Why Netflix’s Split Business Probably Makes Sense

[October 10 Update: “Netflix “has abandoned its unpopular plan to spin off its DVD-by-mail service and rename it Qwikster, saying it will continue to offer both services through its flagship web site.” From Netflix: “It is clear that for many of our members two websites would make things more difficult, so we are going to keep Netflix as one place to go for streaming and DVDs. This means no change: one website, one account, one password… in other words, no Qwikster.” Obviously this news renders moot much of my previous discussion, preserved below. -Ari]

As I indicated yesterday, I’m a little shocked by all the people sliming Netflix for the “crime” of offering customers amazing services for stunningly low prices.

No, the company did not handle the price hike well (though its real error was offering unrealistically low prices in the first place). And I do recognize that splitting the DVD rental from the online streaming (with two web portals and two bills) adds a minor inconvenience to customers using both services.

But many treat Netflix like its leaders had absolutely no reason for splitting the business other than to annoy customers. In other words, people utterly ignorant of the business’s internal forecasts and long-range strategic plans think they can armchair-CEO better than those whose livelihoods and futures rest on the success of the company. I think that attitude is more than a little presumptuous.

Now, I don’t know those forecasts or plans, either; however, I can take some educated guesses as to why Netflix decided to split the business.

1. The inconvenience is minor. Is it really that hard to maintain two accounts? No. It’s extremely easy to log into two pages and maintain two queues. Until recently I used both of Netflix’s services, and that required maintaining two lists, anyway. If something in my DVD queue appeared in streaming, I still had to manually rank the item in my streaming list and remove it from my DVD list. So the new system is trivially different. (That said, Netflix would do well to alert customers when DVD items become available for streaming.) [Update: Somebody pointed out to me that it was possible to maintain an integrated queue on the Netflix DVD list, as everything streaming is also on DVD, but I never found that helpful.] And two lines on one’s credit card bill instead of one? Like, Oh, My, God, surely the sky falling comes next. Get a grip, people.

2. Most people will naturally gravitate to one service or the other. As I reviewed yesterday, I dropped the DVD rentals after Netflix announced the price hike. According to Henry Blodget, half of Netflix’s customers used both services. (For those keeping track, that means half used only one service or the other.) But the figure for both services was inflated by the ridiculously and unsustainably low bundling price. If you wanted the DVD service, you could get streaming on the side for a pittance more, and vice versa.

Those running Netflix, not being as dense and short-sighted as so many of their critics have managed to appear, can see the technological trend lines. Streaming is getting progressively faster and cheaper. More and more people are buying iPads and other portable devices that can handle streaming. Ever more content is becoming available for streaming. At the same time, some people just prefer the older technology, can’t get good internet connections, or don’t want to tie up their internet with streaming. Thus, the two groups of customers seem to be diverging, not merging.

3. The split allows more tailored marketing. Assuming the above to be true, that the DVD and streaming customers represent very different demographics, a split company may have a much easier time tailoring its marketing campaigns to the two distinct groups.

4. Splitting the business allows easier adjustments to both sides. Not a single critic of Netflix can predict what’s going to happen to the Post Office over the coming months and years. Perhaps Netflix’s critics have failed to notice this little detail, but the USPS delivers Netflix disks. The USPS has been hemorrhaging billions of dollars, so delivery schedules or prices may change dramatically over the coming months. Netflix may have to change its DVD rental service accordingly. At the same time, while streaming becomes faster and cheaper, it could be that hot new content may cost Netflix more to secure. Splitting the business allows each side to easily and independently adjust pricing and details of service.

5. Splitting the services allows for splitting the company. Others have suggested this. With the services split within Netflix, the company could easy split legally as well, forming two autonomous corporations. Or Netflix could eventually sell off the DVD side. I can’t imagine that the people running Netflix have never contemplated such possibilities.

Netflix can clearly see the model of what happens to companies that fail to adapt to changing technology: Borders. Netflix has chosen to take its lumps in the market now in the hopes of sustaining its long-term health. While sensible observers can debate whether Netflix made the best long-range decision, I think it’s foolish and frankly mean-spirited to fail to recognize the plausible reasons supporing the company’s shift.

1 thought on “Why Netflix’s Split Business Probably Makes Sense”

  1. Comment by Diana Hsieh September 20, 2011 at 12:53 PM

    Ari — I haven’t seen people “sliming” NetFlix, so much as customers upset by a business decision that will dramatically reduce the value of NetFlix for them. (I saw lots of sliming about the price increase, which I thought was silly and wrong.)

    Personally, for me to maintain two queues would be a hassle, given how I use NetFlix. And I’m not willing to pay $10 per month for that hassle, not when I can get the same from Amazon for free with my Prime account.

    Before this change, I didn’t have any reason to investigate Amazon’s offerings, because using NetFlix as my sole source for movies was better. Now, since I have to have two sources, I would be stupid not to switch to the (effectively) free option on Amazon. Even if I didn’t already have Amazon Prime, that would be cheaper than NetFlix’s streaming-only subscription.

