Should investors start to question Netflix’s pricing power?

Management was surprised by a negative development in the most recent quarter.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

When Netflix (NASDAQ: NFLX) reported 2022 first-quarter financial results on April 19, what captured the market's attention was a loss of 200,000 subscribers during the period. Making matters worse was management's expectation of losing another 2 million customers in the current quarter. Unsurprisingly, the stock immediately crashed 35% following the announcement. 

For a business that was growing rapidly over the past decade, adding tens of millions of new members every year and increasing revenue at a brisk rate, the dramatic slowdown is raising questions about the streaming company's prospects. And investors have a lot to think about. 

Arguably, topping the list of what shareholders should start to question is Netflix's pricing power. Let's take a closer look. 

Netflix's weakening moat 

Netflix has historically been able to raise prices in the U.S. with seemingly no impact on its customer growth. It hiked prices in April 2014 (the first of six price hikes), and since then, the membership count has increased from 48 million to 221.6 million today. But it's starting to look like the party could be over. 

Management blamed elevated churn as the reason for the first-quarter subscriber miss and weak second-quarter forecast. Furthermore, it specifically said that the most recent U.S. price increase in January was not the reason for higher churn. Instead, the leadership team called out the war in Ukraine, macro issues in Latin America, seasonality, and heightened competition for the attrition. 

However, some could be sceptical of this argument. The U.S. and Canada region (UCAN) lost 640,000 members last quarter, the biggest decline in at least the past decade. And this was during the three-month period that Netflix raised prices in the U.S. and in a period when Bridgerton 2, its most popular English-language TV show, was released. Top-notch content wasn't enough for consumers to want to pay more, a key part of the company's strategy that has worked so well in the past. 

It's only going to get harder to bring these fallen-off customers back onto the platform. Including accounts that share passwords, Netflix estimates that there are 105 million households in the UCAN region that watch Netflix. Market saturation is real. Additionally, there are an unlimited number of entertainment options today. Is Netflix still superior enough to rival services to warrant its premium pricing? I'm not so sure. 

Excluding the impact of Russia, Netflix would've added 500,000 customers in the first quarter. That still would've substantially missed management's previous guidance of 2.5 million adds. So there were an unexpected 2 million accounts that chose to cancel their subscriptions. Losing members is problematic because it not only affects sales in the current quarter, but in future periods as well. 

The leadership team's long-term pricing strategy, however, hasn't changed. The objective is still to continue finding ways to add greater entertainment value, while asking its customers to pay more over time. But the company's latest struggles call into question a key part of Netflix's thesis: its pricing power. 

Warren Buffett once said that pricing power is the most important determinant of a company's quality. Is Netflix now a worse business than it was before? 

What now? 

With the stock down 68% since the start of the year, Netflix's current price-to-earnings (P/E) ratio of 17 makes shares appear cheap right now. It's still the top streaming service by number of subscribers, and this scale is a huge advantage when it comes to producing content. But the U.S. market is starting to look saturated. At the same time, competition for consumers' attention has never been higher. 

Regardless of the seemingly attractive stock price, whether this is a temporary blip on the company's radar or not remains to be seen.  

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Netflix. The Motley Fool Australia has recommended Netflix. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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