Did Netflix overlook consumer inertia?

This is a guest post by Sam Vasisht.  Sam is president of 21TechMedia, a Boston-based firm providing market entry and market growth strategy consulting for tech companies. More of his contributions to industry publications and other posts can be found on his blog at www.techmediatalk.com, and you'll find him on twitter @21TechMedia.

With everything being said about the Netflix price increase and its ripple effect in projected subscriber loss, as well as the steep drop in stock price, we still may not know everything that caused this unexpected turn of events for the video-rental company.  I could list here all the reasons that are being suggested including price sensitivity, service bundles and competitive forces, but at the end of the day the unexpected outcome could be more tied to consumer behavior than any of the more obvious reasons. I expect that Netflix modeled the price increase taking into account price elasticity measurements to project some subscriber loss.  Given that they then had to change their Q3 guidance, something went terribly wrong.

Could it be that they did not take into account consumer inertia?  Despite nearly perfecting how to make video recommendations to consumers, does Netflix actually understand everything about its users?

As consumers, we are, for the most part, creatures of habit.  We don’t examine everything we do, nor why we do it, particularly when dealing with small ticket items.  In the scheme of things, taking into account prices of other subscription services such as cable, Internet, and cellphones, Netflix is a small ticket item.  Small ticket items are driven by impulse and inertia.  Netflix probably benefited from both impulse and inertia for a long time.

More recently, Netflix was probably benefiting more from inertia, particularly in the DVD segment of its subscriber base.  What Netflix did in announcing the price increase may have broken that inertia, more so than change people’s perception of the value of the service.  It is still a small ticket item after all.  When prompted, users will pay attention and make a choice.  That is what Netflix did – prompt users – in a way that it probably did not anticipate.  

Let’s hypothesize how this inertia and Netflix’s actions manifested itself:

For subscribers who were highly infrequent DVD users:

These are people who did not watch sufficient DVD’s but kept the service out of inertia and frankly limited other alternatives for the past many years.  The price change woke them from their slumber, and many decided to make a decision that could have been postponed, in some cases indefinitely, had the inertia not been broken.  With the availability of Redbox and other kiosk services, the tradeoff may have been sufficient for such users to drop Netflix when they stopped to think about it.

Interestingly, these were also the most profitable customers for Netflix.  By waking their slumber, Netflix may have done the greatest damage.

For subscribers who watched a lot of DVDs:

I expect a lot of these users are still with Netflix, but it is possible that for some such users their high appetite for DVDs is also being satisfied by Redbox.  To pick up the occasional Redbox impulse DVD while keeping a Netflix service would not be out of the ordinary for such users.  However, by creating a decision point as a result of its price hike, Netflix would give these users reason to pause on how to best allocate their dollars for their voracious habit.  For some the idea of an impulse rental at a nearby Redbox outweighs the hassle of actually needing to pick up and return the DVD.  At a dollar a rental, that’s one DVD every other day for a $15 monthly spend.  With Netflix, even with a 2 DVD option at approximately the same price, the logistics don’t allow watching a new DVD every other day.  While that math alone may not have overtaken the previous state of inertia, giving people a reason to pause with the price increase, caused them to reevaluate their options. The inertia was broken.

For the others in the middle:

Even among others, I expect Netflix broke people out of their inertia.  While many may have concluded that Netflix is still good value for money, others may have felt compelled to make a change.  With the likes of Redbox popping up everywhere and various attractive options for getting current TV programming online, some customers likely chose alternatives over Netflix when prompted. 

An interesting corollary, if you buy into this thesis, is that any unbundling or price increase by Netflix could have triggered this behavior and upset the apple cart as it did.  So the actual dollar amount of the price increase may have been less relevant than the directional change of unbundling and price increase.  This is where any quantitative pricing models go out the window.

While it is important to monitor customer satisfaction (which actually woefully few companies do, but at least most know to try and keep customers satisfied), it may be just as important for companies to know why customers stay with them in the first place.  Whether satisfied or not, if customers stay with you for reasons other than what you think, it may be a sign of other impending problems.