Netflix: Up Shit Creek

I got an email from the CEO of Netflix today. I’m guessing a lot of other people got it too, and that it probably wasn’t actually written by Mr. Hastings, but it was enlightening.

The full text of the email follows below, but the gist is that he’s sorry for fucking up the separation of the Netflix streaming service from the DVD mailing service which has been their bread and butter for the past ten years. He says he thinks he could have been clearer about what was going on and why. As if that would have made a difference. He then goes on to explain the corporate thinking at Netflix, thereby proving that knowing why they made a stupid ass decision does not make the decision any less stupid ass.

This letter reveals a great many things about Netflix and the market forces that are encouraging the company to shit all over the devoted user base they’ve worked very hard (and deftly) to establish for the past decade. It reveals that the Netflix leadership isn’t as clueless as they appear to be about some things (like the rapidly changing face of digitally-distributed video entertainment), but far more clueless than anyone suspected about other things (like the reasons for their own success and the videogames market).

We’ll address most of this in turn, but first, the big one:

So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently.

It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”.

Aside from the dumb new name, this was inevitable. Mail-to-order DVD rentals is a dying market and the company is wise to distance themselves from it. This move will allow them to spin the service off entirely at a later date, or sell it to another company with less interest in aggressively capturing new markets.

Reading between the lines, what Hastings is saying here is that the DVD portion of their business has been an albatross for some time, and they are happy to have the DVD folks off in their own corner holding their own meetings without taking time away from the people doing the important work of destroying their successful streaming service. Editorial snark aside, this is a strong move that would have been even stronger had it not come on the heels of a dramatic reduction in user base and stock value.

But still, stupid name.

Now the other big one:

There are no pricing changes (we’re done with that!).

This is both good and bad news. The good news is that whatever you’re paying now for streaming video and DVD mailing is what you will continue to pay (for a time). The bad news is that Netflix/Qwikster clearly do not intend to walk those rates back to what you were paying earlier this year. “We’re done with that” being the equivalent of “we’ve already fucked you and we don’t want seconds.” Not a shining moment.

And now the final big one:

One improvement we will make at [Qwikster] launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done.

This will be good news to some, marginally meaningless to others but will not, I predict, make any lasting impact on the Netflix/Qwikster business model. Five years ago, maybe, but not now. The future of game rentals is the same as it is for video rentals: streaming. If Hastings is worth his golden parachute he’ll be looking to purchase OnLive or Gakkai, or be developing a streaming videogame service of his own under the Netflix brand instead of staffing up to compete toe-to-toe with GameFly, which is already dying a slow death of attrition without the help from Qwikster.

Seriously, does that name sound like a bad weight loss milkshake product or is that just me?

Moving on, Hastings has this to say about how the price change and announcement were conducted:

It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology.

Here he’s either being oblivious or whitewashing or both. It wasn’t the lack of humility in how the change was announced that drove a million or more users away from a service that, just one day prior, had been ranked one of the highest companies in the world in terms of user satisfaction, it was the change itself.

I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do.

And if that explanation would not have changed the price increase, then it would not have changed the user outcry. This is the number one lesson any company can stand to take away from this debacle: Your customers do not care about your business model. They care about what you give them in exchange for their patronage.

The core disgruntlement over the Netflix price hike had nothing to do with the communication or lack thereof regarding why the executives of Netflix decided to make the change. It had everything to do with the fact that users went to sleep one night paying one price and woke up the next paying almost twice that and got nothing new to show for it.

Unfortunately, I don’t see what Netflix could have done to avoid this situation, short of not raising prices to begin with, but that’s not really an option for them right now. Here’s what’s going on: Streaming video has become so successful a business model that it is in danger of being destroyed by the very people who stand to benefit from it the most. This would seem to be counter-intuitive until you understand who is doing the destroying – and why.

So who’s doing the destroying? Not Netflix. They’re reacting to market pressure here for a change, not creating it. Which is part of why they are panicking. The real damage being done to streaming video is being done further up the food chain, by the people who pay for the creation of the content in the first place: The major movie studios. Why? Because they do not understand how the market is changing. Or, rather, they are starting to understand, but in the clumsy way that record companies started to understand that most new music fans were turned on to new music through file sharing, and then set out to try and destroy file sharing. That didn’t work for the record companies and it won’t work for the movie studios.

The movie studios are at least making an effort to be smart about this. After years of bombarding major torrent hubs and all but ignoring opportunities for giving users what they want at a price they’d agree to pay, some major studios are starting to get wise and are offering their wares to people who would rather not leave the house, pay $20 for a ticket, $10 for a tub of popcorn and $5 for a bottle of water just to watch a bad movie, or wait for it to come on cable (for which they are also overcharged). They’re still stuck on exactly what they think people will agree to pay for online movies, but they’re at least willing to get into the game. You can thank Apple’s iTunes for paving the way with an easy-to-use service that delivers video content directly to users where they want it when they want it while simultaneously all but guaranteeing the sanctity of the copyright. Not an easy trick and they deserve all the credit in the world for mastering it.

