Netflix – A Great Example of Constructive Arrogance

Netflix recently decided to implement what basically amounts to a 60% price hike for subscribers.  In order to get streaming and DVD rentals (one at a time), you’ll have to pay $16.00 and have two separate plans.  We subscribe to Netflix but I don’t use it a lot.  Anyone who knows me at all knows I’m not a big movie watcher, and so far most of the shows that Netflix streams are ones I don’t watch.  (30 Rock being the one exception).  I certainly don’t care enough about movies to select DVDs in advance, as convenient as it is.  My wife and son like Netflix, and so does my father in law.  There’s all kinds of outrage, and I frequently see bunches of “greedy corporation” griping.  People are demanding an explanation for the price hike, as if cost is required to be the only reason businesses charge more.

Here’s the explanation, and I wish Netflix would have the guts to just come out and say it.  They are raising their prices because they believe they can and make more money in doing so.  Wouldn’t you love to raise your salary unilaterally and either your boss pays it or you know with 98% certainty someone else will?  If you have ever left one job for another with higher pay, then I don’t want to hear your griping.  You’re going to cancel your subscription?  Great!  Less broadband congestion for me.  The math is simple – unless more than 59% of subscribers cancel their subscriptions, this instantly gives Netflix more revenue, and probably with a marginally lower cost structure.

By the way, anyone notice how, after oil prices stabilized, the fuel and bag surchargrs on airlines largely remained?  The airlines figured out that we have to get places and we’ll not pay for something else because we have to fly.  Are you going to take Amtrak for 20 hours to get to New York?  Hang out with retirees and aviophobes?  The airlines figured out we’d continue paying. Frankly, given America’s cultural reliance on the car, the only reason the oil companies aren’t charging us $4.00/gallon or more right now is because they think that if they did, the government would either a) tax it away, b) regulate it away, c) impose price controls, or d) (unlikely but not 0% probable) nationalize the U.S. oil industry altogether (and I think they are right).  It ain’t because Exxon loves us so much that they want to keep gas prices low and it ain’t because demand for gasoline would drop that much.  My own guess is that gas prices could reach $8 per gallon before price elasticity hit its inflection point and revenue would start to decrease with prices above that level.  (It would be prudent to short retail and hotel stocks though because those discretionary purchases would go out the window).

Here’s what else I’d love Netflix to say, just to remind people of basic economic forces.  “Remember when you had to get off your duff and drive to a Blockbuster to rent a movie, and then go back to drop it off, and if you’re 5 minutes late, the late fees equate the rental with actually buying the movie?  Oh wait, we put them out of business!”  “How about you go ahead and buy that season of Family guy for $25?”  “Oh wait a minute, you can get all of Netflix for one month for less than half that!”  Or, you can go to one of these kiosks at the grocery store to get a DVD and hope that one of the 20 they have on hand is one you want to watch.   Thanks to Netflix, I don’t even have to put DVDs in my player anymore (which, believe it or not, I always found a tedious process, and I hate storing the darned things). I think it was Keynes who once said that, “the cure for high prices is high prices.”  You want lower prices?  Stop using Netflix.  I bet we won’t – not in large enough numbers to matter anyway.

I’ll bet that when push comes to shove, Netflix loses less than 5% of their subscribers.  And really, if $8 is that important to you, maybe that’s a great sign that your spare time is better spent on activities more economically productive than movies, like job searches or education.

The hard, cold reality is that Netflix has, in fact, been underpriced for years, as they get customers to switch their habits and try something new.  This has been particularly true since they introduced streaming services.  Any entrepreneur understands the concept of practically giving away their service or product to get some customers.  Thanks to Netflix, the entire movie-watching experience has been revolutionized.  That combined with cheap, big TVs could well put movie theaters out of business next.  Bottom line is that you’re mad at Netflix because they can raise their prices with impunity and you probably can’t, and it burns you up.  Get over it.  Invent something that revolutionary and that exclusive and let’s see if you just give it away and leave billions of dollars on the table.  I can’t find the Constitutional article that says we are entitled to low prices for anything.  If you can, please point it out to me.

Here’s what’s coming next.  All you cord-cutters think you’re beating the system by switching off your cable TV and going all IP video?  The cable companies aren’t going to just sulk in the corner, your broadband-only rates are going up – a lot.  It’s already happening, where “heavy users” are being charged for extra gigabytes downloaded.  I’ve got news for you, only a small percentage of those heavy users are downloading high-def, hardcore porn.  Most of them are watching regular ol’ TV and the cable companies are going to make you pay for watching video over their networks one way or another, and it’s going to be irrelevant if you get that video by CAT 5 or co-ax.  If we like stuff, we need to pay for it, or we are reduced to relying on True Socialist Believers and smart hippies to invent new stuff for us.  Ask the Soviet Union how that worked out.

