Netflix is still struggling with this fundamental problem

Netflix needs more hits to justify higher prices.
Netflix needs more hits to justify higher prices.
Image: Netflix
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A single trading session is all it has taken for all of Netflix’s share price gains in 2014 to be wiped out completely.

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Suffice to say, the reaction to last night’s quarterly earnings release has been absolutely savage, with the stock falling by more than 20%. Netflix added 3 million subscribers globally during the quarter, which sounds impressive, but was below its own forecast for the addition of 3.7 million new customers during the period.

This was the full first quarter since Netflix raised prices by $1 a month for new users in the US. (There also were hikes in other markets.) The rate of  subscriber growth is slowing, which is a concern for a company like Netflix, whose heroic valuation implies aggressive, unimpeded expansion.

But the real concern isn’t growth per se.  More worrisome is the fact that every time Netflix attempts to charge more for its service, it encounters difficulties. What happened last quarter is nowhere on the level of Netflix’s disastrous attempt to hike prices (and spin off its DVD business) back in 2011. But the recent price hike was relatively modest and applied only to new users (existing customers won’t feel the effect till next year) so the reaction is still alarming.

Warren Buffett has described pricing power as “the single most important decision in evaluating a business.” Apple, which charges much more for its products than its rivals do, has it in spades. Netflix does not enjoy this luxury. Nor is it in the same league, in terms of original programming, as HBO, which announced yesterday that it would finally offer a direct-to-consumer, internet-based service. HBO has argued it can do this because it is one of the few global brands in television, thanks in no small part to its seemingly endless stream of hit shows. The excitement surrounding its standalone offering suggests it could be right.

The obvious way for Netflix to enhance the value of its brand and stand out in the increasingly crowded streaming market is to keep commissioning and releasing original shows. The company already has had two bona fide hits, Orange is the New Black and House of Cards. It has high hopes for new programs that will be released in coming months, and is even getting into the movie business (it signed up Adam Sandler for four comedies that will air exclusively on its service).

Good content is hard to create. It’s also expensive — that’s why Netflix had to hike prices in the first place. But Netflix needs to come up with more breakout hits, otherwise it risks being seen as a House of Cards itself.