GRADUATE SCHOOL OF BUSINESS

MASTER OF BUSINESS ADMINISTRATION PROGRAM

SET 2, SEMESTER 2, Session 2021/2022

ZCMA6012 Business Economics

CASES

NOTE: Case 1 is due on the 16th of April 2022 and Case 2 is due on the 23rd
of April 2022

CASE 1
Netflix Price Increase Hurts Membership

Netflix experienced some membership turbulence in 2016 as a price increase was phased in for
its US subscribers. In May 2014, Netflix announced that the price of its standard subscription
service would increase from $8 to $9. However, established customers were allowed to stay at
the $7.99 price for two years. In 2015, Netflix increased the standard price to $9.99. As a result
of the pricing plan and the deferred price increase, in May, 2016, the standard pricing plan for
long time customers of Netflix increased from $7.99 per month to $9.99 per month. Netflix
began notifying customers in April that the price increase would become effective in the
second quarter.

Netflix was trying to implement price increases more slowly after a 2011 increase led to
negative publicity and a customer backlash. In that case, Netflix separated its streaming and
DVD services, and charged separately for both services.

However, regardless of the implementation of the price increase, the higher monthly prices
seem to have impacted the growth of membership among US subscribers. In the two quarters
before the price increase, Netflix added net membership of 1.6 million and 2.2 million
members. By contrast, the number of members added in Q2 was only 160,000, and in Q3 only
400,000. The Q2 growth in US subscribers was the lowest since Netflix began reporting those
numbers in 2012.

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 US Streaming (millions) Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016

Revenue 1026 1064 1106 1161 1208 1304

Contribution Profit 340 344 379 413 414 475

Contribution Margin 33.1% 32.3% 34.3% 35.6% 34.3% 36.4%

Paid Memberships 41.1 42.1 43.4 45.7 46.0 46.5

Total Memberships 42.3 43.2 44.7 47.0 47.1 47.5

Net Additions 0.90 0.88 1.56 2.23 0.16 0.40

Monthly Revenue per

Paid Member $ 8.33 $ 8.43 $ 8.49 $ 8.47 $ 8.75 $ 9.40

Percentage Chg. Rev 3.7% 3.9% 5.0% 4.0% 7.9%

Percentage Chg.
Memberships 2.5% 3.2% 5.3% 0.6% 0.9%

Source: Netflix 10Q Q3, 2016

According to a MarketWatch article1 on the price increase:

Netflix said Monday that customers who learned in April that the price was about to
increase had begun canceling their subscriptions, leading to unexpected “churn.”
Netflix did not flat-out say in its letter to investors that the price increase led to higher
churn among subscribers, however, instead saying it coincided with “press coverage” of
the rate hike and that subscribers misunderstood “the news as an impending new price
increase rather than the completion of two years of grandfathering.”

The stock market reacted to news of Netflix price increase as well. The stock closed at $102.23
as of March 31, 2016. After the release of second quarter earnings in July, the stock price had
fallen to $85.84 per share, a decline of 16%. This decline wiped out almost $7 billion of
shareholder value during this period. Most of this decline was immediately following the
release of the second quarter numbers.

With competition increasing in for streaming services, especially with the growth of Amazon
Prime Video and Hulu, the decline in membership growth could be a troubling sign. 

1
‘Netflix price increase does damage, but media and subscribers blamed’ Jeremy C. Owens, Marketwatch.com,
July 19, 2016. http://www.marketwatch.com/story/netflix-price-increases-causing-subscribers-to-sign-off-2016-
07-18
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 Questions:

(1) Briefly describe the background information regarding this case.

The case is a description of how price increase affects the members of Netflix.

(2) What is the main issue presented in this case?

The issue presented is the change in the membership status of Netflix with changes in the price.
The increase in monthly membership price of Netflix impact

(3) Can we use the information in the case to estimate the elasticity of demand for Netflix
subscription services?

Yes, we can use the information in the case to estimate the elasticity of demand for Netflix
subscription services.

Here we can easily conclude that Netflix customers seem to be highly price inelastic in their
demand for one of the company's streaming services. Hence, Netflix can easily take advantage
of increasing its prices without losing a greater number of customers. People were loving the
services while paying $7.99 per month as it seems a good worth to spent. But after an increase
in service value, stock prices fell up to 16% either. Demand is elastic, but because of price
inelasticity even a significant change in price will affect the demand very less.

(4) Can we calculate an own-price elasticity of demand?

Yes, we can calculate. "The percentage change in quantity demanded of a good or services by
percentage change in its price."

(5) Are there other concerns with our elasticity estimates?

