How the lens of Netflix gives foreign exchange a new look

A “CRACKDOWN” by Netflix to stop subscribers from taking advantage of its cheaper pricing in some countries has some viewers checking online for solutions.

Many posters in Reddit forums describe how they have set up Netflix accounts in countries that they do not live in – such as Turkey, Nigeria and Egypt – where subscription pricing is a fraction of the cost compared with their resident countries.

Charges for a monthly subscription in these countries are among the lowest of the 244 countries and territories where the streaming service is available – at less than US$8 a month.

Comparatively, Switzerland and Liechtenstein – a small European country near Austria – have the highest subscription rates at US$28.18, after converting from Swiss Franc to US dollar. These are higher than the US$22.99 in the United States, where Netflix is based.

In Singapore, subscribers pay S$25.98 for the premium plan now, after a recent hike of S$4. In contrast, viewers across the Causeway pay only RM 55 (S$15.66) or 60 per cent of Singapore’s pricing in Singapore dollar terms.

Comparing the price of Netflix in two countries gives an indication of whether a currency is relatively overvalued or undervalued against the other. This is because we can compare the implied exchange rate (based on Netflix prices) with the actual exchange rate.

This week, we examine why there are differences in Netflix prices around the world and whether this can potentially be an opportunity for currency traders.

What’s the difference?

In finance, investors could take advantage of pricing difference for a tradable security, and arbitrage by selling the higher-priced in one market and buying the lower-priced in another market.

Given the differences in the subscription rates and after taking into account favourable exchange rates for some countries, some savvy viewers have leveraged the difference in pricing and set up subscription accounts in Turkey, Nigeria and Egypt.

Song Seng Wun, CGS International Securities’ economic adviser, says: “I think it’s normal human behaviour. You try to get the best deal.” However, he adds that Netflix offerings vary by country and this could have contributed to pricing differences.

This loophole is being eliminated by Netflix, which is asking customers to verify their payment method with local phone numbers, according to Reddit posts. Despite this, users are still seeking solutions to work around the requirements.

Jamus Lim, associate professor of economics at Essec Business School, says that the amount of market power a firm has will make a difference in pricing its offerings, as well as whether it is trying to capture more of market share, along with the willingness of consumers to substitute the product for something else.

“The exchange rate regime (fixed or floating or somewhere in between), level of development of the country, and how strong overall consumer demand is could all also matter at the margin,” the academic adds.

Netflix would likely price subscriptions in countries based on whether it is trying to build up a subscriber base, he says. Given that the costs are largely fixed as Netflix has built its inventory of shows, the delivery of every additional unit to a subscriber is negligible.

“(It) would then adjust this overall pricing by the level of development of the country. Can’t overprice Netflix in Addis Ababa (Ethiopian capital) or Nairobi (Kenyan capital), right? But (it) can likely do so in Abu Dhabi or New Zealand,” Prof Lim says.

Although it may cost the same for Netflix to stream to Singapore as anywhere else, it can charge more in a high-income country, says Walter Theseira, associate professor of economics at the Singapore University of Social Sciences (SUSS).

The supply costs of the product matter a lot, Prof Theseira adds.

For certain goods and services – such as digital services, or pharmaceuticals – where supply marginal cost is minimal, it is really all about price discrimination, that is, pricing based on demand conditions, the SUSS professor says.

However, cost structure matters a lot more for fast food, where it would likely scale with the local market level of economic development (for instance, labour cost), so it is less clear price differences are due to demand differences there, he says.

Netflix did not comment by press time on the “crackdown” or its differentiated pricing.

The Netflix Index

Based on the pricing published on Netflix’s website, The Business Times took a look at how the Singapore dollar stacked up against the US dollar, the Malaysian ringgit and the Japanese yen in terms of foreign exchange rate – the so-called Netflix Index.

The Netflix Index was inspired by the Big Mac Index, a light-hearted invention by The Economist to assess whether currencies are at their “correct” levels vis-a-vis the actual prevailing foreign exchange rate.

The Big Mac Index applies the theory of purchasing-power parity, which states that the implied exchange rate in the long run should move towards the rate that would equalise the prices of a Big Mac – or an identical basket of goods and services – in any two countries.

