Blog Archive for September 2011

Netflix's Big Gamble

This morning, Netflix CEO Reed Hastings took what may possibly be the biggest gamble of his life. Netflix has been a successful company for over a decade, starting as a DVD-rental-by-mail service since 1998. Ten years later, they started offering streaming of movies and TV shows over the Internet, no longer requiring the DVD-by-mail. In the last six months or so, some Internet statistics companies (which are a bit spurious) claimed that as much as 40% of prime-time Internet traffic was Netflix Instant traffic. Netflix was a force to be reckoned with, but the last couple months, they've been struggling with that status and may be losing their footing.

Recently, many casual Netflix customers have been threatening to cancel their service due to Netflix's termination of their contract with Starz. Starz was providing access to a limited amount of new-release movies on Instant, but it was a drop in the bucket of the streaming content. But those of us who like quality in movie presentation were nonplussed with the Starz contract, as most of the content was not in HD and sometimes in a full-screen presentation instead of the original widescreen. Personally, I believe the cancellation of the Starz Play deal was a great move for Netflix because it allowed Netflix to spend that money to make deals directly with the studios.

The next big move was Netflix's announcement a couple months ago that September would bring two different feature sets to the service. Streaming, which started as a free bonus for DVD customers just over 3 years ago, was now to cost $7.99. If you wanted to keep the DVD service as well, that was an additional $7.99. From a business point of view, I think this made sense to some extent. As Hastings says, each of these products has their own business model and set of costs. But, while I was happy to pay $7.99 in August, I'm not happy to pay $15.98 in September. The Instant service has drastically increased in value to me with the inclusion of many more great TV shows and some movies, but to suddenly pay twice as much for Netflix service is a hard pill to swallow. And while there are days and days of content I want to watch on Instant, there's no way to watch that movie that I just recently missed while it was in theaters if I cancel the DVD-by-mail service. Long-time Netflix customers either have to choose to pay the big bucks or cancel one half of their services. This would have been easily mitigated by offering a discount of $3 or so when both services were included. And, honestly, when I got an e-mail from Netflix (which is much like this post from their official blog) this morning apologizing, I was expecting that kind of discount. But what we got was much more confusing.

Netflix CEO Reed Hastings apologized not for the price hikes, but he apologized for not really telling us why the price hikes were happening. Funnily enough, that was not something I thought he needed to apologize for. I already explained why the pricing was separated; the services are really two separate products and should be treated as such. I was on board with that. In fact, just a few days ago I canceled the streaming service because I was worried I'd spend all winder watching every episode of Star Trek and getting nothing productive done while online. No, the real reason the price hikes were apparently happening was much more puzzling.

As Hastings mentions in his blog post, he firmly believes that streaming movies and TV shows to your home via the Internet is the future. I believe he's right. Once the Internet is fast enough to deliver high-quality content to the masses on a just-in-time basis, the movie disc will disappear. (While the technology to deliver content this fast exists, it seems that most of the developed world is still years away from achieving this.) Also, as Hastings says, for five years, he has feared that he'd miss that point. He doesn't want Netflix to become the next AOL or Borders, where the business model died and they went down with it. For years I've heard him talk about this and thought he was on the right track, but today it has become apparent that Hastings is no longer healthily fearful of the future, he's foolishly obsessed with it.

The fact is, Hastings's Netflix is far from missing the trend. In reality, Netflix has done most of the work to make the trend happen. Before Netflix Instant appeared, almost no one was streaming movies online. YouTube had only been around for a couple years. Heck, Hulu had just started a year before. Netflix brought streaming video from a thing the computer nerds might do to millions of American households in the span of a couple years. Their streaming service is still built into thousands of different TVs, Blu-Ray players, and Internet-connected boxes and phones besides your computer, more than any other competitor. Without Netflix, Blockbuster would still be going strong and we'd still be going there every week to get the next disc of 30 Rock for a week. There would maybe not even be a streaming video market.

This morning, Hastings announced that the reason the pricing was changing was because the Netflix DVD service was being spun off into a subsidiary called Qwikster. Apparently it wasn't enough to have two separate products, but each product had to be under it's own brand and company in the name of bringing "simplicity for our members". (Speaking of which, I think many companies would like to have just two products -- many companies Netflix's size have hundreds of products.) For gamers, there was the addition of disc-by-mail game rentals via the new Qwikster product announced, so at least some customers may find a silver lining. But for the majority of Netflix users, it seems like the only result is more confusion and pain.

Netflix and Qwikster, for those who really enjoy movies, are not two separate products, they are two parts of the same whole. If I find a movie I want to watch, I add it to my Netflix Queue. It's my "what I want to watch" list. It's been great that Netflix says, for now, "Instead of waiting for you to get to this in your queue, you could watch it right now via Instant." But, as described now, a subscriber to both Netflix and Qwikster would have two separate queues with no interaction. If Qwikster offers a similar developer API to what Netflix offers, I"m sure someone will write an app to sync the queues, but it will inherently not work as well as a first-party solution. Two separate services do not provide as comprehensive a solution for their most devoted customer, I believe.

One unified company also seemed to be a good place to negotiate with studios. A streaming-only Netflix service is entirely dependent on the whims of the major studios. If the major studios pulled all their content off of streaming, Netflix wouldn't have much content to speak of. Netflix does give the studios substantial money for the rights to stream their content, but it's not as substantial per viewer as the studios selling it on iTunes or Amazon or via DVD or Blu-Ray. It's much less. Many content properties are worth more than the earnings the studios get from Netflix, and if they want to make more per viewer, they can cut Netflix off. In short, if the studios want to shut Netflix Instant down, they definitely can now because Qwikster is no longer a built-in bargaining chip. That doesn't seem like a better spot to be in to me.

In the long term, I think it makes sense to relegate Qwikster to a separate service, company and brand. Qwikster may thrive for a number of years, but it is a dog that has seen its day and will not grow. Netflix is where the exciting stuff is. But I think that Reed Hastings has, overcome with fear, split them off a couple years too soon. Even he admits in the blog: "It is possible we are moving too fast – it is hard to say." He's right, it is hard to say. I think the next few years will be tough for Netflix and its subsidiaries to regain the momentum that it has lost in the last couple months, but they may be able to keep the car running. Or, we may be witnessing Netflix flying through the air, about to crash into a concrete wall. Only time will tell.