In July 2011, Netflix decided to separate its DVD-by-mail service from its streaming video service. In addition to the hassle of receiving two bills instead of one, Netflix subscribers now had to pay about S16 for both services, when they previously only paid about $10. Many Netflix customers were outraged by this decision, and the company reportedly lost about 1 million of its 25 million subscribers due to this decision.
In response to the uproar from customers and investors, Netflix co-founder and CEO, reed Hastings, posted a letter of explanation on the company website. He did not apologize for the decision to split the services and raise prices, which he maintained was the right strategic decision given the importance of streaming video to Netflix's future. However, he acknowledged that he should have done a better job of communicating the rationale for the change to customers in advance of making the change.
Consider the following additional information and estimates:
• Prior to the split, Netflix had about 25 million subscribers who were paying an average subscription fee of $10 per month.
• After the split, Netflix estimated the following:
* 21 million subscribers would continue with the streaming video service.
* 12 million of those subscribers would also continue with the DVD-by-mail service.
* 3 million users would subscribe to DVD-by-mail only.
• The new subscription fee for each service is SS per month.
• Assume that variable costs of the DVD-by-mail service (for shipping, handling, and DVD replacement) are $0.40 per movie exchange and that the average user exchanges 5 movies per month. The variable costs of the streaming video service are negligible.
Required:
1. Determine how much Netflix's monthly profit would increase or decrease with the new pricing and subscription structure.
2. If you were a Netflix shareholder, how would you react to this change? Optional: This is an opportunity for you to research what actually happened to Netflix's stock price in the days and months after the price change.
3. Do you think Netflix made the change to boost short-term or long-tan profit?
4. In your opinion, was Netflix's decision to separate the streaming video from DVD-by-mail a good one?