U.S. Postal Service Fails in Bid to Raise Prices on Netflix

Netflix sign  - H 2015
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Netflix still has 5 million people who subscribe to its DVD-by-mail service. That might not sound like a lot, especially when compared to the 75 million who are streaming customers, but it's more important to Netflix than you might think. The mail business is a lot more profitable — with profit margins of nearly 50 percent — than streaming. Although the mail business continues to decline by about 20 percent each year, Netflix would like to hold on to it as long as it can. Fortunately, the Court of Appeals for the D.C. Circuit has just handed down a decision that will save the company quite a bit on postage stamps.

The U.S. Postal Service wanted to increase prices on Netflix, as well as GameFly, a similar company in the video game rental business. To do this, because there are antitrust concerns, it needed approval from the Postal Regulatory Commission. When it comes to the mail business, there are two kinds of products — "competitive" ones, which are subject to a statutory pricing floor, and "market dominant" ones, which are subject to a pricing ceiling.

Because nobody else sells to Netflix in the DVD-by-mail business, the round-trip mailers offered by the Postal Service have been classified in the "market dominant" camp, but the Postal Service aimed to change that. The main argument was that streaming had become a marketplace substitute for DVDs by mail, and thus, Netflix should be paying "competitive" rates. In other words, the Postal Service believed that if the cost of getting DVDs by mail got too high, customers would switch to streaming. Netflix would thus have a less of a demand for postage, and this marketplace dynamic would be a check on Postal Service pricing.

Alas, the commission rejected this argument, pointing out that some people prefer DVDs by mail because there are more movies and television shows available, or the quality of streaming might be inferior. Also, nearly two-thirds of those who get DVDs by mail also subscribe to Netflix's streaming service. The commission also wasn't convinced that the shift toward streaming correlated to the price sensitivity of the mailing business.

Courts generally defer to decisions from administrative agencies, and in this case, the D.C. Circuit not only says the commission's conclusions are "reasonable" but also "rather compelling."

Writing for the appellate court, which has decided to turn down a petition for review, Judge Laurence Silberman also points to the Postal Service's fundamental logic flaw.

"The Service enjoys market power in the [DVD-by-mail] (upstream) distribution market regardless of conditions in the [streaming] (downstream) content market because it does not face any competition in the distribution market," writes Silberman in the opinion. "Whether because of economic or legal hurdles, no other business offers or seems reasonably poised to offer a competing distribution channel that Netflix could readily take advantage of."

Silberman adds that Netflix simply has no other way of transporting DVDs by mail, so even if Netflix wanted to exercise bargaining leverage, there would be no way for it to do so. He also won't give the Postal Service any breaks for the speed of technological change, writing that the commission was not "unreasonable to hold that the potential technological evolution suggested by the Service was too speculative to condition its market power analysis here."