What would Netflix do?

September 20, 2011

By John C. Abell
The opinions expressed are his own.

There was a time, actually not that very long ago, when the headline for this post would have been an excellent question. NetFlix enjoys customer loyalty which rivals the rarified levels of Apple. Its stock price was setting records — so much so that some head-scratching Street types couldn’t exactly explain why, without resorting to the sort of “good will,” “first adopter,” and “eyeballs” metrics that got us all into trouble a decade ago. Netflix even got extra cred with the Netflix Prize competition, a $1 million bounty for anyone who could just incrementally improve the service’s legendary recommendation algorithm.

It short, it looked like Netflix could do no wrong. It was the Google of streaming media. It created a DVD revolution, allowing couch potatoes to travel no further than their mailboxes for DVDs, killing off the Blockbusters of the world (which had killed off the local video stores) — and then it disrupted its own disruption. Netflix is already a verb — like Google — and was on track to become an ultimate comparative entity: Soon there would be phrases like [your rock star company here] is the Netflix of [insert vertical].

But a funny thing happened on the way to world domination.

First Netflix pissed off everyone with higher prices by turning a buffet plan for streaming plus DVDs by mail into two a la carte offerings, at a significantly higher cost for a woefully underestimated number of customers who still wanted access to both services. This untelegraphed move was accompanied by a poorly-received explanation about why, even if this wasn’t a good deal for customers, it just had to be.

Now, Netflix has double-downed by spinning off its DVD business entirely into a separate company, called Qwikster. The decision, announced in a blog post late Sunday night, took everyone by surprise, to say the least — engendering the same sort of “Really?! That can’t be!” initial reactions that met Coke’s decision, a quarter-century ago to, well, stop making Coke.

For some reason (emphasis on “some”) Netflix has decided to abandon the best competitive advantage it still had: The ability to pacify customers annoyed that a movie isn’t available on demand with a seamless counter-offer to mail a DVD. It remains to be seen how well Qwikster will be integrated with Netflix, but it is logically impossible that it could be integrated with Netflix better than when it actually was Netflix.

So, what’s the story here? The big problem in the streaming media space isn’t the tech. There is no problem providing instant gratification for anything that can be digitized, including three-hour movies. The issue is the economics of entertainment. It is still in the best interests of Hollywood to have exclusive theatrical releases and prime-time programming because that’s where the money is.

It’s the same in all media: Books and newspapers and magazines would love to go all digital, for the production and distribution cost savings alone, but the dollars aren’t the same. Netflix and Hulu and others satisfy a craving that will only increase, but the demand clearly is outpacing the supply, and this imbalance is sure to be a fixture for the foreseeable future.

Netflix managed to cover the waterfront, by backing every horse: gaming consoles, computers, smartphones, tablets. Their digital distribution system is a marvel, and, as impressive as their mail-order analog was: fulfillment worthy of Amazon Prime (which, by the way, offers a smart, competitive streaming service of its own). The story of how CEO and founder Reed Hastings decided at the last minute not to back the “Netflix Player” — what we know now as the Roku box — is the stuff of genius.

There might be a very smart business reason to separate out what are, arguably, two businesses. The trick, though, is to make this seamless to the customer. If that is unavoidable, then they need to come up with some combined strategy that softens the blow, buys off the loudest malcontents and bleeds contrition.

The real mystery here isn’t why Netflix might be making a savvy business decision, but how, as Hasting said, it so utterly botched the messaging. Doubters on the Street now have the upper hand, pushing Netflix to less than half of its historical high of about $300. Perhaps they think that by creating a separate company for physical media, Netflix has succeeded in creating yet another competitor in what is already a very competitive space.

By creating a separate disk business Netflix has suddenly given everyone who happily let Netflix take care of everything an excellent new reason to consider the alternatives. What will be the magical differentiator about Qwikster, anyway?

Amazon, Wal-Mart, Apple, and who knows who else wants a piece of this action. And, all of a sudden, they will all have much more recognizable brands in this space than some company called Qwikster.


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Hastings will not have a job for much longer. Nominated for worst CEO of the year.

Posted by blee808 | Report as abusive

The key thing is that the CEO Mr. Hastings did not have a good reliable (less predictive error) price elasticity (from a statistician/econometrician) point of view. If it is properly predicted with least error and validated against all kinds of what if scenarios along with their corresponding opportunity costs there is a very high probability (almost 1) this could have been avoided – a botched case of loosing $4 Billion dollars and counting…

The CEO still can redeem at least a billion dollar if he acts on the following…

Wish he could save those money to invest back in the company.

Posted by CRMstrategies | Report as abusive

Netflix is on the ropes here. DVD mail order is a business with a very small profit margin. Hollywood is attempting to squeeze more out of Netflix per year than they make in profits. 1.94 billion dollars is what Hollywood is pushing for even if they bargain that down to 1/2 the starting point it’s far more than total profit for both business units. I suspect they are separating the business into two units so that if the cable companies and Hollywood succeed in killing their streaming side they still have the DVD mail order business.

I’m not saying they are down and out but they are upsetting the revenue model of the content providers. The content providers want them dead. The cable companies want them throttled or dead. It just surprises me that most people overlook these simple facts. What do they do if hollywood just cuts them off? With DVD’s they can buy them retail like everyone else. With streaming they just lose.

Posted by samuel_c | Report as abusive

“By creating a separate disk business Netflix has suddenly given everyone who happily let Netflix take care of everything an excellent new reason to consider the alternatives.”

The more I think about it, the more I think they did this as a forced move to appease either distributors or shareholders, although I doubt the facts will ever be public. The streaming service is certainly worth $8/mo, but now they have to struggle against customer AND distributor discontent.

Posted by hypodoche | Report as abusive