Did Netflix Blow It?

It was a mere two weeks ago that Netflix announced that it was increasing its subscription fees by as much as 60%.  That launched a tsunami of customer complaints.  Anyone with their pulse on social media felt the blood pounding through the network veins of Twitter, Facebook, Google+ and blogs.

On Monday’s quarterly earnings call CEO Reed Hastings acknowledged that the price hikes are having a ‘negative impact’.  Results were mixed, Wall Street was unhappy, and shares fell 10% in after-hours trading.

Hastings went on to say some other things:

• “We knew what we were getting into.”
• “We feel bad about having our customers upset with us.”
• “We’re feeling great about the decision, as tough as it is."

It is useful to understand what Netflix did, why they did, and which customers are unhappy - and then question what Netflix might want to do next.

What Netflix did: unbundled its streaming video and DVD plans.  Before, one could opt for streaming video and one DVD for $10 a month (actually $9.99).  Now the plans are priced separately - DVDs or streaming video at $8 a month, or $16 for the pair.  For streaming-only subscribers (40% of Netflix’s 24.6 million base) and DVD-only (12% of the base) the price hike isn’t a big deal.  The 60% bump hit he 48% of the base that subscribes to both DVD and streaming.

Why they did it: Hollywood and the changing dynamics of content distribution.  It took years for motion picture studios to get comfortable with videotape and DVDs.  Once assured that they could control distribution and released timing they were off to the races.  In fact, not only did theater revenue not tank as had been feared, but overall revenue increased.

Video streaming is a different game.  Distribution control is in the hands of a few dominant players - Netflix, Amazon and Google among them.  It harkens back to broadcast television where ABC, CBS and NBC controlled the medium for a half-century.  Add cable providers into the mix (especially Comcast, new owner of NBC Universal) and a combined content and distribution player enters the scene.

Not only is there money to be made from content distribution, but there’s a ton of opportunity with advertising.  No one has figured it all out yet.  The economics are complex, and technology is reaching the market faster than strategic options can be lined up.  

There’s are other matters to be concerned about, too:

• What’s occurred in the recording industry in the past decade (e.g. plummeting CD sales).  No picture studio wants to be Napstered.  
• Fringe players who may not be happy staying on the fringe -  Facebook, Apple, Walmart - and who possess the muscle to be spoilers.

There is much at stake.

Content is king.  Rights to the hottest new movies and TV shows are on the line.  That’s where the lever rests on the fulcrum for the studios.  They are jealously guarding hot content and pricing it at a premium.  Therein lies the rub for Netflix.

Netflix cannot grow a profitable long term streaming business with yesterday’s content.  Subscribers want the latest and greatest.  But, to provide that and stay profitable, Netflix has to shed the cost of physical DVD distribution.

Why Customers are Upset: At $10 a month subscribers get the best of both worlds - new releases via DVD, and everything else streamed to their flat panels.  It’s good value.  At $6 more, many would argue that it’s still good value.  

But for the many of the 48% of customers who, by design or inability to migrate near term to streaming video, a 60% bump seems a shot to the gut.  Reading the online comments suggests that these folks were expecting an orderly, steady-as-she-goes migration - not a shotgun start.  As a result they feel caught off guard, backed into a corner and betrayed.

Everyone enjoys hitting the piñata; no one enjoys being the piñata.

What’s to be Made of all This?  Let’s first get something straight.  I don’t believe that Reed Hastings or anyone at Netflix has enjoyed the past two weeks, or is as excited about the upcoming quarter as the scripted rhetoric of the earnings call would have us believe.

I’ve sat in more than my share of similar corporate meetings where the unpleasant trade-offs between having happy customers and happy shareholders end up on the table.  Scenarios are considered.  Spreadsheets tally the financial upside and customer attrition downside.  The CFO usually assumes customers are the stoic kind who grumble at first, but soon settle back into civility and teh uninterrupted routine of paying their invoices.

I’d wager that, though this customer reaction was taken into account by Netflix when evaluating options, it wasn’t the outcome they expected.  Otherwise, they would have had better damage control in place (including a better-prepared call center than was apparently on deck).

Customers fear when upstarts become successful and powerful.  History shows that powerful firms begin to act like monopolies: pay the price or find an alternative.  I’m not accusing Netflix of this.  But I am suggesting that enough of their customer based has a chip on its shoulder to be worrisome.

Can (should) Netflix do anything?  To begin, Netflix is not about to fall off a cliff and into the abyss anytime soon.  How it conducts itself in the next few months will, however, set its course for the next several years.  The situation is not trivial. 

There are three things Netflix should seriously consider:

1. Leave the new pricing as is, and secure in-demand content.  There’s little percentage in retreat.  The issue is about securing the rights to in-demand content.  The studios hold that card.  The sooner Netflix delivers high-demand content (as they intend) the sooner customers receive the value.
2. Expand choice and access quickly for streaming customers.  Nothing neutralizes lingering doubts about a price increase than seeing immediate increase value.  Price increases kick in September 1 - so should new, fresh content.  Lots of it, too.  It’s the strongest incentive they can put on the table for DVD customers to migrate fully to the streaming option.
3. Decrease DVD waiting queues.  These customers feel the price squeeze most, and are at greatest risk of loss.  The biggest complaint among them is the long wait times given the demand for recently released DVDs.  Reducing lead times by increasing the number of DVD copies is the best short term salve that Netflix can offer them.  Make no mistake: these customers now know for certain that they must migrate to streaming video.  Soon.

Netflix can bring its customers along, or risk leaving them behind.  At a combined 48% of their customer base, it’s a no-brainer.  They may not have expected to be on this journey so soon, but Netflix can make the trip enjoyable for them.