Tuesday, September 20, 2011

Netflix continues come-from-ahead strategy

Now the other shoe has dropped at Netflix — the controversial decision to hike prices and charge separately for mailed and downloaded discs was a prelude to separating the two businesses.

The stock price had already dropped more than 25% last week after warning shareholders that subscribers were down due to the price hike. That in itself was not remarkable, since the growth rate (was clearly unsustainable and so eventually the company (like Google, Microsoft and most large tech companies not named after fruits) would have to give up its generous growth multiple.

However, the decision to rebrand its original (physical disc) option as “Qwikster” is puzzling, even by normal standards of Silicon Valley hubris.

Let’s set aside the decision to label its slowest option “Qwik.” Also forget Reed Hastings with the normal CEO ego of wanting to keep the high growth business and (someday soon) dump the slow growth one — as Carly Fiorina did HP’s original instrument business (now Agilent). Even more aggressively, Sam Ginn spun off Pacific Bell’s only growth business —- cellphones — to form AirTouch and then left PacBell for AirTouch — which eventually led to AirTouch being acquired by Vodafone and Ginn’s sidekick Arun Sarin becoming Vodafone CEO.

Nor is it surprising that Hastings wants to leave behind the business of atoms and replace it one of bits. We’ve all been told this for so long that most people might even believe it to be true — and it will be most true during our lifetime for information goods such as words, music and video. This is even though the decision to split the businesses seems to have exacerbated customer objections to the unbundled pricing.


No, what I find puzzling is that Netflix is leaving behind a business with high entry barriers for one with much lower barriers. It’s hard to reliably and cheaply ship disc to millions of subscribers: the entry barriers include not only complex operational processes but also inventory and economies of scope (catalog variety). Netflix created the disc-by-mail business, had no serious competitors and now is walking away from it.

Meanwhile, what does it take to do online downloads? Most of all, a fast and cheap Internet connection bad for by the prospective customer. Also, a brand, technology, and good relationships with studios. Amazon and Apple certainly have shown they can match this, and other companies — including Blockbuster, Sony, Walmart — seem to have the will and the resources to also offer a credible alternative.

Back in January 2009, I remarked on Netflix’ remarkable five year run, and suggested that it had a good start on the next decade. Today it’s clear that its original business of renting movies to Americans is running out of steam, and that the NEW Netflix — absent its legacy business — must fine new products and markets if it hopes to resume its growth ways.

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