Netflix: Perfect Competition, Demand & Supply Increase Revenues - Essay Sample

Introduction

Netflix Inc. operates in a perfectly competitive market that is affected by the changes in demand and supply. The law of demand states that the quantity of demanded commodities and services increases with a decrease in price and vice versa, holding other factors constant. Netflix’s revenues continue to grow every year due to the increase in the number of subscribers (Burrows, 2016). At the end of 2012, it reported a total of 3.6 billion, which was a 12.6 increase in the 2011 revenues. In 2013, the company reported having over 40 million subscribers. Although the company has been facing stiff competition companies such as Amazon and Hulu, the demand for its product has been increasing steadily. According to Watson (2020), Netflix has 182 million subscribers that were paying for streaming services in the first quarter of 2020. 69.9 million people of these worldwide subscribers were from the US. However, data indicates that although the demand streaming services have been increasing, the DVD section had declined drastically. In 2011 the number of people who demanded DVD rental service was 11.17 million, while in 2018, only 2.15 million demand the service (Watson, 2020).

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Figure 1: Number of Netflix paid streaming subscribers worldwide 2011-2020

Source: statista.com

In 2014, Netflix increased the subscription fees with one fee, and approximately 800,000 did not renew their services between July and September (Wingfield & Stelter, 2011). The increase in price caused movement along the demand curve as shown below;

Diagram 2: The effect of price increase on quantity demanded

Netflix demand curve is downward sloping, and the graph shows the relationship between demand and price. The number of subscriptions reduces with an increase in price in a common good. If the rate remained at 7.99 per month, 53.75 million subscribers would have demanded their various services (Wingfield & Stelter, 2011). The company did not meet the targeted demand due to the increased price. Netflix has to be careful when making price decisions because they cannot avoid the law of demand.

A decrease in demand is not only contributed by an increase in price because Netflix offers luxury services that are not significantly affected by prices. One of the other factors that reduce the demand for Netflix services is competition. Netflix might have lost some of its market share to HBOS, who also begun offering streaming services during 2015. Netflix has identified HBO, Amazon, and Hulu as its main competitors making it to differentiate its services to meet the untouched demand. Prices of similar services at HBO and Hulu are relatively lower than those of Netflix, making individuals shift their demand to spend less money (Ashwin Taylor, & Mankiw, 2016)). The price of related services, such as complement or substitute, is a significant determinant of the demand for Netflix services. Competitors offer their services at the same rate as Netflix; hence the customers continue to refer their friends and family to Netflix, increasing the overall demand. For instance, in 2015, HBOs offered their services at $7 per month while the Netflix fee was $9.99. The customers prefer Netflix over the competitors because they provide quality and differentiated products. However, if they provide similar services at lower prices, there would be a decrease in the demand for Netflix. Although the competitors offer movies at relatively lower prices, they cannot compete with Netflix because it has established its brand across the world.

Changes in customers’ income may also contribute to the increased demand for services offered by Netflix because they have money to renew or upgrade their subscriptions. For instance, an increase in income in the developing world such as Asia and India can account for the increased demand making the curve shift outwards. Changes in tastes and preferences are also another factor that has increased demand for movies documentaries and series. People no longer depend on movies or series aired on television due to their preferred movies. On Netflix, they can watch their favorite episodes at any time as long as they have paid for the subscription (Ashwin et al., 2016).

Supply of Netflix

According to the law of supply, a rise in the subscription fee will lead to an increase in the quantity supplied. Price and quantity supplies have a positive relationship. Increased price creates a market surplus because the amount demanded a monthly subscription is lower than that supplied. No customer is willing and able to buy the extra supply in the market.

Diagram 3: Netflix demand and supply curves following increased in price

At a new price P1, the quality supplied increases (moves to the right) while the quantity demanded decreases (moves to the left), creating a surplus. To reduce the excess supply, Netflix has to reduce its prices to Pe and achieve the equilibrium point at e. Drop in price will increase the quantity demanded because many customers will be able to pay for the reduced subscription fees.

The customers are satisfied by Netflix’s movies and documentaries because it meet everyone's preferences. It uses different pricing strategies, such as value-based pricing to attract consumers to subscribe and enjoy features and added value services that come with every package. Netflix supplies its services to the domestic and international markets, ensuring that their products are accessible on multiple platforms that are easy to use. Netflix's supply strategies are strong and appealing in a way that no one can resist them. One of them is original content or programs such as original series, ministries, documentaries, exclusive comedies, and films that have been commissioned by Netflix. It also supplies multiple viewing options, where the customers watch what they want. The customers are allowed to control what they want to watch because of the wide variety of programs to choose from. The price of a monthly subscription is relatively low compared to buying a movie at the shop or watching one at a movie theatre. The customers are also given a free trial month where they watch everything they want without paying.

