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What You Can Learn From Netflix's Pricing Plan

How much you raise prices is important, but so is the way you package the price increase.
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There has recently been some speculation Netflix will raise its prices. And a new national poll indicates that other businesses will soon do the same. 

In a National Association for Business Economics (NABE) survey released yesterday, more than 40 percent of respondents indicated that they plan to raise prices next quarter. According to NABE, that is the highest response to the question in more than one year. 

If you, too, plan to raise your pricing, what Netflix announced yesterday can help you think through your strategy for doing so.

How Netflix Is Thinking About Pricing

First things first: Netflix hasn't yet announced a pricing increase. What they've announced is that they're pondering it.

More importantly, CEO Reed Hastings shared how the company is pondering it. "We're testing some things and we're continuing to try to figure out how to evolve to a good, better, best plan that makes sense to consumers and feels fair," he said during last week's earnings call.

Later, CFO David Wells added that consumers sometimes make their pricing decisions based on the segmenting or tiering of the options a company offers them. "They take the middle or the upper or the low," he said.

The Concept of Anchoring

All this talk of three-tiered pricing ("good, better, best" and "middle or the upper or the low") invokes a pricing concept known as "the anchoring effect," which you're probably familiar with. If you haven't used it for your business, you've certainly experienced it as a consumer. 

There are many experiments demonstrating the anchoring effect. My favorite comes from author and Duke professor Dan Ariely. At the 12:30 mark of a TED Talk called "Are we in control of our own decisions?" he describes an old advertisement for a subscription to the Economist, which offered three-tiered pricing: $59 for web only, $125 for print only, and $125 for print and web. 

You read that correctly: $125 was the price for both "print only" and "print and web." Ariely, who was at MIT at the time, asked 100 students which of the three options they'd choose. Eighty-four of them chose the $125 "print and web" option. None of them chose the $125 "print only" option. Sixteen of them chose the $59 "web only" option.

Easy Math

You might ask: Why did the Economist even bother with that $125 "print only" option? Ariely conducted a second survey that shows why. In the second survey, he removed the $125 "print only" option and asked a separate set of 100 MIT students what they would choose. This time, 68 chose the $59 "web only" and 32 chose the $125 "print and web."

The bottom line: The mere presence of the "print only" option--even though no one chose it--prompted a much higher percentage of people to choose the more expensive ($125) "print and web" option. The difference, when all the $125 and $59 sums are added up, would have amounted to 42.8 percent more hypothetical revenues for the Economist.

In other words, "print and web" for $125 seems like a much better value when it's anchored by a $125 "print only" option and a $59 "web only" option.

The Key Takeaways

Ariely's experiment reveals why three tiers are better than two--even if the middle tier is a mere anchor. Derek Thompson in The Atlantic offers another lucid example of the three-tiered anchoring effect. Thompson believes Netflix's new pricing plan will include three options: "(a) a cheapo discount with inferior access; (b) a "premium" product that costs more than the current $7.99; and (c) a "super-premium" product whose higher price will make the premium product seem tolerable."

Only time will tell what happens. Here's what we know: Less than three years ago, Netflix lost 800,000 subscribers in one quarter when it announced both a price increase (July, 2011) and a plan to siphon its DVD-only customers to a separate entity called Qwikster (September, 2011). It's no wonder that Hastings also made it clear, during the earnings call, that Netflix "would grandfather very generously" its existing customers into any new pricing structure. 

All told, then, there are two lessons to learn: (1) If you're going to raise prices (and according to the NABE survey, you are), announce it early, announce it gingerly, and keep your incumbent customers in mind; (2) A three-tiered pricing model is one of the best ways to do just that.

Last updated: Jan 28, 2014




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