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On July 12, 2011, Netflix CEO Reed Hastings announced a new pricing model separating its streaming service from DVD-rentals. The combined subscription that had previously cost $9.99 was split into two separate plans at $7.99 each. The pricing reform was followed by public outcry over what was effectively a 60% price hike for subscribers of both services.

By December 2011, Netflix had fallen from $290/share to about $74/share.

The biggest problem with this strategy is Netflix had effectively used Penetration Pricing to dominate the former video-rental leader, Blockbuster. At its peak in 2004, Blockbuster consisted of nearly 60,000 employees and over 9,000 stores. Today, due to their inability to compete with the skeleton crew of 2,400 employees delivering videos via online and through the mail, Blockbuster is gone.

The goal of penetration pricing is to dramatically increase market share through differentiating your product with below normal prices with every intention of eventually increasing them once targeted market share is acquired.

This worked remarkably well for Netflix because people naturally assumed that this new model (mail order) of renting movies/games was a much less expensive operation than that of brick-and-mortar chains such as Suncoast and Blockbuster. However, the reason 800,000 Netflix subscribers, including myself, ran for the hills after the unforeseen increase in price was due to the product’s loss of value.

When you subscribed to Netflix before the pricing increase, you selected 1 of 3 packages priced differently. Each package offered more videos/games you could rent at one time, although all allowed you to view streaming videos.

However, when Netflix increased their prices, you would now only be able to choose 2 packages: Streaming video or mail rental videos, respectively.

The mail rentals went up in price, and streaming video now had a price. Now I, probably like many others, switched services to primarily streaming video figuring that every movie I wanted to watch would be available at the click of a Wii remote.

This was not the case.

Surprisingly the only videos available to watch instantly were a handful of videos I already owned or simply did not want to watch. Frankly, they seemed to be movies that never even hit theaters.

This was a stark contrast to the amount of videos you could watch instantly only a few weeks before the introduction of these new packages.

Now, I could’ve payed an additional $6 and received unlimited rentals; however, for just a couple bucks more I could subscribe to Blockbuster and get unlimited movies every day verses unlimited movies for only 1/3 of every month (due to shipping time of Netflix).

The point is, Netflix not only changed their prices, they changed the value of the product. Subscribers felt like they were not only being charged more, but they were getting less in exchange as well. The combination was deadly to their market share, and subsequently their competition, Dish Network, struck a deal with Blockbuster to stream movies for Dish subscribers.

The subscription started at $10 a month and included DVD rentals by mail as well as all participating Blockbuster stores.

Nevertheless, Netflix was able to rebound after this flop, and Reed Hastings, CEO of Netflix, even wrote an apology letter to customers taking full responsibility, and promising to fix the pricing changes.

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