business-modelI’m doing some random thought experiments on the DVD rental industry (what there is left of it, now that Blockbuster and Walmart are long-gone), and I got to thinking: among the various dvd-by-mail rental services out there, why is their go-to model the monthly subscription?
For example, Netflix’s lowest plan was 2 DVDs per month at a price of $2.50 per disc ($4.99/mo). Why not offer to rent discs individually for $2.50 per disc, and maybe offer bulk discounts to encourage loyalty and reduce costs?
Any thoughts on this? Is this to reduce friction in continued payments? e.g. if someone is paying monthly they’re less likely to stop paying in general. Or maybe this model reduced incentive for theft?
Is it possible they were missing out on some customers who only wanted to rent a movie once every 3 months?
Thanks for indulging my questions :)
My first thought would be that their cost of customer acquisition was too high OR/AND they needed to cover high fixed costs from marketing, employees, and warehouses. A second thought is to ask “how much it cost to send one disc? And how much fixed cost does it include?” Maybe more than 2,50, in which case single orders were not profitable.
All businesses benefit from increased customer loyalty. By some estimates it is 6 times more expensive to acquire new customers than to keep them, but it depends on the business. Netflix had an intense rivalry with Blockbusters and price was king among consumer preferences so subscription model makes sense.
For the customers, cancelling their previous subscription and taking on a new subscription does create some switching costs. One-time rentals have nearly zero switching costs. Consumers’ time and effort are valuable.
Edit: of course they were missing some potential customers. Nearly every business has to select which customers to serve and which customers not to serve. All are not equal. Serving different customer segments requires different strategy.
The answer is a little more sophisticated. It has a lot to do with the licensing terms and royalties (license fees).
Think of itunes vs Pandora (for music) ... it's a rough analogy (still not perfect). Music, like Movies, consists of many individual consumable products (songs) by many artists (and other people who get paid for the song), and these are generally distributed by a handful of music labels - the ones that charge the $$ and distribute it to all parties who are due their cut. Movies have studios etc.
Anyway. If you download (a song) on itunes - that is one kind of license - very and it very specifically can be measured and money charged, collected and distributed. But on Pandora it's more sophisticated. They have to make deals with record labels, that are based on estimates on how many average streams per month etc.
The difference. itunes is when you know exactly what song you want. Pandora is when you want to have lots of choices at any given time.
Same for Netflix. RedBox is when you specifically want to rent a movie that is just after its first run (which really only a handful of selections) ... Redbox does offer a lot of other movies just so it doesn't look empty, but for the most part Redbox is for people want to see recent, popular feature films.
Netflix, at least at first, was to give you a chance to create an eclectic list of your personal favorites (movies, shows, that you wan to watch again, ... or those that you always wanted to watch) - and get them on a revolving basis each month. The licensing is much different.
But even more important - the psychology is much much different than on-demand, PPV or Redbox. People love the idea of "choice" but hate making decisions. So the Netflix model relieved you of both!! ie ... when you created your "wish list" - you were satisfying your brain's requirement for control, for choice. But the movies sent each month were not a direct result of your choices ... they were based on availability and some other VERY sophisticated algorithms (see the Netflix prize) ... so you were not forced to make a choice every month.
Over the years the Netflix model has evolved and morphed - due to changing technology (particularly streaming), and evolving licensing terms from studios - and they've gotten into originals. But the basic psychology has never changed. And the results are that Netflix is far more successful than redbox (or even HBO - for streaming).
So - there's a glimpse as to why.
One added benefit of the growing interest in subscription based pricing models is that it creates a consistent and reliable cash flow mechanism. The “on-off” nature of subscriptions creates easily trackable usage, which will help in resource planning and financial analysis. By tracking the number of active subscriptions, you can more readily provide user consumption insights and forecasts. Oppositely, in a pay-per-use model the multiple variables that affect individual consumption patterns makes modeling much more difficult.
Example 1: Subscription Model: Every month you pay $10.00 for access to 10 DVDs a month.
Every month, the business owner knows that the number of active subscription and can multiply it by the price. (10 members = $100.00) This is regardless of whether the customer’s consumption; whether the customer gets 1 DVD or 10 DVDs that month.
Doing a segment analysis, the owner can see the metrics of actual usage per subscription, and create multiple subscription levels to encapsulate different user types, but still has a simplified metric to track, that has some level of consistent expect income (number of subscription multiplied by the price of the subscriptions).
Example 2: Pay-Per-Use Model: When you want a DVD, you pay $2.00 each time.
Every month, the business owner tracks the number of sales and multiples is by the price per sale. However, as usage fluctuates more chaotically, the insights and modeling will be more volatile.
Doing segment analysis, the owner will need to aggregate each customer’s usage and then would need to do an additional analysis to decide how to segment it based on the data sets. The metrics are initially more granular and have a higher degree of volatility.
Another added benefit to the subscription model is, capturing the unearned value in terms of users who do not maximize their subscription consumption; You pay to access 10 DVDs a month, but only use 5 DVDs. The subscription model pays out the same for the business owner, capturing the value for the 5 unused DVDs available to the customer. In the pay-per-use model, the business owner cannot acquire any more value than the specific customer usage allows.
Lastly, I would agree that a subscription model has a certain advantage for customer retention and loyalty. Customers are less likely to purchase similar services from multiple vendors given a subscription model. Therefore you have the added benefit of retaining customers and preventing market share bleeding to competition. In the pay-per-usage model, there is no sunk cost for the customer, so switching between providers is simple and does not require the steps to cancel a subscription and initiate a new subscription with the competitor.
Because Netflix makes its money off of the lag time that mailing earns. Netflix does not want you to return the DVDs and wants long mail times.
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