Netflix's Logic Was Sound But Poorly Executed: A Lesson For Sirius XM

Sep.22.11 | About: Netflix, Inc. (NFLX)

I was reminded on Tuesday of just how unforgiving investors can be after suggesting that investors should accept Netflix’s (NFLX) apology. I was also reminded that there is a coherent difference between being an investor and a consumer; a distinction that many fail to realize. Clearly there is a saying that suggests, “One should invest in things that they like or know about.” While I appreciate the fundamental message of that quote, but I can’t say that I entirely agree with the idea. I say this for several reasons, but we’ll get to them later.

I once said that Sirius XM (SIRI) might be able to learn something from Netflix; particularly for its ability to raise prices – something that has occurred twice in 10 months. Seeing how Netflix is now in the midst of not only a public relations nightmare, but also an equity disaster, I think it is even more critical for Sirius to take out its composition notebook and write down “what not to do.” But I sense that the management at Sirius has already gotten things under control from the standpoint of how and when it has chosen to announce the increase. By last week’s announcement, Sirius has essentially given consumers 4 months to make up their minds on what direction they need to go whereas Netflix had given its subscribers essentially less than two months; likely the prime result of the one million reported defections that sent the stock tanking.

The prevailing theme continues to be how consumers and investors got “screwed.” One of the most poignant comments on the article was by “theshawn” who wrote:

  • Why should investors forgive? Forgive what? That they screwed their loyal customers in attempting to keep margins the same? How about letting margins lower and increasing subscriptions to make up the difference, thereby keeping competitors at bay? They were chugging along just fine adding millions per quarter and now this? Does anyone honestly believe the sub additions will continue as before now?
  • How much faster will people jump ship to competitors now? Will those who stayed be the same rabid free marketing arm of Netflix they once were? They destroyed 10 yrs of goodwill for millions of people in just two months and we're supposed to forgive?

I could not help but to thoroughly agree with the sentiment. Though I suggested that investors should forgive Netflix in light of its recent apology, but I didn’t say that we should forget, nor was I speaking from a consumer’s perspective. Now perhaps it is Netflix that should observe Sirius XM to take a lesson for how an increase should be handled; although it remains too early to tell.

The clear winner of Netflix’ misstep is going to be Coinstar (CSTR) and the many streaming competitors such as Amazon (AMZN) and to a lesser extent Apple (AAPL) and Google (GOOG). For many who may not know, it was a calculated gamble by Netflix which turned out to be poorly executed. Although it is now well documented, let’s dissect what the company was thinking.

Netflix places high bet on higher prices

We know that the company made several changes to its movie rental pricing plan but looking deeper into its thought process, we can somewhat excuse its poor execution. The logic was there only its application was flawed.

  • Effective September 1st the new pricing plan became in effect for existing customers, whereas it was immediate for new subscribers.
  • Netflix split off streaming and 1 DVD rental into two separate pricing plans. What was once a combined package for a small price became two separate fees for a total of $15.98 per month.

The gamble for Netflix was that its higher subscription revenue would more than offset its rate of churn; something that Sirius XM sought not to do. In an article last week, I criticized the company for not having seized an opportunity to raise rates an additional 50 cents. To a certain extent I still feel it would have been more than justified, but clearly I can no longer fault Karmazin and gang seeing how Netflix completely dropped the ball on this. Again, I was speaking from the standpoint of the investor and not the consumer.

Another reason that I think Sirius XM can learn from Netflix and also the reason that I feel investors should forgive has to do with Reed Hasting’s apology. I want to draw your attention to the red lines below.

Apology2.PNGClick to enlarge
(Click to enlarge)

Clearly, Netflix feared it would immediately become irrelevant; it cited two companies that fit the profile of not having transitioned in time to sustain its significance in America Online (AOL) and Borders Books (OTC:BGPIQ). Who can argue that these are not great examples of “dropping the ball?”

Netflix clearly wanted to accelerate its transition into digital distribution. But I could not understand the need for the rush until I received the letter of apology. Video streaming was very popular as evident by the growth in earnings to the tune of 88% in the prior quarter which resulted in 3.6 million new subscribers. I loved it! How else can one what 6 seasons of “Lost” or 8 season of “24” in one month? Not me of course, but I’m just saying it’s possible.

While the idea was sound, clearly the new pricing plan has resulted in a higher churn rate than previously anticipated. Not only has consumers churned out of Netflix, obviously investors have churned out as well seeing as the stock has lost over 60% of its value over the past month. While I continue to maintain that people should forgive, I am not naïve to suggest that anyone should forget. But clearly, many lessons are being taught and learned by what has happened to this once Wall Street darling.


Becoming a “dinosaur” is every company’s greatest fear. Netflix became popular primarily because it exposed Blockbuster’s “pre-historic qualities.” But at the same time, losing sight of what you do well can be suicide for many prominent companies. Cisco (CSCO) realized this by migrating into businesses that was outside of its competency and as a result the stock has languished for an entire decade. While Netflix did not steer from what it did not know, it took for granted the loyal customer base that stuck with it even though the company is highly criticized for an outdated video library. The letter of apology is a great start at restoring the lost trust, but I can’t help but wonder how reverting back to the previous price structure might have a greater and immediate impact. For Sirius, let's hope 2.0 will keep the dinosaur fears away for a long time. Better yet, let's hope it never has to apologize for its decisions.

Disclosure: I am long SIRI, CSCO.