How price increase affects the members of Netflix demonstrated the pricing elasticity in this
case study. There are no other issues with our elasticity estimates because we can identify it by
comparing the percentage change in demand to the percentage change in price.

(6) What could make this analysis better?

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The analysis would have been better if it had contained better information about consumer
responses, projected profit and more detailed information about the company so that the price
elasticity of demand can be easily calculated.

(7) What do we expect to happen to Netflix’s revenue due to the price increase?

They suddenly increased the price by 60% in 2011 providing the same services. Before
customers were paying $10 for both streaming videos and DVD rentals but later the prices
hiked up to $15.98 per month. Here the price rise can be seen as a boon for revenue as Netflix
has continuously improved the quality of its offerings over the past few years and the demand
has already made people go addicted towards its outstanding services. The table clearly shows
that revenue increases concurrently with price increases, but this may only be temporary or just
a short-term result. Probably the long term effect of the spike prices increase could be resulted
into long-term effects, one of which is revenue growth in a long run.

(8) What do we expect to happen to Netflix’s profit due to the price increase?

Netflix’s profit due to the price increase is also moving in the upward direction with a slow but
constant growth rate because of Elasticity in Demand. Though the company had to deal with
some short-term negative events, the decision to raise the price of Netflix's standard
subscription services will result in an increase in profit in the long run. This covers the
company's long-term objectives.

(9) Given this analysis, why did Netflix stock get hammered after releasing results?

Netflix stock got hammered after releasing results and plunged more than 16% because of
decline in the rate of number of new and existing subscriptions since three continuous quarters.
Subscribers keep on declining and get separated out themselves from the availing services. It
shows a rapid increase in membership subscriptions from the second quarter of 2015 to the first
quarter of 2016. However, as a result of their decision to raise the price in the second quarter of
2016, the percentage of membership added drops to 0.6 percent and 0.9 percent in the second
and third quarters of 2016, respectively. And this, in turn, has an impact on the company's
stockholder value.

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 CASE 2
Burger King Dollar Double Cheeseburgers
Recently, the National Franchise Association (NFA) filed a lawsuit against Burger King
Corporation (BKC) over the pricing of products on its value menu, and specifically its $1
double cheeseburger promotion. The NFA is group that represents more than 80% of Burger
King Franchise owners.

Here are excerpts from the Associated Press2 report on the case:

The National Franchise Association, a group that represents more than 80 percent of
Burger King's U.S. franchise owners, said the $1 promotion forces restaurant owners to
sell the quarter-pound burger with at least a 10-cent loss.

While costs vary by location, the $1 double cheeseburger typically costs franchisees at
least $1.10, said Dan Fitzpatrick, a Burger King franchisee from South Bend, Ind. who
is a spokesman for the association. That includes about 55 cents for the cost of the
meat, bun, cheese and toppings. The remainder typically covers expenses such as rent,
royalties and worker wages.

"New math, or old math, the math just doesn't work," Fitzpatrick said.

Burger King justified the move by stating that the company needs to remain competitive in a
tough economic environment:

Restaurants, especially fast-food chains, have been slashing menu prices because of the
poor economy. Executives hope the deeply discounted deals will bring in diners who
are spending less when they eat out, or opting to stay home altogether.

When the $1 double cheeseburger was announced this fall, analysts said it could
increase restaurant visits by as much as 20 percent. But despite that boost, a Deutsche
Bank analyst said as much as half of the gain recorded from increased traffic could be
lost because customers were spending less when they ordered food.

Burger King Franchisees pay a royalty to Burger King that is typically equal to 4.5% of
revenues for the store.

The lawsuit alleges that the value menu restriction illegally sets a maximum price for the
Burger King franchises, and that Burger King is not acting in “good faith” by forcing
franchises to sell a product below its cost. The case was filed in U.S. District Court in South
Florida.
2
‘Food Fight: Burger King Franchisees sue chain over $1 burger promotion’ Ashley M. Heher, Associated Press,
USA Today, Nov. 12, 2009.
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 Questions

(1) Briefly describe the background information regarding this case.

(2) What is the main issue presented in this case?

(3) As “experts in managerial economics”, do you support the idea that Burger King
franchises are losing money by selling $1 double cheeseburgers?

(4) What are the relevant costs to a franchise of selling a double cheeseburger?

(5) What other factors need to be considered in making this decision?

(6) Is there an opportunity cost that needs to be factored in?

(7) What is the goal of a Burger King franchise? What is the goal of Burger King Corporate?

(8) So it seems that the fundamental problem is that incentives are misaligned. Can this be
resolved?