Netflix’s Move to Separate the DVD Business Is More Than a PR Excuse for Price Hike

On Saturday, September 17, I wrote about my thoughts on Netflix’s recent price hike. Just hours afterwards, Netflix’s CEO, Reed Hastings, released a new bombshell through his blog informing the public that Netflix will be moving forward with a virtual (for now, at least) spin-off of its DVD business into a separate brand. I thought it would be wise on my behalf to drop a few lines on my perspective since this new move by Netflix seems to fit well with some of the things I was saying in my previous post.

In essence, I think the move to separate the DVD business even more formally than just through pricing makes a lot of business sense. Here are some quick reasons:

  • The company can communicate clearer messages in its advertising and other marketing materials. Netflix will focus only on advertising the coolness and convenience of watching movies wherever you are, whenever you want, just by clicking a button on your Netflix-enabled device or hitting “Watch Now” on your computer/iPad/smartphone. The newly formed division, Qwikster, will focus on advertising the benefits of having a physical DVD – targeting an arguably different demographic segment.
  • The company will align its P&L even better. Qwikster will have higher costs but will be positioned as the more mature business (whose sunset can be seen down the horizon in a few years). The expectations from this business are going to be different than the expectations from a high-growth business, such as the Netflix streaming division. In addition, Qwikster will be able to “milk” the high-paying customers even better – through add-on fees for Blu-ray movies and video games. It would be much more complicated for the company and confusing for the customer to try to add the extra fees onto a hybrid (DVD and streaming) plan.
  • The company will have a better chance at building its negotiation case when talking to studios to renew or sign new streaming licenses. Now it will be clearer to project how many customers are indeed the “streaming customers” and should be included in calculations of the licensing fees. The DVD-only customers will be easily excluded from the calculation.
  • The company could finally add the “video gaming” feature. With a hybrid model (both DVDs and streaming), it would be confusing to say the least to offer video games rentals but only on DVD. There would have been pressure to add the “video gaming” option to both streaming and DVD, which would all of a sudden position the company competing against both GameFly (for DVD) and OnLive (for streaming).

There are most likely many other reasons, I am sure. But, at least to me, the four reasons above are the main factors.

Now, many detractors have been whining that the split adds confusion and inconvenience. Well, I think the confusion existed before the split, as well. I would go to Netflix, browse for movies, select a movie – only to find out that it is available on DVD only. Then, I’d be disappointed because I really wanted to watch that movie tonight, and would start the search for a movie title all over again. Now, at least, I know that whatever I see on is available for instant watching. And if I really want to see a movie that is only available on DVD, I can go to Qwikster to look it up and order it in my queue. At least to me, that means a bit more order to the chaos. The inconvenience factor I’d simply be tempted to dismiss as a cliche that people throw out there because it has become so popular these days to talk about complete convenience (thanks to Apple, etc.)

Finally, a few words about the brand name chosen for the DVD business. Qwikster does not sound Web 2.0 at all. But wait a minute, is Qwikster really targeting the 2.0 demographic? I don’t think so! I wish I had the breakdown of DVD-only vs. streaming-only customers by age group and geography – but I am willing to bet that most of the DVD-only customers will fall in the 45+ age group and will not be located in “hipster” centers, such as San Francisco, LA, New York… And they are not going to be located internationally. So for them, a brand that sounds “like a MidWestern retail chain from the 1990s” may actually appeal better. Maybe not. Only time will tell.

Please let me know what your thoughts are. I am sure we can start a very nice discussion here.

Update: September 23 2011

Rick Newman posted a very insightful and forward-thinking piece on how Netflix’s actions are focused on the future, but customers need some time to grasp the premise of that future and catch up with it. Definitely, worth reading this post on Seeking Alpha’s site.

Update: September 26 2011

Marc Randolph, the co-founder and former CEO of Netflix, has posted his thoughts on the subject. I am happy to see that my analysis and his perspective converge pretty neatly.

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8 Responses to Netflix’s Move to Separate the DVD Business Is More Than a PR Excuse for Price Hike

  1. Allyn Horne says:

    Emil, there are lots of reasons got Netflix to adjust their business model, and you’ve named a lot of them here. In fact, I would be hard pressed to argue with any of them. My bigger question – which makes me wonder about this spin-off and the execution – is whether the benefits will be outweighed by customer attrition.

