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Price Cuts Bloody Netflix

Nat Worden

Shares of Netflix (NFLX Quote) plunged Monday after the online DVD-rental service cut its prices -- a move that signals that rival Blockbuster (BBI Quote) may be winning a price war and luring away customers.

Netflix lowered the monthly subscriptions rates for two of its most popular plans by $1 on Sunday. The company's shares recently were trading down 11% to $17.45, after earlier hitting a 52-week low of $17.17.

Wedbush Morgan Securities analyst Michael Pachter says the price cut is a sign that Netflix is bleeding subscribers.

"The Netflix story is all about subscriber growth," says Pachter. "The wording of this, the timing and the actual act of cutting price suggests they lost subs in the second quarter, which means people are going to realize that they aren't going to grow anymore."

Netflix had 6.8 million subscribers as of the end of March, and it said in its news release on Sunday that its new pricing will benefit its "more than six million members." Pachter says that language suggests the company hasn't gotten any closer to 7 million subscribers, and it may be losing ground -- a prospect that would disappoint Wall Street.

The release came out just before Netflix's report of its second-quarter results after Monday's closing bell.

In the first quarter, Blockbuster added 800,000 net new subscribers to its online subscription service, which launched in 2004, bringing its total to over 3 million subscribers. In late 2006, it had only 1.5 million subscribers.

Netflix added only 481,000 net new subscribers in the first quarter.

The numbers reflect Blockbuster's aggressive marketing spending to promote its so-called Total Access plan. They also vindicate the company's aggressive pricing plan, in which it is sacrificing profitability in the short-term in order to weaken Netflix's early lead in the market.

Blockbuster's most popular offering allows subscribers to rent an unlimited amount of movies and have as many as three at one time for $17.99 a month. That matches the former price of a similar plan offered by Netflix, but it was more valuable to most consumers because Blockbuster Total Access members can exchange movies at the company's stores rather than wait for new movies to come in the mail.

Netflix has no stores -- only a Web site. Its price cuts put its three-at-a-time plan to $16.99 a month, bringing its prices in line with Blockbuster's mail-only offering, which doesn't allow in-store movie exchanges. It also lowered the price of its one-DVD-at-a-time plan to $8.99 from $9.99, also consistent with Blockbuster's mail-only plan.

"Instant gratification is king, and most Americans will be happy to pay an extra dollar so they can exchange movies on Friday night in a Blockbuster store," says Pachter. "[Netflix CEO] Reed Hastings will probably say tonight that Blockbuster will have to raise its prices soon to survive, but Blockbuster's new CEO, Jim Keyes, will say that they won't raise prices when they report quarterly results on Thursday."

Steve Swasey, a Netflix spokesman, declined to comment on the company's second-quarter performance. He said the price reductions on Sunday came after it successfully reduced prices on its less popular subscription offerings, such as its $4.99-a-month introductory price and its $13.99 unlimited rental offering with a maximum of two DVDs out at a time.

"We've been looking at price reductions for our most popular plans, and based on the success of previous price reductions, we decided now was the time," says Swasey.

He declined to comment on Blockbuster's pricing, but he pointed to Netflix's online viewing option for its members, which allows subscribers to access more than 2,000 movie titles on its Web site for instant viewing on their personal computers.

"We think that's a compelling value for consumers," Swasey says.

A Blockbuster representative couldn't be reached for comment on Netflix's move.

Analysts, on average, expect Netflix to report second-quarter earnings of 27 cents a share after the closing bell, according to Thomson First Call.

For its part, Blockbuster is expected to report a loss of 9 cents a share for the quarter on Thursday. Its shares recently were down 9 cents, or 2.1%, to $4.19.

Meanwhile, the prospect of lower prices on its most popular subscription offerings could mean lower profits for Netflix in future quarters if it's not able to cut its technology and marketing spending to offset the lost revenue.

"They can cut back spending to preserve profitability and hold on to subscribers, but that could start the company's death spiral in the long-term, because their technology is their competitive advantage," says Pachter. "It's going to be very difficult for these guys to draw the right balance between spending and pricing when they have an aggressive Blockbuster coming at them with its huge store base."