Wednesday, September 21, 2011

The Netflix Announcement - My Take

A couple of days ago, I, like many others received the below email from Netflix CEO Reed Hastings. Since that time the Internet has been buzzing with responses (mostly negative) to the email, the changes, and Netflix in general. I have a different take. If you read most of the criticism it sounds something like this "Reed Hastings is a brilliant guy its amazing that he would make a blunder like this..." Perhaps if you think of business as a sprint, and the recent Netflix changes as a false start you'd be right. A better analogy might be chess. There are plenty of scenarios where the sacrifice of a single piece leads to winning the game. So here are a couple of reasons I believe Netflix has are the moves its been making.

1. Reality Check
   Up until now Netflix's primary expense has been postage. The 45 to 50 cents it takes to get us those red envelopes. It doesn't take a rocky scientist to see that depending entirely on usage patterns that business can be very low margin or a loss due to the cost of delivery. This upward cost pressure made an eventual increase in the price of the service inevitable. Secondly, while the Netflix streaming service started out as some nice extra change for content providers, they have figured out that just like the cable companies they've been exploiting with high content fees, they'd like to do the same with Netflix. This applies pressure to the company in two very important ways. 1. The cost of content greatly affects the math used to keep the service in the black as it grows. 2. Pressures the company to get rid of its commercial free model. One of the things that makes the service great is that at a lower time expense from cable or any other media, and at a lower cost, you get entertainment you want. Finally, Hastings realizes that his goal is not to be the cheapest option in addition to cable, he wants to be the replacement to cable.

2. The Master Stroke that is Qwikster
   My guess is that Qwikster remains in the Netflix tent for no more than a year. Hastings will use that year to show its profitability and success as an independent company (coupled with the 8 or so years of results before streaming was introduced) Then Qwikster will have a big for sale sign in front of it. Netflix will get a windfall of billions and the cash will be used for a content spending spree. (It should be noted that exclusive content deals expire over the next couple of years). With Qwikster out of the way, Netflix will be able to focus on becoming the new cable company. One that requires no onsite technicians, no cables, and hopefully no commercials. Remember the days when cable meant virtually no commercials? That would be Netflix for at least another 5-10 years. Further, by rebranding the mail DVD business, when it finally goes the way of the dinosaur, eight track, cassette tape and the floppy, no one will see it as a Netflix failure.

3. Content Rules
     Netflix knows that content rules as king. But they have also invested longer than anyone else in getting themselves a platform that s easy to use and works well. I'd be surprised if they hadn't also amassed a view patents along the way. This means that while their present spate of content is somewhat underwhelming, they can still pack a punch others can't. When the time comes, we may see them get back in the fight for Hulu or wait out their current content contract slump until they make a bigger splash. Once they do, you can kiss Blockbuster's soon to be announced streaming service and other comers goodbye. (Seriously, can Blockbuster do anything right anymore?)

Some of the comments have been frightfully naive regarding the Netflix pricing, Qwikster change. Netflix is first and foremost a business. Their job is to make money. Their costs are going to skyrocket next year and I'd rather pay a higher (but still way cheaper than $75+ for cable) price and have the service viable then have it disappear like so many too good to be true items before it. Hope I'm right, I really don't want to go somewhere else to stream..

The Hastings Letter:

Dear JAA,

I messed up. I owe you an explanation.

It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology. Let me explain what we are doing.

For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming. Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us). So we moved quickly into streaming, but I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do.

So here is what we are doing and why.

Many members love our DVD service, as I do, because nearly every movie ever made is published on DVD. DVD is a great option for those who want the huge and comprehensive selection of movies.

I also love our streaming service because it is integrated into my TV, and I can watch anytime I want. The benefits of our streaming service are really quite different from the benefits of DVD by mail. We need to focus on rapid improvement as streaming technology and the market evolves, without maintaining compatibility with our DVD by mail service.

So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently.

It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”. We chose the name Qwikster because it refers to quick delivery. We will keep the name “Netflix” for streaming.

Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to to access their DVD queues and choose movies. One improvement we will make at launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done. Other improvements will follow. A negative of the renaming and separation is that the and websites will not be integrated.

There are no pricing changes (we’re done with that!). If you subscribe to both services you will have two entries on your credit card statement, one for Qwikster and one for Netflix. The total will be the same as your current charges. We will let you know in a few weeks when the website is up and ready.

For me the Netflix red envelope has always been a source of joy. The new envelope is still that lovely red, but now it will have a Qwikster logo. I know that logo will grow on me over time, but still, it is hard. I imagine it will be similar for many of you.

I want to acknowledge and thank you for sticking with us, and to apologize again to those members, both current and former, who felt we treated them thoughtlessly.

Both the Qwikster and Netflix teams will work hard to regain your trust. We know it will not be overnight. Actions speak louder than words. But words help people to understand actions.

Respectfully yours,

-Reed Hastings, Co-Founder and CEO, Netflix

p.s. I have a slightly longer explanation along with a video posted on our blog, where you can also post comments.

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