    There is no question that Netflix’ previous pricing/business models were unsustainable, especially for the business that they are in. But they violated some fairly seminal rules of customer change management/PR…namely that a customer’s trust must be earned and is not a birthright. Despite wobbly fulfillment performance, Netflix has always had a fairly strong brand (with a high degree of affection from customers). They singlehandedly erased much of this goodwill with their initial price increase communication.

    And the tone/timing (Sunday afternoon?!) of this announcement won’t make things better…I don’t think that they have rebuilt the trust necessary to drop this latest bombshell. They appear rudderless to a customer base that clearly has other DVD rental and media streaming options. And far from compensating for, or making earlier changes better, this communication just reinforces the idea of a company intent on forcing it’s customers to accept changes (which they clearly don’t have to do).

    This may work out well for them…I hope so, if only because I have always liked Netflix, even if my affection for them is diminished at the moment. But they have not made it easy for their customers to cross the chasm with them.

    • Emil_M says:

      Allyn, thanks for your comments. Very well thought, as always.

      I agree that the greatest problem with Netflix at the moment is how they communicated the whole thing. But blame it a bit on the times we are living in. In an era of daily leaks about the upcoming iPhone or iPad, and subterfuge announcements about changed services by Facebook and Google, every CEO feels tempted to act just as cool as Steve Jobs and drop a bombshell in a casual way. Alas, it (almost) always works out for the blessed few stalwarts of Web 2.0, but rarely does so for the rest of the corporate pack.

      Regarding alienating the customer base, I have some mixed feelings. Yes, Netflix definitely managed to tick off a number of customers. But how many of these would defect is questionable. I can’t help but think of some more blatant cases of completely ticked off customers who still stick around with the company, even if they hate its guts. Comcast and AT&T come to mind. Yes, they got defectors but they also continued to grow healthily in the meantime.

      There is competition to Netflix but it is not (still) a fully fledged threat. Red Box is great as long as 1) you want to watch a super mainstream and current blockbuster movie; 2) you have a Red Box in the near vicinity (1-3 miles); and 3) you have a car or feel like driving (especially on a rainy or snowy night). Hulu has great current TV shows, but lacks depth in terms of previous seasons and offers a pretty pedestrian choice of movies. Apple TV is good if you consume a limited amount of times during the month – otherwise, it becomes more expensive. And in one way or another, it is less platform neutral than Netflix or Hulu. Microsoft’s Zune is also a bit more limited in choice and also platform dependent.

      In essence, I believe Netflix still owns the “sweet spot” – as a combination of convenience, diversity of content (serving several “long tails” such as independent movies or foreign films), price competitiveness, and – last but not the least – the reliability of the best recommendations/ratings system of all available options. That last point by itself is what is keeping my subscription with Netflix. Many times I log on not knowing what I want to watch, but I heed the system’s advice and end up pretty satisfied at the end – and sometimes, even enlightened by discovering a hidden gem of a Danish dark comedy film or something similar.

      But you’re right – let’s wait and see what happens. And I hope Netflix manages to overcome this mess, because I still like this company, even after some of the screw-ups it has presented to us lately.

    • Emil_M says:

      Oh, and one more thing that I forgot. I am more curious to see how Netflix delivers on its international expansion promise.

      Going to Latin America first makes sense – closer to the base and in relatively underdeveloped markets for streaming entertainment.

      But Europe will be a very tought nut to crack – because the concept of renting movies over the internet is “old news” there. LoveFilm is big in the UK and Germany. Glowria has been around in France for many years.

      Not sure what the situation in Asia-Pacific or the Middle East is. What are your thoughts?

  2. Oh my goodness! an incredible article dude. Thanks Nevertheless I’m experiencing challenge with ur rss . Don?t know why Unable to subscribe to it. Is there anybody getting similar rss drawback? Anybody who is aware of kindly respond. Thnkx

    • Emil_M says:

      Darwin, sorry for the delayed reply. For some reason, your comment got tagged as “spam” by the WordPress system and I only noticed it today – when I was reviewing the spam folder. I am not sure why the RSS feed is not working, but if that is giving you trouble and you still want to sign up, please use the email option. I just added it to the site yesterday. In the meantime, I’ll investigate the RSS feed issue. I’ll be happy to see you subscribe and look forward to seeing more of your comments. Thanks!

  3. meg43tr44gi joe says:

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    • Emil_M says:

      Please feel free to share the blog contents with your friends. The more viewers the better — as long as you don’t bring spam to my posts. 🙂

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