of it; 20 percent in my case, a potential frustration for some customers.

I’m not suggesting that Netflix should make all its content available for streaming. It’s understandable that streaming rights cost more and not all movies may become available for streaming. But the way Netflix structures its services doesn’t seem to really help the company. Its streaming and DVD-mailing services are kind of tiered whereby customers pay $7.99 to first get the streaming service and pay another $7.99 for the DVD-mailing service if they want the full access to its content. While such a service arrangement makes streaming appear less expensive, it can really surprise customers when they realize that streaming gives them only partial access to the entire Netflix content. This may lead to some customer dissatisfaction and reduce the attractiveness of its streaming service to potential customers.

Netflix's selling point has become more focused on its streaming service, which promises the ability to stream thousands of movies and shows; while in reality, potentially many more thousands of its DVDs are not available for streaming. Is there a better way to promote Netflix’s streaming service while shielding customers away from the unwelcoming attention to the service’s content limitation?

One alternative would be to advertise its streaming service for its convenience and premium nature. Some people will always turn to streaming for movies and shows simply because of its convenience, and streaming rights do cost more, and thus the streaming service deserves a premium charge. So instead of providing its streaming service at the apparent discount, Netflix could charge more for streaming with the proper cause of the added convenience and the service’s premium nature, potentially bringing in more revenue.

To restructure its service offerings, Netflix could reverse its now seemingly misplaced services between streaming and DVD-by-mail. A new Netflix service would start with the DVD-by-mail subscription, say, still for $7.99. For customers who want the convenience of online streaming, they can subscribe to the premium streaming service for another $7.99. Organizing the two service this way makes more sense for both DVD-mailing customers and streaming customers.

Under Netflix’s current service arrangement, the second-tier DVD-by-mail service doubles the price of streaming subscription, effectively costing $15.98. As a likely result, the number of DVD-mailing customers are about one-third the number of streaming customers, who pay only $7.99. In comparison, DVD-mailing service from Dish Network's (NASDAQ: DISH) Blockbuster costs less, at $9.99, which can certainly draw non-streaming customers away from Netflix, potentially another reason why Netflix has far fewer DVD customers than streaming customers. Furthermore, the mere $1.20 individual rental rate from Coinstar's (NASDAQ: OUTR) Redbox provides an even more competitive pricing that Netflix may not be able to match without re-pricing its DVD-mailing service. 

With the recommended new service line up, Netflix customers would get a cheaper subscription for DVD-by-mail, which should be the case because of its lower content acquisition and operating costs. Thus, Netflix would likely see an increase of DVD-mailing customers to potentially the level of current streaming customers. This would bring in the same amount of revenue per customer as that from signing up new streaming customers now.

On the other hand, the number of Netflix’s current streaming customers wouldn’t necessarily decrease from the premium charge, if streaming is to be the future for watching movies and TV shows. In addition, streaming customers wouldn’t have to worry about being unable to watch a movie or show that they like but are not available for streaming, because a premium streaming subscription would also cover DVD-mail orders, allowing unlimited access to the entire Netflix content.

Absent corrective actions by Netflix management about its seemingly flawed service structure, we may continue to see streaming customers grumbling about the limitation of its streaming content, and DVD customers complaining about its uncompetitive pricing of the DVD-mailing service. For Netflix investors, it shouldn’t be a surprise if the company goes on to report slow subscription increases again in the future.

Know What You Own

The precipitous drop in Netflix shares since the summer of 2011 has caused many shareholders to lose hope. While the company's first mover status is often viewed as a competitive advantage, the opportunities in streaming media have brought some new, deep pocketed, rivals looking for their piece of a growing pie. Can Netflix fend off this burgeoning competition, and will its international growth aspirations really pay off? These kinds of issues are a must know for investors, which is why The Motley Fool released a brand new premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to both buy and sell the stock. They’re also offering a full year of updates as key news hits, so make sure to click here and claim a copy today. 





JJtheArdent has no positions in the stocks mentioned above. The Motley Fool owns shares of Netflix. Motley Fool newsletter services recommend Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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