For the first time in 10 years, Netflix lost subscribers. In order to avoid this erosion of revenue, the platform is considering offering a new type of subscription, cheaper but subject to advertising. Long refused by its founder, the streaming company will therefore switch to a freemium model comparable to what players like Spotify do in the audio field.
A change of attitude
Increased competition (from Amazon Prime, Disney+, Hulu, etc.) and the resulting erosion of revenues have driven Netflix to reconsider its position regarding account sharing.
In fact, many Netflix users take advantage of the subscription of someone they know and enjoy the same quality of service without paying for it. As long as the streaming market was growing and Netflix was dominating it, tolerating these ‘free riders’ made sense.
Even if these users were not generating any immediate revenue for Netflix, they were nevertheless contributing to the company’s bottom line in some indirect way. First, revenues were just delayed as many users eventually decided to subscribe after having experienced the service for free through a friend’s account. Second, Netflix was able to put to good use the data collected from observing the behavior of all its users – whether they paid a subscription or not. More data allowed Netflix to improve its recommendation algorithm and the tailoring of its content to the users’ tastes. As this resulted in attracting new users, Netflix was able to leverage the positive network effects that free users were generating.
Nowadays, these two indirect sources of monetization have largely dried up.
The challenge of versioning
As a result, the group of free riders is now seen by Netflix as a potential pool of value that is not fully captured. Yet, simply cracking down on account sharing is not likely to do the trick. Netflix understands that not all its users share the same propensity to pay. In other words, free riders would rather give up the streaming service than pay a subscription at the current price.
Netflix must, therefore, provide these users with a legitimate alternative that is sufficiently attractive to them. Hence, the creation of this new version, which combines a cheaper subscription with exposure to ads. In Platform Strategies, we call ‘same-side differential pricing’ this pricing strategy that consists in charging different prices within a given user group (Chapter 5).
The challenge for Netflix is now to set the prices of the versions right, to convert enough free users into semi-premium ones. This, without compromising the overall revenue generation. Indeed, one should not underestimate the risk that subscribers today might be tempted to switch to the ad-supported version, mainly for budgetary reasons in difficult economic times. When it comes to platform pricing, it's all about finding the right balance.