07/14/2011 11:15 am ET Updated Sep 13, 2011

The Netflix Squeeze: Value Migrating Away From the Consumer

Economic theory states that in an efficient market, value migrates to the consumer. That is, the more competition there is for consumers, the lower the profit margins as businesses compete for consumers.

As I ponder the latest rate change and effort by Netflix to push consumers more towards their streaming only plan, I have to wonder why does this theory seem like it is breaking down with Netflix? While it is possible the theory is wrong (after all economics has far less predictive ability than a subject like physics), it seems more likely that the issue is we don't have an efficient market right now.

Let's journey along the history of the home rental movie market to see how we arrived at our latest price hike by Netflix. Mom-and-pop shops renting movie's on videotape popped up in the 80's where you had to pay a lifetime membership of often well over $100 and then paid an additional amount of sometimes around $5 per movie. They usually had only a few hundred movies so the selection was limited and you had a tough time getting the latest film (true side story: I was with my father when he was opening up his account at a local store like this in the 80's. When told that by the elderly, heavyset owner that "for $100 you will receive a lifetime membership" my dad replied, "Who's lifetime, your's or mine, because, quite frankly, you're not looking so good"). The big chains entered the scene with Blockbuster and Hollywood leading the pack. You had far more choice in movies, could easily get the latest hit and no longer paid an annual membership -- value was migrating to the consumer. Along came Netflix with the added convenience of receiving DVD's at home with a fixed price for as many movies as you could cycle through given the speed of the post office and the amount of free time you had. Netflix's original model added convenience and better pricing to the consumer so value migrated.

Today Netflix has only a limited amount of competition. Netflix's streaming movie business is high margin and it wants to wean its customers away from the DVD by mail system which is less profitable. So what is Netflix doing? It is passing through price hikes and forcing customer to pay extra if they want both streaming movie and DVD's mailed. Price hikes aren't surprising, after all their goal is to make as much money as possible, but it seems that value is migrating away from the consumer. Shouldn't Netflix be trying to maximum the lifetime value of the customer, not risking a high attrition rate by passing through another price hike?

More generally, how can value migrate away from the consumer? As I mentioned earlier, it seems that right now we don't have an efficient market? Netflix appears to currently be in a situation where it has a good amount of leaway in how much it charges its customers. That won't last. If Netflix continues to annoy their customers, then strong competitors will pop up to challenge its business. Down the pipeline are increasingly interesting options from Wal-Mart, Inc., Best Buy Co., Hulu, the Dish Network and others just waiting for your consumer dollar.

Netflix has a good business model and has been well-run in the past. Perhaps they will recognize that as their market gets competitive, they will need to offer more, not less, in order to be the most competitive. In the meantime, I hope that my post office delivers those CD's quickly before another price hike arrives.

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