    Basically, for customers to have a single source for streaming and DVD movies is a major value. NetFlix just eliminated that, shortly after a major price increase. As a result, customers can and will look elsewhere, just as I’ve done. It’s not good business strategy to give your customers a major reason to cancel or downgrade your account with them, but that’s exactly what NetFlix has done. As a customer, I find that disappointing, but… I’m happy to take my business elsewhere.

    NetFlix didn’t offer any substantive explanation for this change. Instead, their CEO made some vague claims about the split improving their capacity to improve services — but even if separation on the business side is required, they could still offer consumers of both DVDs and streaming an integrated website. (I’m fine with separating pricing.)

    Of course, NetFlix might have some better plans in the works — and I hope they do. But at this point, based on what they’ve said, I don’t have any reason to think that they’re acting on some long-range vision, rather than just making a major blunder. Both are common in business, and I’m just glad that I don’t own any of their stock!

    Comment by Ari September 20, 2011 at 1:04 PM

    I too considered going with Amazon Prime over Netflix, but Amazon just doesn’t offer the selection of streaming content I’m interested in watching. But it is cheaper, and the free shipping would be spectacular. (I get by with the “super saver” shipping.)

    I continue to see how maintaining two accounts constitutes a major hassle. As noted, users have to maintain two queues, anyway.

    But your switch, Diana, illustrates my broader point. You seem to care more about Netflix’s DVD rental service, and you don’t really care about the streaming service. I’m the exact opposite. I think Netflix sensibly predicts the DVD customers are basically a different group than the streaming customers, and for most people it’s just not worth it to pay for both (given realistic pricing).

    As to Netflix stocks, I personally think the company has placed itself in better position for long-term sustainability. I think Netflix was seriously facing eventual bankruptcy, and now the company has a chance to survive and even thrive. I think the company will take a hit, but taking a hit is better than going out of existence.

    I’m not arguing that every customer should stick with Netflix. I’m arguing that Netflix can’t appeal to every customer and still remain in business.

    Comment by Ari September 20, 2011 at 1:06 PM

    Correction: “I continue to FAIL to see how maintaining two accounts constitutes a major hassle.”

    Comment by Realist Theorist September 20, 2011 at 1:56 PM

    Amazon just announced they’re splitting into multiple companies. One will sell paper books, another Kindle and the like, a third will take over their video-streaming, another the music, and a few others will handle all sorts of other products. Used books is another possible spin-off.

    Just kidding, of course.
    Mr. Bezos explained the changes saying “I was inspired by Netflix’s example. They couldn’t handle two business units; how can anyone expect me to handle ten!”

    Comment by Ari September 20, 2011 at 2:02 PM

    I fail to see the analogy. Of course Amazon does not attempt to handle a DVD rental service, and that’s the big detail here.

    Comment by kazriko September 20, 2011 at 3:05 PM

    What I would like is something that would integrate all of my video and dvd services together. I create a single list of what I want to watch, and if something is on watch instantly, it will put it on the list that way. If something isn’t available to watch instantly, it would find the DVD service that it’s available from immediately and put it at the top of their queue… If it’s not available for DVD rental, tell me where I can pay $2-3 to rent it. With Hulu, Netflix, Qwikster, Sony PSN, Amazon, Anime Takeout, and Blockbuster, it’s a pain to search all 7 sites to find that show I want to watch…

    Instead I have to manually go through randomly and look through the “unavailable” list of each site, then look at other sites to see if any of them still have that disc.

    Comment by Ari September 20, 2011 at 3:14 PM

    You describe an interesting problem, Kazriko. I guess one of the reasons I’m not worried about two portals for Netflix is I was already using many different services: Netflix, Redbox, Hulu, Amazon (streaming), and new and used DVD purchases. So I was already very far away from having anything like an integrated queue.

    But I haven’t found this to be too big of a problem. Mostly I rent new-release DVDs, buy older DVDs I want, and stream a specific set of shows through Netflix and Hulu. So at this point my media consumption patters are pretty stable, if diverse.

    I suppose it is possible for a third party to create an integration service (you’d have to grant it access to all your accounts) to maintain an integrated queue. It would have to alert you to expiration dates for streaming, and it would have to list options in certain cases. I’m not sure it would be worth it for somebody to set something like that up, but it’s an interesting idea.

    Comment by Ari September 21, 2011 at 12:01 AM

    I thought I’d mention as an aside the possibility of something like “Netflix Premium” — a higher monthly price for the hottest (and most expensive) new content. Those satisfied with older titles could pay less. Alternately, Netflix could start charging per-view fees for new releases (which I would actually prefer, so long as it was only a buck or so extra per item).

    Comment by D September 21, 2011 at 1:23 AM

    I’m not sure how you’d define “slime,” but I think you’re absolutely on to something there, Ari, in that there is something unjust about the general tenor of the comments many are making about Netflix. Many of the comments I browsed on the Netflix Blog were extremely snide and/or sarcastic. How many of these people had ever publicly written *praise* for the value that Netflix created (a value in fact, that Netflix actually innovated)? It’s unjust, even if the changes are illogical.

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