Price Elasticity of Demand for the Goods that Netflix Sells

Price elasticity of demand shows a change in quantity demanded due to a change in price. Netflix is price followers because it operates in a perfectly competitive market. It competes with Amazon Prime, Hulu, HBO Go, and Vudu that prevent it from achieving monopolistic power in the streaming industry. Netflix has to consider substitute companies when setting their prices. However, Netflix provides non-essential services (luxury); an increase in rates may not lead to a significantly decreased demand. Price elasticity may be classified as elastic or inelastic depending on the customers' responsiveness when prices are changed. Inelastic price elasticity, a small change in prices, leads to a significant decrease in quantity demanded. On the other hand, when products offered are price-inelastic, their demand does not change with price changes. If services provided by Netflix are priced inelastic, their number of subscribers will not change with the increase in price. The customers would still subscribe to stream television series, movies, and documentaries. In this case, if the company increases its price of monthly subscriptions, it would not lose its customers or minor changes are noted in quantity demanded. However, when Netflix increased their prices in 2014, the number of subscribers dropped significantly, indicating that the services have elastic price elasticity (Wingfield & Stelter, 2011). When demand is elastic, a small change in price leads to great change in the quantity demanded. According to Allen, Feils, and Disbrow (2014), Netflix increased its price between $1 and $ 2 from 7.99 to 9.99. Before the rise in price, they had attracted about 3 million subscribers in three months, but due to the increased price, they only attracted 1.3 million subscribers in the following months (Allen et al., 2014). The data can help identify that Netflix's demand elasticity is -8.15, demonstrating that Netflix services are highly elastic to price changes. The primary reason for the elastic demand is the availability of close substitutes because it faces stiff competition from companies that offer similar services. Moreover, Netflix provides luxury services, not necessities that people cannot survive without them. Therefore, the subscribers will not be willing to pay for a fee of 8.99 or 9.99 per month for non-essential services (Wingfield & Stelter, 2011).

Diagram 4: Decrease in the number of subscribers due to price increase

Graph 4 above shows that Netflix had new subscribers in three months 2014 when the subscription fee was at $7.99 per month. After the company increased its price to 8.99, the demand reduced shifting to the left, and the number of new subscribers decreased to 1 million in the next three months. The graph shows that quality demand is highly sensitive and elastic to price change.

Income Elasticity

Income elasticity of demand Netflix products is elastic because the quantity demanded increases with an increase in income. Netflix offers luxury products as an individual can survive without them, but when their income increases, they consume more services.

Diagram 5: Elastic income elasticity of demand for Netflix services

The graph shows that at Y0, the quantity demanded is Q0, but when income increases to Y1, the quantity demanded also increases to Q1.

Overall Market

According to Clark (2020), Netflix has been growing globally because the number of subscribers as of 2019 was 162million compared to 11.2 million in 2011. However, the market share has dropped over time, and an analysis performed by Ampere Research Company demonstrated that Netflix's international market share had fallen from an enormous 91% in 2007 to 19% in 2019 (Clark, 2020). Ampere also predicts that by the end of 2020, Netflix's market share could drop to 18%.

Figure 6: Netflix market share reduces over time

In 2007, Netflix was the only company offering streaming services, unlike others that only focused on DVD services. In 2011, it separated streaming services from DVD services and introduced original shows such as "Orange Is the New Black" and "House of Cards." Over time many streaming companies have launched similar services in the market, taking a significant share of subscribers. For example, in China, Netflix cannot provide their services unless it merges with a local partner. The Chinese tech giant Tencent has been the leading company taking the Asian market that has grown tremendously.

Netflix is still growing as demonstrated by its statistics has 182 million subscribers that were paying for streaming services in the first quarter of 2020, and 69.9 million people of these worldwide subscribers were from the US (Watson, 2020). However, data indicates that although the demand streaming services have been increasing, the DVD section had declined drastically. When the company began in 1997, it proposed to rent movies to its customers at a certain fee. It shifted from daily charges of the film to a monthly fee where customers would rent several movies if they had paid the monthly payment. In 2007, it took off the ground and charged the video market when it created its streaming websites, and this was its blue ocean strategy. This differentiation makes its huge profits and makes competition irrelevant by producing original content at a low price. The strategy still works since they continue to produce original movies and series and prices that are convenient for everyone. They also interact with their customers on social media such as Netflix websites, e-mail, Facebook, Twitter, and I...