In July 2011, Netflix (NFLX) announced that it would charge separately for its DVD and streaming offerings, raising prices for some customers as much as 60%. Its shares plunged from a high of $304.79 set in July 2011, to $155.19 on Friday September 16. That weekend it announced that it was splitting its DVD business into a separate company called "Qwikster" and the Netflix share price plunged further, ending at a low of $62.37 on Nov 30, 2011, even after customer outrage had prompted the reversal of the Qwikster decision in October. Netflix accounts for its DVD content library as a non-current asset on its balance sheet, amortizing the DVD cost over 1 to 3 years. However, its new pricing structure, which it retains to date despite the reversal of its ill-fated Qwikster decision shows the company is treating the DVD part of the business like an unwanted step-child rather than a competitive asset for customer retention against challengers like Hulu, Amazon (AMZN) and other potential streaming-only entrants.
In the original blog post Qwikster, Netflix CEO Reed Hastings explained his position as follows:
The benefits of our streaming service are really quite different from the benefits of DVD by mail. We feel we need to focus on rapid improvement as streaming technology and the market evolve, without having to maintain compatibility with our DVD by mail service.
So we realized that streaming and DVD by mail are becoming two quite different businesses, with very different cost structures, different benefits that need to be marketed differently, and we need to let each grow and operate independently.
In all of his moves, Hastings has missed a key point. From a technology or a cost structure point of view the streaming and the DVD offerings may well be different businesses but from the customer point of view they positioned Netflix as a one-stop shop for movie buffs, some could be watched instantly - but if not available on instant, could be obtained as a conveniently mailed DVD for one low price. Rather than expanding its offerings toward a one-stop entertainment company, Netflix lost its customers over format and delivery. It also created one of the strangest pricing strategies. While every other company looks to upsell and cross-sell its offerings, Netflix's current pricing structure offers no incentive for its streaming customers to be DVD customers or vice versa. As a result, Netflix is actually losing revenue.
As one sample customer, I started with Netflix's 2 DVDs at a time plan, and as its streaming offerings increased had dropped down to its $9.99 unlimited streaming+1 DVD plan. Based on how busy I was, often I would end up not watching the DVD I had out for a couple of months, but it was nice to know that I had the option of putting DVDs on my queue that were not available on streaming.
When the price for unlimited streaming + 1 DVD suddenly became $15.99, paying the extra money per month for the DVD service I only used once in a while made little sense. So I dropped my plan to the $7.99 streaming only plan. Netflix ended up losing $2/month in revenue and at the same time has a less satisfied customer. I have become increasingly unhappy with the relatively limited content offering of Netflix streaming (I watch mostly movies, not TV shows) in comparison to the much wider selection available on DVD. Though, at the end of the day, Netflix prices are still a tremendous value, it did not make sense for me to pay $7.99 a month for a DVD service I used no more than once or twice a month.
Netflix does have a $4.99 1 DVD a month plan limited to two rentals a month but it comes with limited streaming, further narrowing my entertainment options. I cannot add this $4.99 DVD plan to my $7.99 plan for a total of $12.98 a month for unlimited streaming and two rentals a month. It is as if the company is trying hard not to get my money! Since there is no benefit from getting both streaming and DVDs from Netflix, and it is, in fact, impossible to get the package I want, I am expanding my options and looking at other competitors for both streaming and DVDs. Netflix has turned a stable and loyal customer into a dissatisfied one. A smart bundling strategy would instead preempt competition.
Netflix's DVD content library can be a tremendous asset to present a more comprehensive selection to customers than streaming-only services from Amazon, Hulu and potential competitors like Comcast (CMCSA) and others. For this, Hastings and Netflix have to wear customer-colored glasses. Yes, over time DVDs will be obsolete. But in the battle for customer retention and loyalty is to be won and lost today.
In the blog post announcing Qwikster, Hastings wrote:
For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming. Most companies that are great at something - like AOL dialup or Borders bookstores - do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business. ...Companies rarely die from moving too fast, and they frequently die from moving too slowly.
This may well become a case study for a company dying from moving too fast, or perhaps just too stupidly by letting its own fear and concepts on what a company must do to "make the leap" overpower listening hard to what customers want from the company. People want to feel they have choices even if they don't always exercise them. DVD rentals as a low-priced add-on to the streaming offerings will make its DVD content library into an asset for customer retention by creating a much larger content offering than its streaming-only competitors even as DVD usage will decline. There is still time for Netflix to fix its pricing with creative bundling options using its DVD library asset to make its customers happy paying more.
Disclosure: I am long NFLX.