Not long ago, Netflix was the darling of the movie rental industry, changing the way that people get access to movies through their innovative on-demand streaming service and their distinctive red DVD mailing envelopes.

Then on July 13, Netflix suddenly announced that it was raising the prices of its movie rental plans, including a 60% hike to its cheapest plan (Wall Street Journal: “Netflix Plays Down DVDs”). To get a combined plan of DVDs by mail plus online streaming video, customers will now have to pay $16 a month instead of $10.

There will also be “DVD only” and “streaming only” plans for $8 a month, but customers don’t seem to want to be forced to choose. On the whole, customers are crying foul about the new Netflix pricing plan. This is a rare misstep (and rare bad publicity) for a company that has been one of the biggest success stories in the American entertainment industry.

What is it about movie rental companies and pricing? Netflix is making the same mistake that its former competitor, Blockbuster, made a few years ago.

It seems like ancient history now, but a few years ago, Blockbuster was America’s #1 video rental company, with over 5,000 Blockbuster stores in the U.S. and 17 countries. Today, Blockbuster is a shell of its former self, after going bankrupt, closing many of its stores, and being acquired by Dish Network.

There are many reasons for the demise of Blockbuster, ranging from changes in technology to changing consumer preferences, to smart moves by Netflix and other competitors to capitalize on new opportunities that Blockbuster was too slow to recognize. But one of the big reasons why Blockbuster lost favor with customers is because their pricing was confusing.

Back in 2004, Blockbuster made a change to its pricing structure. People were getting tired of paying late fees to Blockbuster (and Netflix made “no late fees” a major part of its advertising), so Blockbuster tried to adapt. Even though late fees were a major portion of its revenues, Blockbuster removed its late fees, and instead starting charging customers for the full sales price of the movie in case they kept it longer than 7 days.

Needless to say, many customers were angered by Blockbuster’s move. Getting nickel-and-dimed by late fees was bad enough, but now Blockbuster was forcing their customers to buy movies whether they wanted to or not. Blockbuster even had to pay $630,000 in legal settlements for deceptive advertising, since many customers assumed “no late fees” meant they could keep the videos as long as they wished.

Although this was but one chapter in the long decline of Blockbuster, the clumsy pricing fiasco damaged the company’s reputation and undermined its goodwill with customers.

In the same way, it’s hard to imagine that Netflix’s latest pricing move is going to be anything but a blunder. Customer reaction has been overwhelmingly negative, with the Netflix blog getting over 4,200 comments in the early days after the announcement. Many Netflix customers are threatening to cancel their memberships.

What is wrong with Netflix’s price hike, and what lessons can your company learn?

  • It’s not about you; it’s about your customers: Too often, companies focus on making a change in pricing, introducing a new product, or some other strategic move based on “what it can do to maximize revenue for the company” instead of “what it can do for customers.” This is backward thinking. If you do what is right for the customers, the company will inevitably benefit.
  • Customers don’t like to be confused: Even in a down economy, an extra $6 a month for movie rentals won’t break the bank for most people. However, it seems that Netflix’s customers are reacting not out of financial strain, but out of feelings of betrayal and annoyance. Netflix is taking away customers’ choices, making them choose between DVDs and streaming video, or forcing them to pay more to keep both.
  • Sudden price hikes are hard for customers to accept: If Netflix was already earning a profit at the old price point of $10 a month, why did they suddenly have to jack up the price by 60%? Customers are willing to pay more for products and services that truly offer a competitive advantage, but when price hikes seem arbitrary and disconnected from the customer’s reality, customers will walk away. It’s always best not to compete on price. But if you’re going to raise prices, raise them gradually, while communicating with your customers to manage their expectations. If you suddenly raise your prices, you might suddenly lose a lot of customers.

It will be interesting to see whether Netflix’s new prices help improve their bottom line, or whether the clumsy handling and confusion of the new pricing structure causes them to lose customers. The lesson for all companies: Before you make a decision based on boosting your profits, make sure you find out what your customers think.

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