Internet Industry

Netflix’s Huge Gamble

Ever since Netflix announced its new pricing structure, I thought the structure odd as there’s no discount for subscribing both to DVDs and streaming.  The resulting subscriber loss erased 2.8 billion is market value between Wednesday’s market close and Friday’s close after new subscriber projections were announced.  25.6% of Netflix market cap evaporated over two days even as the S&P 500 rose 2.3%.   Today, Netflix announced that it’s renaming and separating the DVD business.    This move is a stunning gamble as it will likely lead to further subscriber erosion and is the underlying reason for the new pricing structure which is leaving money on the table in the short run.

Bundle Pricing

The lack of bundle pricing is costing both revenue and profit today.   A quick thought experiment illustrates how:  First, figure out the highest price you would pay for Netflix’s unlimited streaming service.   This what economists call your reservation price.  It’s the price at which one penny more would cause you not to buy the service.  Next, figure out the highest price you would pay for Netflix’s DVD service. Now assume that you already have Netflix’s streaming service.  Either someone gave it you or you purchased it.  Now what’s the highest price you would pay for DVD service?  For most people, the reservation price for DVDs falls if they already have streaming.  People already have so much demand for entertainment and once they have some options, the value they place on additional options falls.

This substitution effect between Netflix’s two services is easily addressed by bundle pricing.  A discount for subscribing to both services would have meant less canceling subscribers as some customers would have found the bundle to provide enough value even though  buying both separately did not.  The customers who are closest to their reservation prices are likely to the DVD customers who turn over their DVD’s the least often and are thus the most profitable, as costs in the DVD business primarily driven by postage.   Not offering bundle pricing loses customers and reduces both revenue and earnings though higher subscriber loss.

Brand Equity

The Netflix brand has enjoyed a very strong reputation.  The DVD business being renamed means that DVD business will lose the benefits of the brand.  Building a new brand from scratch is a difficult, long-term, and often expensive endeavor.  In the customer’s mind, offering both DVD and streaming both fit within the brand.  Separating the brands,  doesn’t provide any business value today.

An Impaired Product Experience

The integrated streaming and DVD website provided a great experience customers who subscribed to both services.  Ratings a movie improved recommendations for both services.  Searching for a movie shows both the streaming and DVD options.  Separating the two services means users have to rate on two different sites to get recommendations and search for movies they want to see twice.  This is a degraded user experience and one customers have been quick to point out the Netflix blog.

A Huge Gamble

Given all the immediate negatives for the business Netflix has today, the move to separate the streaming and DVD services places a huge bet on it’s streaming service.  And while it’s clear the growth opportunities are in streaming business, what’s not clear is where to capitalize on the streaming opportunity required forgoing a substantial immediate value in the DVD business.

Most great companies can handle multiple related lines of business.  Apple didn’t marginalize the Mac business to capitalize on the iOS opportunity.  Other than the management challenges of managing related lines of business, there’s no external reason that Netflix could not have kept multiple integrated services under one brand.  It will be quite interesting to see how this gamble turns out in the long run.  I suspect the Netflix stock will be in for a rough ride in the short-term.

Standard

2 thoughts on “Netflix’s Huge Gamble

  1. Pingback: Is streaming video a disruptive technology? | Marginal Cost

  2. Sridevi says:

    its not fair to say that Netflix was not disruptive with technology, even though streaming itself was not their creation. Its like saying the iPod was not disruptive since Sony and other MP3 mini players were already in the market, even the famous iPod wheel is not invented here! Disruptive innovations are generally those that simpler and cheaper to use versions of products and technology that already may exist in some form in the market. What iPod did was the tight integration of the iTunes application and now anyone with a computer had the option of picking their favorite song off the internet and rip their CDs : all accessible with a single button.
    Netflix was disruptive in the way they allowed every consumer to access streaming video without having to change behavior, as in, no new device was needed, no new app was to be downloaded and profiles created. Along with a entry acceptable price, they changed the way streaming video was allowed into every home.
    Now , Netflix can either bask in its success and eat away into margins and do disservice to their shareholders, or pay the price of being a sustainable company..constantly bettering their best product, or they can divide and let both streaming and DVD survive.
    There are two ways to enter a market for disruptive products.. start low and work your way to mid point, or start high as iPod did and milk the market for Willingness to pay. 
    I think Netflix is faced with a very difficult challenge, and their posture to allow user to still have streaming at such a ‘give-away’ price, and DVD at pretty much the same, and only charge when the two are combined is a good move. Not every bundled price is meant to solve economy pricing.

Leave a Reply