Netflix recently announced that it is splitting its business into two pieces: 1) DVD by mail (now called “Qwikster”) and 2) streaming media (called “Netflix”) and changing its prices. There was a sizable reaction to this move, from subscribers and shareholders. As a result, Reed Hastings, the CEO of Netflix, sent a note to customers and issued his thoughts in a post called An Explanation and Some Reflections.
My take: This move shouldn’t be seen as a surprise, but as a natural evolution for Netflix. The DVD and streaming operations are completely different businesses, with quite different economics. The DVD business is an distribution-intensive business with high marginal costs associated with the movement of physical DVDs. The streaming business is a technology-intensive business with high infrastructure costs, but low marginal costs.
In addition to the difference in the models, the two areas are at different points in their maturity. The streaming business is much earlier in its lifecycle and looks to have significantly more future growth.
So Netflix needs to develop and execute quite different strategies for each of these businesses. Trying to keep parity in the pricing would either make it too expensive to capture its desired share of the growing streaming market, or too cheap to cover the DVD shipping costs (with appropriate margins). The decoupling of these businesses allows Netflix to develop and execute appropriate strategies for each of them.
When it’s all said and done, I don’t think Netflix will lose many customers and investors will applaud the move. But there are some very important lessons that we can learn from the intense reaction:
- Customers don’t like price increases. No matter how Netflix had announced this change, customers would be up in arms about the price increase to the DVD offering. Sometimes it’s just best to “pull off the band aid” and live with the quick, short-term pain of the reactions. Since businesses often need to increase prices, you have to live with some short-term negative responses.
- You can’t always listen to customers. As I mentioned in a previous post about Steve Jobs, businesses can’t always make decisions based on customer feedback. Customers are almost always reluctant to change. If your business environment is changing rapidly (as it is for Netflix), then you might need to do something that customers won’t like in the short-term.
- Investors overreact. This is my observation. Whenever there is something that appears to be negative news, the stock market seems to overly discount a company’s worth (it also works a little bit in the other direction as well). When you make a key strategic decision, don’t pay attention to your stock price for a month.
- Communicate, communicate, communicate. I love this line by Hastings: “Actions speak louder than words. But words help people to understand actions.” Hastings and Netflix could have done a better job of being more proactive in their communications.
The bottom line: Sometimes success in the future requires letting go of the past