Netflix CEO Unbowed
by: Ethan Smith
Sep 20, 2011
SUMMARY: Customer reaction was swift and angry against Reed Hastings's announcement that Netflix was
separating its DVD-by-mail business and its Internet movie-streaming businesses. The DVD business will be
renamed Qwikster, hived off into a separate subsidiary that will have its own billing system, website and list of
movies. Hastings is willing to endure the current drubbing because the long-term dynamics indicate that people will
be less and less reliant on the DVD side of the business. By separating the two now, Netflix appears to be preparing
for the day when the DVD business dwindles or even disappears. Netflix expects its DVD business to remain viable
for only about 15 more years.
CLASSROOM APPLICATION: Netflix offers a terrific case study in long-term thinking. After encouraging the class to
lash out at Reed Hastings as consumers at first, the instructor should defend Hastings as one of America's most
foresight-gifted and forward-thinking managers. As the 2009 related article below shows, Hastings could foresee the
decline of his DVD rental business even when it was still thriving. In fact, Netflix has been surprisingly successful in
making the transition to downloadable videos and avoiding the competence trap that most such companies (e.g.
AOL) fall into when they harvest a declining business model and try to avoid displeasing customers.
QUESTIONS:
1. Which decision making model is best represented by Mr Hastings action? Why?
2. Discuss the decision style that Mr Hastings most likely used?
3. Do you think Mr Hasting’s use of texting his reasoning to subscribers was a good decision?
4. Discuss a method for solving this problem using the Decision Making steps and tools highlighted in class.
Reviewed By: Mark Lehrer, Suffolk University
If the CEO of Netflix Inc. were in a movie, the townspeople would be chasing him with torches
and pitchforks.
The customer reaction was swift and angry against Reed Hastings's late Sunday announcement
that the company was separating its DVD-by-mail business and its "Watch Instantly" Internet
movie-streaming businesses.
Still, Mr. Hastings, a co-founder of the company, indicated that he's willing to take the shortterm heat—and risk losing yet more customers—to usher Netflix into its new digital identity,
focused not on snail mail but movies over the Web.
Calling It Splits
Several companies have announced plans to split themselves apart in recent months.
In his overnight email to the company's 23 million domestic subscribers, Mr. Hastings said the
DVD business will be renamed Qwikster, hived off into a separate subsidiary that will have its
own billing system, website and list of movies.
By late afternoon on Monday, more than 16,000 users had left comments on the Netflix blog—
and the overwhelming majority were livid.
"You are making things significantly worse for us," one customer wrote, in a screed that echoed
many of the others. "Now not only will we have to pay a LOT more for your services, but we
will also have to access two separate websites."
Journal Community
The transition from physical to digital hasn't been easy for any media business. The pain often
has been exacerbated by attempts to hang onto their old businesses without focusing on new
ones. Mr. Hastings is betting that rankling subscribers is preferable to falling behind those
changes.
Two months ago, Netflix said it would price its offerings separately, starting at $8 with no
discount for combining the two, an apparent move to accelerate the migration to Web viewing
from mailed movies. Just last week, Netflix said price change was costing it more subscribers
than it expected. On Sunday, the company conceded that was the first step in creating Qwikster.
Many angry customers, threatening to cancel their Netflix subscriptions, griped that the selection
of titles for streaming is small compared to the DVDs. Netflix offers about 100,000 DVD titles
and has about 20,000 titles in its streaming library, estimates Wedbush Securities analyst
Michael Pachter. The company doesn't disclose the size of its library.
Many users also noted that movies and videos are increasingly available elsewhere on the Web,
giving them options.
Underscoring that notion, Dish Network Corp. is expected to soon unveil some kind of streaming
service. On Monday, Dish said its recently acquired Blockbuster video-rental chain would make
"a stream come true" announcement on Friday. Dish declined to comment.
According to person familiar with his thinking, Mr. Hastings is willing to endure the current
drubbing because the long-term dynamics indicate that people will be less and less reliant on the
DVD side of the business. By separating the two now, Netflix appears to be preparing for the day
when the DVD business dwindles or even disappears.
Netflix expects its DVD business to remain viable for only about 15 more years, the person said.
Separating the two businesses could keep the DVD operation alive longer by letting its managers
concentrate on their own needs, without the distractions of running the online business.
Netflix shares dropped 7.3%, or $11.39, in a broad market sell-off on Monday, to $143.80, on
the Nasdaq Stock Market
Wedbush's Mr. Pachter called Netflix's separation plan "premature," citing the changing
economics of the DVD and streaming businesses. He estimates that for now, streaming-only
customers are more profitable to Netflix than its DVD customers. But he believes that state of
affairs won't last as studios charge Netflix more for the digital licensing deals it relies on.
"On the DVD side the studios have zero ability to raise price," Mr. Pachter says. "On the
streaming side, the studios have 100% leverage."
Subscribers to Netflix's DVD-by-mail business, created in 1997, have been leveling off,
according to recent company data, while the number of subscribers to its movie-streaming
business have grown rapidly since its introduction in 2007.
After assessing the fallout from the price increase, Netflix said it expects to end this month with
2.2 million DVD-only subscribers, down from the previous forecast of 3 million, and 9.8 million
streaming-only customers, down from an earlier forecast of 10 million. The company's forecast
for combination subscriptions held steady at 12 million. Its current 23 million total subscribers
represent a 37% increase from the year-ago level of nearly 16.8 million.
Netflix has run almost no ads promoting its DVD business in the past six to eight months. At the
same time, the company has been aggressively expanding the streaming business, moving into
Latin America and exploring other international markets.
Though the move could make it more costly for Netflix to license content for its streaming
service, it is unlikely to have much effect on the costs of the DVDs it buys from movie studios
and television companies. Studios often negotiate DVD and digital deals separately, with Netflix
and with other companies, according to people in the movie and technology businesses. Walt
Disney Co.'s movie studio is in the process of separating its DVD and digital-distribution
operations. DVD sales are being transferred to the consumer-products group that sells toys and
clothes to chains like Wal-Mart Stores Inc., while responsibility for striking digital deals will
remain with the studio.
Among the factors making the DVD and streaming businesses so different: Streamed versions of
movies remain subject to the complex "windowing" deals studios strike with television
broadcasters and others. Generally when movies are being shown on premium-cable channels
like HBO and Showtime, for instance, they cannot also be available on a service like Netflix. By
contrast, Netflix owns outright the DVDs it rents, and can do with them as it likes.
To preserve discounts on bulk purchases of DVDs, Netflix has been willing to make concessions
such as waiting 28 days after some movies come out on DVD before offering them to mail-order
subscribers. Studio executives view that as a way of protecting DVD sales. Last year domestic
DVD and Blu-ray sales generated $5.6 billion in revenue for the studios, according to an
estimate from IHS. Physical movie rentals, meanwhile, generated $1.6 billion.