Simply put, a burger, no matter where it is sold, should be priced the same when denominated in a common currency after taking into account the foreign exchange rate between the two currencies.

According to the Big Mac Index, the burger was selling at S$6.65 or US$5.69 in the United States as of January. Hence, the implied exchange rate was 1.17, that is, US$1=S$1.17, but the actual exchange rate was US$1=S$1.33.

Against the US dollar, the Sing dollar was considered 12.9 per cent undervalued because the Big Mac in the city-state should have been priced at S$7.57, or US$5 based on the actual exchange rate of 1.33.

Against the Japanese yen, the Sing dollar was a whopping 62.9 per cent overvalued as a Big Mac costs 450 yen in Japan when it should have been 730 yen based on the actual exchange rate of 0.91.

Against the US dollar, the Malaysian ringgit was 51.1 per cent undervalued. Against the Japanese yen, the ringgit was 8.6 per cent undervalued, the Big Mac Index showed.

Now let’s apply this to the Netflix Index.

According to Netflix’s pricing, a monthly premium plan costs S$25.98 in Singapore, RM55 in Malaysia and 1,980 yen in Japan.

Against the ringgit, the Sing dollar was 66.2 per cent overvalued at an exchange rate of 3.51 on Mar 18.

Against the Japanese yen, the Singapore currency was 46.2 per cent overvalued.

However, against the greenback, the Sing dollar was 15.5 per cent undervalued.

Overall, the Big Mac and Netflix indexes were broadly aligned in terms of the direction of valuation, reflecting that the Sing dollar was relatively overvalued against the yen and the ringgit.

How useful is the Netflix Index?

According to Prof Lim, if the product is homogeneous and foreign exchange markets are efficient (the rate adjusts quickly without interventions or impediments), then the law of one price will hold, such that the product or service will cost the same when converted to a common currency.

However, if producers exercise some choice over pricing (or if other real-world frictions such as transport costs that inhibit trade are at play) or forex markets are inefficient, then these deviations can exist.

The Netflix Index combines a choice over pricing and effects of exchange rate movements, which can alter the price observed.

A company can choose to set its prices according to the properties of its local consumer market (local currency pricing) or the costs in its producing home country (producer currency pricing).

Are the percentage over/under valuations reasonable? Well, they are unreasonable if you believe that the law of one price must prevail, Prof Lim says.

“Personally, my sense is that the general direction (over or under valuation) is broadly correct, but suggesting that the Sing dollar is 46 and 66 per cent overvalued against the yen and ringgit seems a stretch,” he says.

Currency trading

Could arbitrageurs leverage differences in currency valuations to trade in the financial markets? For example, when the Big Mac Index and the Netflix Index both suggest that the Sing dollar is overvalued against the US currency, they would sell the Sing dollar and buy the greenback.

Such indexes cannot be relied on for making investment decisions, economists advise.

“That’s because Netflix and burgers aren’t the entire economy – they could be, but we’d all be pretty unhealthy, albeit happy at the same time. Usually, such models are used for entertainment,” Prof Lim says.

For the Netflix Index, there are also limitations as the streaming platform is not available in mainland China (the world’s second-largest economy), North Korea, Russia and Syria.

CGS’ Song says that currency valuation differences in the Big Mac or Netflix Indexes can be useful and interesting, but it takes more than just McDonald’s and Netflix for the financial market to determine the exchange rate.

In the case of Singapore, the trade-weighted exchange rate depends on the world’s inflation and other factors, Song says, and the economic strength or weakness matters as well.

“This is also about the country’s management of exchange rate, depending on where we see inflation because we import all our goods and services, even Netflix is imported,” Song notes.

Prof Lim says traders need to look at an aggregate of all goods in the economy.

There are other considerations as well. For example, the weight of a good in the basket that makes up the price index differs from country to country. While Netflix may appear in the consumer price index of Japan and Singapore, sushi probably garners a greater weight in the former’s price basket, as would chicken rice in the latter, the academic says.

“The other reason you’d want to be careful before executing trading strategies of this sort is that PPP (purchasing power parity) tends to be a long-run relationship – estimates in the literature suggest that you get halfway to the ‘efficient’ exchange rate in three to four years,” he says.

“That is an eternity for most traders, and you’d likely go bust with your short covering before the rate eventually winds its way there.”