Netflix Missteps; Creates A Hobbled Dinosaur

| About: Netflix, Inc. (NFLX)
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The blogosphere is all atwitter with reactions to the latest jarring Netflix (NASDAQ:NFLX) change. Many users have taken to twitter to protest the further splitting of the DVD by mail business from the streaming business. Mark Suster wrote a thoughtful piece on why the split is a good move. Bill Gurley provided a logical hypothesis on why the pricing move was made. The Washington Post had a sardonic editorial about how the move screams to customers to stop renting DVDs by mail. The stock has continued its descent - it has now dropped more than 50% from its peak.

I agree that Reed's apology was the right thing to do and was well written, but the pricing change was a tactical misstep and a missed opportunity. The splitting of the business was perhaps the right long term move but feels more about the company than the customer. For such a successful customer focused company, these moves feel pretty jarring. Customers are clearly voting with their feet. A better (albeit slower) approach would have been:

  1. Communicate about the future before any changes

  2. Separate the businesses internally (even two CEOs)

  3. Provide a one month window to grandfather yourself into the old plan for 6-12 months (Netflix would have had a surge in signups that month)

  4. In one month, change the pricing for all new customers

  5. In 6-12 months, split the services and force existing customers to pay for them separately

  6. Keep the interface integrated - at least allow people to manage their queues, billing, ratings, recommendations, etc. in one place

Blockbuster is trying to capitalize on the confusion. Given the customer backlash, a lot of customers seem to want to get back an integrated service. The DVD-by-mail and streaming service complemented each other well. Couldn't find it streaming? Netflix shipped it. When Starz (LSTZA) walked away, Reed Hastings said that they don't need all content on streaming. That's a fine business strategy, but some consumers want that missing content - Netflix streaming has no outlet for them now. Perhaps Blockbuster's upcoming streaming launch, married with their DVD by mail service, will provide a useful and usable service.

I still believe the Netflix streaming business will prevail over Amazon's (NASDAQ:AMZN) Instant Video because winning is existential for Netflix. However, this move weakens Netflix short and medium term value proposition to customers. The end result could be continued customer churn.

In my article from Feburary, I called out the DVD-by-mail business as an asset against Amazon:

The slow death of DVDs. Amazingly, DVDs still matter -- and will for a while. People like seeing the latest movies that studios won't stream via Netflix or Amazon's unlimited plan. People also like getting their HBO and other disc-only content for a reasonable cost. Everyone still has a DVD or Blu-Ray player. Heck, most people can play DVDs on their computers. This makes the "dying" part of Netflix's business a competitive asset.

By making Qwikster a separate entity, Netflix just created a hobbled dinosaur. Just as Netflix did years ago and Blockbuster is doing now, you would expect that the CEO of Qwikster might want to evolve his or her company by launching a companion streaming business. Perhaps they should experiment with different pricing: Want to watch it right away? Stream it for $2.99. As Reed stated bluntly, streaming is the future of the video industry.

Before this impending separation, Qwikster had a huge advantage over competitors - it was integrated with Netflix. Netflix just took that away. Customers of both services will likely get DVDs that are streamable much more often. Recommendations will languish on one service or the other. Will Qwikster be allowed to evolve? Some speculate that Netflix will spin off Qwikster. If that were to happen, I wouldn't be surprised if the Qwikster CEO launches a streaming service to better compete.

I admire Reed's efforts in communication and business clarity, but these rapid changes to the customer experience are detrimental to Netflix's usability and brand. Perhaps these changes will pay off with better margins, more clarity, strategic focus and CEO accountability over the long term. These changes may have been inevitable, but I would have advocated a slower rollout, better communication, more user testing and ongoing site integration.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.