Go Figure: Netflix Price Hike Turns Off Some Viewers

Higher Prices for Some Older Customers Spur Rise in Cancellations

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Netflix CEO Reed Hastings in Tokyo last month. Netflix intends to produce more original Japanese shows after the 10-episode
Netflix CEO Reed Hastings in Tokyo last month. Netflix intends to produce more original Japanese shows after the 10-episode Credit: Akio Kon/Bloomberg

Netflix added nearly 1.7 million subscribers in the second quarter of 2016, falling short of its own forecasts as higher prices for some older customers spurred an increase in cancellations.

The company added 1.5 million new customers overseas, compared with an April projection of 2 million, CEO Reed Hastings said Monday in a statement posted on the company's website. Netflix also added 160,000 in the U.S., well below its prediction of about 500,000 new domestic customers.

The company's total reached 83.2 million, up from 65.6 million a year earlier. But the 1.7 million net additions were also well below the 3.3 million net additions a year ago.

The shares sank as low as 16% to $83.32 in late trading.

While Netflix saw gains in sales and profit, investors focus on subscriber growth, in particular from faster-growing international markets. Mr. Hastings has raised prices by $1 or $2 a month for new customers and slowly imposed those on existing customers to avoid upsetting too many at once.

Netflix acknowledged it experienced higher "churn," with more customers turning off the service. The company's outlook for the current period reflects the continued fallout from higher prices and competition from the Olympics for viewers.

"Gross additions were on target, but churn ticked up slightly and unexpectedly," Mr. Hastings said in the letter. "We think some members perceived the news as an impending new price increase rather than the completion of two years of grandfathering" in higher new rates for older subscribers.

This quarter, Netflix expects to add 2.3 million net new customers, including 300,000 in the U.S. and 2 million internationally. Gains in the just-ended period were the fewest since the second quarter of 2013. The company forecasts profit of 5 cents a share, a drop from 7 cents a year earlier.

The results and the forecast show viewers are sensitive to prices at Netflix, just as they are to prices for cable television, now that they have an array of streaming options to choose from in the U.S., from Hulu to Amazon.com Inc. to HBO Now. Netflix discounted the growth of competitors as a factor in its slowdown.

"We are all growing primarily against linear TV hours and that competition did not contribute materially to our miss in Q2," the company said.

With more than 47 million customers in the U.S., exceeding any domestic premium cable network, Netflix is relying on overseas markets to provide most of its new subscribers in the years ahead. Most analysts anticipate the company's international customer base will surpass the domestic total in the next couple of years.

Revenue reached $2.11 billion, up 28% from a year earlier.

Netflix introduced its TV service to 130 new markets in January, completing its international expansion save for one major market: China. The company has reiterated its interest in entering the world's most populous country, but has provided few updates on its efforts to do so.

With no new market to enter anytime soon, Netflix has moderated forecasts for international growth, citing difficult comparisons with previous quarters when it was making splashy debuts in different countries. Netflix is also in the early days of learning the best ways to satisfy users in countries like India, Japan and Poland.

The service is an expensive proposition for most residents in some countries, starting at around $7 or $8 a month in many markets. While Netflix was the first major pay-TV network sold over the internet in the U.S., it faces greater competition from local players in some of its new markets.

Ted Sarandos, the company's chief content officer, has been acquiring movies and TV shows to satisfy the tastes of a global audience and commissioning local TV series for markets like Italy, Brazil and India. Netflix has used the popularity of programs "House of Cards" and "Orange Is the New Black" to entice new customers in the U.S. and some international markets.

"Although the international opportunity is robust in the long term, we believe that nearer-term, it may be more challenging than expected," John Janedis, an analyst with Jefferies & Co., said in a note issued before earnings. "In developed markets, we believe that there are regional players who have established compelling content offerings ahead of Netflix's launch (some at lower price points than Netflix) with fewer language barriers and more localized content."

Many investors have bought into the long-term vision, trusting Netflix's ability to add new customers and extract more money from each one.

The company's price hikes in the U.S. will add $470 million in incremental annual revenue, according to estimates by Nomura Holdings. Meanwhile, Comcast Corp. agreed to offer Netflix on its X1 set-top boxes, which could help the company add new users at home.

Hastings has promised more material profits starting next year, when the company no longer has to pay the start-up costs of entering new markets.

Netflix has said it will eventually have 60 million to 90 million customers in the U.S. Netflix will claim 88.7 million subscribers outside the U.S. by 2020, according to Nomura.

"We're realistic that Netflix is not going to add 5 million subscribers per quarter every quarter going forward," said Joe Dennison, an associate portfolio manager with Zevenbergen Capital Investments LLC, a Seattle-based firm. He has 1.32 million Netflix shares under management. "But in the big picture, there are seven or eight times as many broadband users internationally as domestically, and the number is growing fast. For Netflix to be the first truly global streaming player in the market makes a lot of sense."

-- Bloomberg News

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