Netflix Penalizing Frequent Renters with Throttling

The popular DVD by mail rental company Netflix is holding its best movies back from its best customers.

Manuel Villanueva realizes he has been getting a pretty good deal since he signed up for Netflix Inc.’s online DVD rental service 2 1/2 years ago, but he still feels shortchanged. That’s because the $17.99 monthly fee that he pays to rent up to three DVDs at a time would amount to an even bigger bargain if the company didn’t penalize him for returning his movies so quickly. Netflix typically sends about 13 movies per month to Villanueva’s home in Warren, Mich. — down from the 18 to 22 DVDs he once received before the company’s automated system identified him as a heavy renter and began delaying his shipments to protect its profits.

The same Netflix formula also shoves Villanueva to the back of the line for the most-wanted DVDs, so the service can send those popular flicks to new subscribers and infrequent renters. The little-known practice, called “throttling” by critics, means Netflix customers who pay the same price for the same service are often treated differently, depending on their rental patterns.
“I wouldn’t have a problem with it if they didn’t advertise `unlimited rentals,'” Villanueva said. “The fact is that they go out of their way to make sure you don’t go over whatever secret limit they have set up for your account.”

Los Gatos, Calif.-based Netflix didn’t publicly acknowledge it differentiates among customers until revising its “terms of use” in January 2005 — four months after a San Francisco subscriber filed a class-action lawsuit alleging that the company had deceptively promised one-day delivery of most DVDs. “In determining priority for shipping and inventory allocation, we give priority to those members who receive the fewest DVDs through our service,” Netflix’s revised policy now reads. The statement specifically warns that heavy renters are more likely to encounter shipping delays and less likely to immediately be sent their top choices.

[…]

Once considered a passing fancy, Netflix has changed the way many households rent movies and spawned several copycats, including a mail service from Blockbuster Inc. Netflix’s most popular rental plan lets subscribers check out up to three DVDs at a time for $17.99 per month. After watching a movie, customers return the DVD in a postage-paid envelope. Netflix then sends out the next available DVD on the customer’s online wish list. Because everyone pays a flat fee, Netflix makes more money from customers who only watch four or five DVDs per month. Customers who quickly return their movies in order to get more erode the company’s profit margin because each DVD sent out and returned costs 78 cents in postage alone.

Although Netflix consistently promoted its service as the DVD equivalent of an all-you-can eat smorgasbord, some heavy renters began to suspect they were being treated differently two or three years ago. To prove the point, one customer even set up a Web site — http://www.dvd-rent-test.dreamhost.com — to show that the service listed different wait times for DVDs requested by subscribers living in the same household.

Netflix’s throttling techniques have also prompted incensed customers to share their outrage in online forums such as http://www.hackingnetflix.com. “Netflix isn’t well within its rights to throttle users,” complained a customer identified as “annoyed” in a posting on the site. “They say unlimited rentals. They are liars.”

Hastings said the company has no specified limit on rentals, but “‘unlimited’ doesn’t mean you should expect to get 10,000 a month.” In its terms of use, Netflix says most subscribers check out two to 11 DVDs per month.

Management has previously acknowledged to analysts that it risks losing money on a relatively small percentage of frequent renters. The risk has increased since Netflix reduced the price of its most popular subscription plan by $4 per month in 2004 and the U.S. Postal Service recently raised first-class mailing costs by 2 cents.

[…]

A September 2004 lawsuit cast a spotlight on the throttling issue. The complaint, filed by Frank Chavez on behalf of all Netflix subscribers before Jan. 15, 2005, said the company had developed a sophisticated formula to slow down DVD deliveries to frequent renters and ensure quicker shipments of the most popular movies to its infrequent — and most profitable — renters to keep them happy.

While I understand their rationale, Netflix’ throttling practice amounts to fraud. Hiding the fact that they punish heavy users in the small print of a service agreement that nobody reads should not insulate them from the fact that they promote the service based on an entirely different business model. Intentionally holding movies an extra day before sending them out is especially egregious; it amounts to theft.

That they lose money on the most aggressive renters is hardly unsurprising. That, presumably, is true of the 400 pound guy who eats ten pounds of shrimp at the buffet or shoppers who buy large quantities of the advertised loss leaders from a grocery store and nothing else. The businesses recoup those occasional losses and much more by taking advantage of those people who either can’t do math or who are willing to pay a flat fee for convenience.

FILED UNDER: Economics and Business, General,
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. McGehee says:

    When my wife and I adjusted our Netflix membership last year we were informed up front that there would be a maximum number of movies we could rent in a given interval, and on one occasion even bumped up against that limit. Were we unique in being properly informed, or just more observant than most in spotting the warning?

  2. DeWaun says:

    I concur. What takes two days to send out and receive often takes 5 days. I could ride a bike to the distribution station in my area where NetFlix ships and receives DVDs. It’s about…oh, maybe 15 miles away? My wife and I have noticed this on many occasions.

  3. bryan says:

    The all-you-can-eat buffet is an apt analogy.

  4. Anderson says:

    Hm. Netflix is engaging in “fraud,” but if a 18-year-old fails to notice that his enlistment contract could keep him overseas on duty for an indefinite period, that’s too bad for him?

    Consumerist America is a strange place.

  5. James Joyner says:

    Anderson: You’ll note that I’ve been pretty consistent on this point, including the enlistment contracts issue.

  6. CalDevil says:

    They’re protected. Reed Hastings is a Dem power broker. Cal’s AG Bill Lockyer would never go after a major contributor like Reed.

    In fact, out of respect for Lockyer and Cal Dems, no other self-styled “watchdog” AG like Spitzer or Blumenthal will go after Netflix either. Netflix gets a pass, kind of like a mobster from a rival family – need to keep the peace.

    It’s not about protecting the consumer. It’s about protecting the interests of your contributors and cronies.

  7. Jane Galt says:

    All you can eat buffets aren’t quite an apt comparison; the food cost is so trivial for those places, in comparison to costs like labour and real estate, that they don’t lose any significant amount of money on even their biggest eaters. There are other reasons that they aren’t the same; Netflix’s business model has the potential for an adverse selection phenomenon, where the heavy renters drive out the light renters by sucking up all the most popular movies. Even the piggiest eater is unlikely to eat all of a popular food, and while all-you-can-eat buffets have a geographically determined mix of customers, only a few of whom will be pigs, Netflix could easily end up with every movie fanatic in the country, which would drive up the price of their service beyond the amount normal eaters are willing to pay. Moreover, since those heavy renters are only a tiny proportion of the overall audience, the fine print is exactly the right place to put that information; the fine print is where you are supposed to put the information that only pertains to a tiny subset of the customer base.