Atomic Tango

A Heavy Price to Pay: The Netflix Debacle

September 20th, 2011 · 1 Comment · Case Studies

by Freddy J. Nager, Founder of Atomic Tango + Netflix Qwikster Netflix Customer

Up In Smoke: Qwikster

What were they smoking?

You’ll find lots of articles and editorials skewering Netflix and its CEO Reed Hastings, including this comprehensive one at CNET, which describes all the following events:

  • Netflix’s 60% price increase
  • the ensuing defection of hundreds-of-thousands of paying customers
  • its subscriber-aggravating loss of the Starz distribution deal
  • the impending future of higher content-licensing costs
  • the entry of other major competitors, such as Amazon
  • Hasting’s mea culpa to subscribers via email
  • his decision to make the DVD business a separate service called Qwikster
  • and the company’s crashing stock price

The key strategic flaw? Not the 60% price increase — Netflix does need to cover its content-licensing costs. The lethal mistake was grossly underpricing its unlimited streaming service in the first place…

Netflix must have known that Hollywood would demand a bigger slice of the pie. Nobody can offer infinite Hollywood content and expect Hollywood to not pull out the forks and knives. The only outsider who has ever successfully negotiated with Hollywood is Steve Jobs, but he’s capable of walking on water. Everyone else, from Starbucks to Vivendi, Matsushita to Coca-Cola, has found that swimming with sharks is exhausting and can eventually cost an arm and a leg.

So why did Netflix underprice?

Companies often do so to penetrate a market and steal market share. That certainly worked for Netflix, as it acquired millions of subscribers and drove Blockbuster and other brick-and-mortar competitors mostly out of business. Once the competition is destroyed, the victor raises its prices. That’s predatory pricing in action.

But as Netflix discovered, if you grossly underprice to land a customer, you’ll find it extremely difficult to significantly jack up prices on them later. Customers will react angrily and vent their fumes on that social media thing. To avoid this, Netflix should have clearly stated that the low-priced unlimited streaming was just a limited-time introductory offer, while also clearly stating the actual price, which is still an awesome deal (all the videos you can watch ad-free for $8.95/month, which won’t buy you a popcorn and a Coke in most movie theaters).

One finance expert commented that Netflix successfully achieved a 60% price increase at a cost of only 2.4% of its customers — the net result being a bottom line gain. But that’s too limited a consideration. The customer attrition hasn’t stopped, yet, and Netflix’s customer acquisition costs are likely to increase now that the service is priced realistically and the company is perceived as having “ripped off” its past customers. Plus, even at just 2.4%, that’s still too many paying customers (and cash flow) to send to your competitors. I’m sure there are a lot of smiles over at Amazon and Hulu today.

What could be worse?

Hastings had also projected subscriber growth to investors, and Netflix’s stock was priced in anticipation of that growth. Where’s the stock price now? The last time I checked, Netflix was trading at $130/share — quite a drop from its 52-week high of $304 just a few months ago. That’s a market cap loss off about $9 billion. Trust me, Netflix will be hearing a lot more from its investors, who are now seeing red (and I’m not referring to the envelopes).

Above all, the previously gleaming Netflix brand has taken a beating. Once celebrated on magazine covers as the unstoppable startup that revolutionized movie rentals, Netflix is now being depicted as the bumbling opportunist that took its customers for granted, miscalculated the cost of Hollywood content, and issued faulty projections to its investors.

That formerly spotless brand wasn’t helped by Hasting’s hasty launch of a new brand, Qwikster. (Note: see update below.) Social mediaphiles quickly identified Qwikster as the Twitter handle of some stoner (see his original Elmo image above). Again, Hastings looks like someone who jumps without looking.

Going forward, Netflix may stabilize its membership base. It may sell off Qwikster to someone who doesn’t mind all the shipping-and-handling hassles of DVD rentals (hello, Amazon, got a sec?). It may negotiate some exclusive deals for prized content and produce its own content to differentiate from a stampede of competitors. Netflix will certainly no longer be the sensation it once was, but it will exist in some form or another. Kind of like that other once high-flying Internet startup that had millions of paying subscribers, fooled around with Hollywood, and miscalculated the future before tanking on its investors. What’s it called? Oh yeah, AOL.

Hello, Netflix, you’ve got fail.

Update 10.10.11: Admitting that the Qwikster move was a mistake (let me guess — they could find no prospective buyers for it), Hastings has dropped the Qwikster name and plans to keep the DVD and streaming services together under the Netflix name. Perhaps the only person bummed about this latest move is the guy who owned the name on Twitter.

Update 4.10.14: Netflix did decide to produce its own content, such as “House of Cards,” which helped rejuvenate the company. Such a move should have been made before announcing a price hike and scuttling distribution deals. That said, Netflix has regained its footing and its stock value. And now it’s facing new predators: the internet service providers who want a piece of the pie. Stay tuned….

Tags: ······

One Comment so far ↓

  • Rick Sanchez

    Pretty fair analysis. I’m a huge Netflix fan. I LOVE those DVDs in the mail. Why they didn’t charge extra or as an either/or charge for the new streaming service when they launched it is beyond belief, especially considering the competition and constantly evolving entertainment distribution models and methods.

    So changing the name and putting it as two separate billing items on your credit card somehow makes up for a boneheaded business move?

    I’m still not sure if I’m going to cancel my subscription, but I’m definitely looking at alternatives, where I was not before this letter showed up in my email. The new cross-branding campaign with Charter Communications (another real winner in customer service area) also does not bolster my confidence in their decision making process.

Leave a Comment