I often say that there’s such a thing as “constructive arrogance”.  That means that you can have supreme confidence in your abilities and offerings, and mentally dismiss those in the market who try to under mine that confidence.  Constructive arrogance means you’re not being a jerk or acting smugly.  Just move on and find someone who will pay your price, and do a better job of making it clear why your offering represents good value at the price you are charging.  When you lower your price, you’re basically saying, “I have no distinction from my competition and there really is no particular reason you should choose me over someone else, except that you happen to be talking to me right now and I’ll effectively pay you to not talk to someone else.  Or you’re saying, “I’m going to pay you to be my alpha/beta tester because my product does not yet work at a world-class level, but it eventually will.  My discount compensates you for the hassle and for the information I collect in trying out my platform in real world conditions”.  The former is awful, demeaning, and demoralizing.  The latter is OK because you are in fact charging the same high price but part of the currency of payment is vital test data and labor from your customer.  It’s also OK to discount for a reference customer or two because they are paying you back in reputation and reducing practical risk for customers #3 and beyond.

The lesson for entrepreneurs?  Be constructively arrogant.  If your stuff is good, and you have a clear, compelling value proposition, don’t be afraid to charge a high price for it, unless you need beta testing. Unless you’re Wal-Mart or Dollar Tree, you can’t build a business around hyper-price-sensitive, uber-cheapskates.  In my day job as a business appraiser, I lose lots of opportunities because I’m almost never the low-cost provider.  It’s not a disaster.  In fact, it’s often a relief.  I don’t want to build a business around hyper-price-sensitive cheapskates.  I absolutely don’t want clients who view my expertise or work product as a commodity (and they don’t want me, either).  I’d rather my competitors work their fingers to the bone eking out a living for clients that don’t appreciate them so I can focus on engagements for intelligent clients that care about the work product, have the sophistication to recognize superior value and the maturity and the dough to pay for it.  Rather than spending my time working for someone who would pay me the bare minimum, I’d rather spend that time identifying new prospects that are in my target market.  Netflix is constructively arrogant.  They are delivering value and proposing most of us will see the equal value at a higher clearing price.  The airlines are being constructively arrogant.  The result?  Fuller planes, and I’m a lot less worried if the airlines are skimping on maintenance in order to maintain profits.

Being constructively arrogant is empowering and it’s good business.  If your value proposition is worthy of your attention as an entrepreneur, then stick by it.  When people complain about your high prices, that’s a good thing.  It means they want your product and realize they will probably pay.  As Reggie Jackson once famously said, “They don’t boo nobodies.”

 

 

3 Comments

  1. Robert says:

    Hey Mike,

    Great post. I think you are right. People will complain but in the end they will still have netflix. Good luck with the new site.

  2. Bob says:

    I guess that “constructive arrogance” theory really worked out given the 55% decline in Netflix market value these last few months. Perhaps Reed Hastings will now have also learned that HIS “spare time is better spent on activities more economically productive than movies, like job searches or education.” I sense a job search may be in his near future.
    But maybe he has also learned a valuable lesson after seeing his customers and investors reactions to his company’s ‘constructive arrogance’? It may be too late for him to correct it now though.
    Maybe the author of this article might learn a lesson about his own condescension towards those for whom $8 a month is a significant sum in this economy, and have voted with their Netflix subsription cancellations.

  3. msblake says:

    I have to admit, I’m shocked that Hastings felt the need to apologize for the price hikes. Personally, I think it’s more kow-towing to.. well, I don’t know to whom. I think that was a bad move.

    Unfortunately, Netflix didn’t stick with their strategy long enough to determine if they were right or wrong. The real corporate crime is the waffling. Hastings folded up like a 3-dollar tent for reasons known only to him. I still very much doubt he risked losing 60% of subscribers and thus would have increased profits.

    The analysts’ opinions on Netflix that I have read indicate that the decline in the stock price isn’t so much a reflection of customer defections as it is a) Netflix was in a bubble and was due for a significant correction), and b) Netflix is due to have margin pressure going forward because as more streaming services come online (Amazon, Wal-Mart, etc.), the bargaining power shifts to the content providers rather than the infrastructure services. They will start (and by the reports I have read, are starting) to charge more for content.

    So, while I don’t think the reality that Netflix’s stock price decline means my analysis was wrong (because it’s declining due to more fundamental industry shifts), I’ll cop to condescension. Not apologize for it but I’ll admit it. I still think that if an $8 – $16 price hike causes that much anger, that $8 was probably better spent elsewhere in the first place and in any event I’ve got no time for the whining. Go ahead and vote with your feet but the paroxysms about corporate greed are tedious.

Leave a Reply

Your email address will not be published. Required fields are marked *