Unfortunately not everyone wants to or can use iTunes, which is why it’s a good thing that concepts like the free market and competition still exist, in spite of the best efforts of certain mega-corps (including several that own movie studios and cable companies). Netflix was not the only company that saw the writing on the wall several years ago and began offering a streaming video services, they were just the most nimble, and one of the few that had already created a devoted user base built on their DVD mailing service, reasonable rates and excellent customer support. Don’t forget that this is the same company that effectively killed Blockbuster, the Wal-Mart of video rentals. You don’t pull the market out from under an established Fortune 1000 company without a plan, and Netflix had a very good one, based on, in equal parts, Silicon Valley savvy and middle-America values. That they seem to have lost sight of their founding values should tell you everything you need to know about a) how rapidly the market is changing, and b) where they see themselves in it (i.e. “at warp speed” and “up Shit Creek” respectively).

What’s happening now in streaming is what I like to call “It’s Working So Let’s Fix It Syndrome.” The major movie studios have been watching their theatrical distribution oasis dry up and wither away, meanwhile Netflix has been turning the lemons tossed their way into cool, refreshing lemonade. You don’t have to be a Harvard MBA to recognize that when you’re dying of thirst while somebody else is drinking your wastewater, then it’s time to reevaluate. And if you were paying attention in class, you’re going to remember that’s it’s better to make your own lemonade and sell it yourself than to lease it to a competitor for a cut of the profits.

If Netflix wants to survive, it has no choice now but to play ball with the movie corporations, pay the exorbitantly higher rates they will now be demanding for access to their streaming catalog and accede to whatever other demands that may come their way. This is why Netflix began making noise about creating (or funding production of) their own content late last year. So long as their business model relies upon a steady stream of content from outside entities, they will be vulnerable to the kind of creeping death that is now upon them, as the major studios raise their rates or pull away from Netflix entirely. Unfortunately, the threat of creating their own content is exactly the kind of nose-thumbing that will further enrage the major movie studios. It’s a catch-22. To survive the market evolution, Netflix has to enrage their user base, annoy the corporations sourcing their product stream or both simultaneously without completely alienating either. In effect, Netflix is between a rock and a hard place. They’re going to get squeezed. How much depends on how nimbly they address the situation and the results so far have been less than impressive.

I will be very interested to see how Netflix chooses to make good on Hastings’s promises to “regain your trust.” As I’ve already noted, Hastings flat ruled out lowering rates, but more interestingly he avoided the issue of increasing the availability of premium streaming content, which is the other major gripe that has contributed to the mass exodus of over 1 million users. These are the two biggest gripes about Netflix right now and the only two things that, if addressed, will win back some of those lost customers. If these issues aren’t addressed, some of those users may come back over time, but not if a competitive product shows up on the horizon. One, perhaps, offering a lower monthly fee than Netflix with earlier access to major studio releases.

Here’s the full text of Hastings’s letter:

I messed up. I owe you an explanation.

It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology. Let me explain what we are doing.

For the past five years, my greatest fear at Netflix has been that we wouldn’t make the leap from success in DVDs to success in streaming. Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us). So we moved quickly into streaming, but I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do.

So here is what we are doing and why.

Many members love our DVD service, as I do, because nearly every movie ever made is published on DVD. DVD is a great option for those who want the huge and comprehensive selection of movies.

I also love our streaming service because it is integrated into my TV, and I can watch anytime I want. The benefits of our streaming service are really quite different from the benefits of DVD by mail. We need to focus on rapid improvement as streaming technology and the market evolves, without maintaining compatibility with our DVD by mail service.

So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently.

It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”. We chose the name Qwikster because it refers to quick delivery. We will keep the name “Netflix” for streaming.

Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to qwikster.com to access their DVD queues and choose movies. One improvement we will make at launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done. Other improvements will follow. A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated.

There are no pricing changes (we’re done with that!). If you subscribe to both services you will have two entries on your credit card statement, one for Qwikster and one for Netflix. The total will be the same as your current charges. We will let you know in a few weeks when the Qwikster.com website is up and ready.

For me the Netflix red envelope has always been a source of joy. The new envelope is still that lovely red, but now it will have a Qwikster logo. I know that logo will grow on me over time, but still, it is hard. I imagine it will be similar for many of you.

I want to acknowledge and thank you for sticking with us, and to apologize again to those members, both current and former, who felt we treated them thoughtlessly.

Both the Qwikster and Netflix teams will work hard to regain your trust. We know it will not be overnight. Actions speak louder than words. But words help people to understand actions.

Respectfully yours,

-Reed Hastings, Co-Founder and CEO, Netflix