Seth Shapiro's Business Innovation Blog

Last week, we looked at the factors that made Netflix one of the best media brands in America. We reviewed the amazing growth of their DVD business, peaking when it surpassed Comcast this summer as the #1 subscription service.

This triumph was followed by a massive stock selloff and widespread customer fury.  What happened? I’d suggest the breakdown came from a perfect storm of factors:

1. Streaming is a much tougher space than DVD.  Netflix dominates the DVD rental space. With the exception of one competitor (Redbox), they virtually own the business.  But streaming video, where they see their future, is a vastly different business.

In streaming video, Netflix competes with the A List of digital media:  Apple, Amazon, Google, Comcast and Hulu. All of these but Hulu (which is still privately owned) dwarf Netflix in market cap and cash on hand. Amazon’s current value, for example, is about 23 times that of Netflix. And Apple is worth about 85 times Netflix. Those are much bigger warchests for content licensing.  So if it comes to a price war for movie and TV streaming rights, Netflix has got a job on its hands.

2. Rights for Streaming and DVD are completely different.  The angriest complaints I’ve heard from Netflix subs concern why so much content is on DVD but not on Netflix Watch Instantly. Customers see that Netflix has a movie, and wonder why the company doesn’t let them watch it now.  The reason is that Netflix does not have the legal right to do so.

In fact, I’d argue this is one of the major missteps Netflix has made: they have not explained to customers that having the right to loan DVDs does not give Netflix the right to stream the same program. Of course, the reason they do not have these rights is that those rights are expensive – and that there is much more competition for internet On Demand rights than there is for buying and loaning DVDs.

3. Communication Breakdown.  CEO Reed Hastings has been a darling of Wall Street and the press, a chill entrepreneur striking fear into Hollywood fat cats.

Until August.  Then came the decision to split Netflix into two separate businesses – resulting in a massive price increase for subs – and major outrage from customers and fans.  The decision to split its DVD and streaming services into two separate businesses caused massive customer outcry, eventually resulting in losses of over 800,000 US subscribers.

The low point was Hastings’ widely-quoted apology email, in which he took responsibility for clumsy communication… but went on to announce the rebranding of Netflix DVD, to a separate business known as Quikster.

Huh?  This seemed to many to increase the perceived cluelessness, culminating in this awesome Netflix parody on Saturday Night Live.

That was probably the bottom. The subscriber losses may have run their course, the company is once again closing distribution deals with studios, and international expansion plans continue in places like Brazil and Spain.  Netflix is still a great value for many people, and the 10-20% or so of their titles available on streaming still amounts to over 50,000 titles, supported by a fantastic recommendation engine and a customer experience people love.

Even the best-known Netflix skeptic, fund manager Whitney Tilson, has had a change of heart.  Tilson famously shorted Netflix–  then declared defeat and took his losses as the stock hurtled towards 300.

Tilson was vindicated in the end, when the stock plummeted to 72. But he made financial headlines when he declared that he’s now looking to get long:

“If you go back and read our original Netflix piece, we pretty well nailed it… But we were quite early … almost a year early. So we got clobbered to the point that we couldn’t take the pain, and we just said, ‘You know what? There are better shorts out here.’ So we covered and got out.  Watching our investment thesis eventually play out and not participating in it has been very annoying,” he said.  Now, Tilson is thinking about going long; the only question is when.

Like much of the cord cutting story, discussions of Netflix are often ruled by hand-waving and over-reaction.  Here’s the bottom line:

1. Don’t believe the hype. Is Netflix going to go out of business? Absolutely not. Is Netflix going destroy Big Cable? Absolutely not.

2. A great source of convenient video. Netflix will hold onto its place as an inexpensive source of video wrapped in a great service, available on a ton of devices. Consumers will continue to pay for it, as part of a larger group of places they go to get video.

3. Netflix = catalog. Netflix will offer a good selection of somewhat older movies and TV – not as fresh as the options in other places, but much better than Comcast CEO Brian Roberts implied when he quipped “What used to be called ‘reruns’ is now called Netflix.”

4. Boutique Original Programming Down the road, look to Netflix to offer some great original programming, taking a page from the HBO playbook.

Next Up. Where will we get the rest of our video?   Next week, we’ll look at the major role Hulu could play in the future of distribution, and why. Then we’ll uncover the long-term strategy of Comcast, before we go on to look at Amazon, Apple and Google.

As always, looking forward to your great feedback and questions – please keep them coming.

Posted in Blog by Seth Shapiro.

  1. Great piece Seth – clear, concise and very definitely in the much needed “cutting-through-the-crap” vein.

    Your point 2 about the consequences of poor customer communication is particularly well made, as is the reminder of where Netflix sits among the rest of the pack and that there is no way it will kill the cable business. Disruption yes, destruction no.

    Cheers,
    Mike

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