Views from Netflix's Annual Shareholder Meeting

| About: Netflix, Inc. (NFLX)

Netflix, Inc. (NASDAQ:NFLX) held its annual shareholder meeting yesterday at its headquarters in Los Gatos, California. The meeting lasted less than half an hour and around fifteen non-employees attended. As usual, only cookies, water, and soda were offered.

The meeting consisted of CEO and Founder Reed Hastings answering shareholder questions. There was no presentation.

I like Reed Hastings. He has great ideas on education reform, and he is smart enough to have caught the eye of Microsoft (NASDAQ:MSFT), which placed him on its board of directors. When it comes to annual meetings, however, Mr. Hastings seems like he can't wait to get back to work. That's a laudable trait in a CEO, and most mathematicians (he majored in math) aren't known as overly social animals.

Shareholders' comments were generally half-question, half-compliment. One shareholder praised Netflix's compensation factors, also known as "performance factors." (See 2009 proxy statement, pages 14-15.) Netflix states, "to attract and retain outstanding performers, it must provide a challenging work environment. To this end, the Company strives to maintain a high-performance culture."

Netflix also evaluates employee performance based on several factors, including judgment; innovation; impact; curiosity; communication; courage; honesty; selflessness; and passion. It's unusual for a company to explicitly tell shareholders that it bases compensation partly on goals like "honesty." Netflix rightfully deserves compliments for having a multi-faceted compensation analysis that includes an ethical component.

Another shareholder asked what the company was doing now that more players were entering the streaming video business. Mr. Hastings answered that Netflix "is always having to compete," and businesses like were changing the competitive landscape. At the same time, he said, "It's a big landscape," and while there will be "more competition in the future," Netflix was continuing to add subscribers at a healthy rate. Mr. Hastings also said that the most competition came from cable and satellite companies.

Another shareholder asked what Netflix would look like in five to ten years. Mr. Hastings answered that he didn't have a crystal ball, but Netflix currently had millions of subscribers and he hoped to to keep increasing its customer base.

I asked two questions. Page 10 of Netflix's 10K states that Netflix had issues with Starz Play service:

Many of the [streaming video] licenses provide for the studios or distributor to withdraw content from our service relatively quickly...For example, in December 2008, certain content associated with our license from the Starz Play service was withdrawn on short notice.

I asked why Starz Play revoked its license in 2008. Mr. Hastings said he didn't know about that (perhaps he didn't understand my question) and said Netflix currently had a good relationship with Starz Play. When I later pointed him to the 10K, Mr. Hastings said he did not want to comment. He reiterated that Netflix currently has licenses for Starz Play. I was a little stunned, because Mr. Hastings was not willing to answer a question relating to a publicly disclosed fact. I realize as a small shareholder, Mr. Hastings doesn't owe me answers on every question I ask, but the Starz Play revocation seemed like an important issue, and an issue that might impact the share price. Although I didn't say it, I was thinking, "If Netflix doesn't want to answer reasonable questions about its company, why did it go public?"

I then mentioned Netflix's failure to add captions/subtitles to its online streaming videos. Netflix's "instant play" option doesn't include captions, making its online video option unusable for many users. As a result of not offering captions, Netflix is alienating its hearing-impaired, deaf, and senior citizen customers. According to some estimates, there are 34 million hearing-impaired persons in the United States. One would think Netflix would think better than to alienate such a large customer base.

I asked what Netflix was doing to make its website and online video accessible to everyone. Mr. Hastings said other sites didn't offer captions, and mentioned as one of them. He said as time progresses, captioning technology will become more widespread, and Netflix would then incorporate it into its own technology. He also said that customers can continue to receive DVDs through the mail, and most DVDs contained captions.

Unfortunately for Mr. Hastings, I use to watch Simpsons episodes. Except for a few episodes, every Simpsons episode I've watched had captions. Obviously, the technology exists to make online video accessible to everyone, so I wasn't quite ready to let this topic pass. I gave Mr. Hastings another chance to explain how he would make his business accessible to everyone. I mentioned that did indeed offer captions, and I said (paraphrased), "It sounds like you're not planning to do anything to add captions to your site. Am I correct in understanding that you don't plan on making your online videos accessible to the disabled?" Mr. Hastings said he would check out, but essentially agreed that adding captions wasn't an active agenda item. Now, I don't want to go Kanye West on anyone, but it didn't feel like Mr. Hastings or Netflix cares about deaf people.

Mr. Hastings is making a poor business decision by not maximizing his site's accessibility. First, Netflix has already signed up the "low-hanging fruit." In order to keep growing and to justify its relatively high P/E, it will now have to maximize its customer outreach efforts. By not even trying to make online video accessible to the disabled, Netflix is losing goodwill and a large potential customer base.

Second, although Netflix wants to grow its online video business, it is subject to the whims of the studios and other content providers. Netflix doesn't have much leverage over the studios, who control their online content and may wonder why they should license content to Netflix. The December 2008 Starz Play incident shows just how vulnerable Netflix is to having its access unilaterally cut off. To encourage content providers to grant Netflix licenses on reasonable terms, Netflix needs to add something of value. Providing captions for online content may be one low-cost method of offering value to content providers. (I don't know exactly how much it would cost to create online video captions, but there are plenty of people in English-friendly countries like India who would be willing to do the work.)

Third, being insensitive to the disabled will harm Netflix's public image. I am surprised that Microsoft's good corporate citizenship in this area hasn't rubbed off on Mr. Hastings. Although Microsoft gets a lot of bad publicity, it is actually at the forefront when it comes to offering tools to assist the disabled. Here is a list of the awards it has received as a result of its work on behalf of the disabled. Here is one relating to the hearing-impaired community:

Microsoft was recognized among 12 companies and two educational institutions for "extraordinary efforts in promoting equal access to telecommunications and media for consumers who are deaf, hard-of-hearing, late-deafened or deaf-blind..." "TDI commends Microsoft for its special commitment and allocation of resources over the years to introduce and offer accessible and usable software applications for all Americans. With this technology, deaf and hard-of-hearing Americans can fulfill their potential as full, active participants in the general mainstream—regardless of differences in culture, language and communication."

Bet you didn't know about Microsoft's good reputation in the disabled community. That reputation has created lots of Microsoft supporters willing to speak up when others bash the company. In short, there is no need for Netflix to alienate an entire community, especially not one that contains millions of potential customers.

I understand that Mr. Hastings founded Netflix, controls much of the stock, and probably feels like he doesn't need to listen to anyone. At the same time, Netflix needs to more carefully manage its reputation so it maximizes its customer base. It already has many loyal fans and will probably keep growing (though its rate of growth may not be as high as some shareholders would like). Despite my criticism, I love Netflix and am a huge fan of the company. The algorithm that recommends movies has pointed me to many wonderful films I would have never found on my own, like Germany's Ali: Fear Eats the Soul, China's Shower, and Iran's Children of Heaven.

Mr. Hastings did shake my hand after the meeting and told me he wished he had better answers for me. He gets points for that gesture. I hope he will actually do something about Netflix's inaccessible features. In the meantime, I will not be adding to my small position in the stock. Absent a buyout, perhaps from Microsoft, Netflix looks fairly valued to me.

Bonus: I also blogged about last year's annual meeting here, calling it one of the strangest meetings I've attended.

Disclosure: I own an insignificant number of Netflix (NFLX) shares.

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