It’s almost as if over the summer someone at Netflix decided that things were just going too well. The company stood astride the entertainment industry, one triumphant foot atop the corpses of brick and mortar video rental stores. Studios hated them, users loved them, investors respected them. The stock price peaked in July at $299 per share. Then Netflix took a baseball bat to their own success. They substantially raised prices and announced that they would be splitting the company in two, breaking apart the DVDs by mail business and the streaming video business into separate companies. Five months after that peak, Netflix’s stock is selling for only $75 per share.
The company clearly didn’t do their homework before the announcements, facing not only direct business consequences but an outrage from a customer base that had previously been one of the happiest in the economy. People liked Netflix, which is a far more difficult standard to reach than mere profitability. Customers will like products, but move on when something newer comes out. In the rare cases in which customers actually like the companies themselves though, they develop a loyalty, giving a company second chances when they would otherwise move on to something else. That’s a difficult situation to create, it can’t be bought and it can’t be sold, but it can be shattered astonishingly quickly.
In the weeks that followed, Netflix lost over 800,000 subscribers, representing at least $50 million in annual revenue. There are a lot of excuses that make it out to not be that big of a deal. They still have another 23 million subscribers, all of whom are paying more than they were six months ago. And of course those 800,000 were probably the non-users anyway for the most part, the people on the one-disc plan with a red enveloped disc of When Harry Met Sally, which had been sitting on top of the DVD player for ten months. They get an email that the price of that dust gathering disc was going up and it’s easy to just click the link in the email and cancel the service.
“Qwikster” quickly became a cultural joke, easy slang for a terrible business decision. They didn’t even bother making sure they controlled the Twitter handle before the announcement, leading to a few blips of fame for the guy who actually did.
The root of the problem is that Netflix made its name on those little red envelopes that come in the mail. Take those away, take away the distribution centers in sixty cities that ensure the envelopes keep flowing at just a couple of days between discs for most subscribers, and all you’re left with is the website. It’s a good website, but so is Hulu.
Netflix’s initial success was built on doing exactly what video rental stores did, only doing it better and cheaper. No late fees, one charge per month on a credit card. No going to a store and standing in line. Not having a storefront meant being able to have an inventory of 35,000 movies instead of what could be crammed into a strip mall. I don’t have to sell you on it, their record and the fact that most people reading this have a Netflix subscription do that.
But perhaps most powerfully, the business model was built on an existing one. Want to start a website that streams movies? You can’t. You won’t be given the licenses for less than millions of dollars. Want to rent out physical discs though and there is already a mechanism for acquiring the product that has been tested and defended. Just buy the discs the exact way that every other video store does. It’s a business that legally cannot simply be unplugged by the content creators.
It’s a silly model from a certain point of view. Streaming video obsoletes the little red envelopes. Physically carting around optical discs to millions of households that have broadband connections is absurdly inefficient. But as absurd as it is, and as correct as the Netflix board is in arguing that from a strictly business perspective, the business of red envelopes and the business of streaming digits have nothing to do with each other, those envelopes are what ensure that they still are allowed to stream those digits in the first place.
The deeper problem is that if the envelopes stop flowing, then Netflix also has very little economic reason for existence. Their business existence depends on the content creators, but benefits from being separate from them. Renting physical DVDs from fifty different networks or studios is a nightmare if you have a different store or service for each of them. But getting bits streamed from a bunch of different ones is not the same problem. That changes the company from being a service to being an aggregator, and that’s not worth a monthly service charge.
This explains why Netflix has made such a press in the last year to start developing original content and to provide venues for independent productions. It’s trying to add value so that it’s not just replaced by a handshake between networks and a few lines of PHP on the backend. But in order to make that work requires customer loyalty and trust. Six months ago Netflix had that. Six months from now? They’ve got some work to do.
Steven Lloyd Wilson is a hopeless romantic and the last scion of Norse warriors and the forbidden elder gods. His novel, ramblings, and assorted fictions coalesce at www.burningviolin.com. You can email him here.