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Netflix is raising prices, but not to pad profits

Netflix (NFLX) announced its first-quarter earnings Monday: profits of $53 million compared to $2.7 million the year before -- a twenty-fold jump -- and 2.25 million new subscribers domestically, with another 1.75 million internationally. And stock price jumped in after-hours trading.

The streaming video company made another announcement as well: a price hike. Netflix will increase subscription prices by $1 to $2 a month for new subscribers soon, "depending on the country." Existing customers would get to keep their current pricing "for a generous time period," which some speculation put at two years. However, those bills will eventually rise as well.

What gives? Rapidly increasing profits require higher prices? Actually, they do. Pressures on Netflix come from the entertainment industry, telecom giants, major competitors and the need to deliver original programming to keep attracting new viewers. That means having a cash war chest larger than what's currently available.

Netflix has raised prices in the past. In 2011, it announced a new service structuring that effectively sharply increased prices. The rationale was in part that the company was leaving money on the table, but the impact was to anger many customers.

You won't hear that this time, for two reasons. One is that CEO Reed Hastings learned his lesson the hard way last time. Another is that the money is likely already spoken for by a legion of business realities:

  • Hollywood studios -- Netflix has to license most of its content from big entertainment companies that want to boost their own profits. They rightly see streaming as a market-disrupting challenge to their formerly lucrative DVD sales. However, even as things change, they want to preserve the financial past.
  • New programming -- One way out from under the thumb of the studios is to independently source as much programming as possible. Such series as House of Cards and Orange Is the New Black draw audiences but are also expensive. The former is said to cost upwards of $100 million for two seasons. Although that was notably expensive, with its current profit levels, Netflix might afford an additional four to six original series a year, and its upcoming lineup is already pushing that boundary.
  • Competition -- Many other major companies are going head-to-head with Netflix. Apple (AAPL), Amazon (AMZN), Google (GOOG) and Microsoft (MSFT) are all rivals. Amazon and Microsoft are both currently planning original series. The more big-money companies join the hunt, the more producers of programming can charge.
  • Telecommunications -- Internet carriers are forcing companies like Netflix to pay a premium to reach consumers with the network speed necessary for good-quality streaming. That's upwards of millions a year each to various companies, which often happen to also be in the business of providing video programming. Otherwise, the carriers will degrade Netflix's streaming performance to the point that customers walk away. This will only get worse as Netflix moves to offer so-called 4K programming that provides ultra-high definition.
  • Investors -- Throughout all this, as a public company, Netflix still has to provide results that keep its investors happy.
Perhaps it could enjoy the extra revenue three years ago. Now it needs the money to keep the business viable in the long run.

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