Top 10 Film Industry Stories of 2011: #2
Netflix Falters
By Kim Hollis
December 30, 2011

Goodbye, New Coke.


The above word will become synonymous with ruination in future years. This is the new punchline that will replace DIVX when people scoff at digital failure. In one fell swoop, Netflix fundamentally switched from being a rising player in media to a laughing stock who didn’t even make sure a Twitter account was open before naming their entirely new company with the newly coined phrase. Incompetence, thy name is...

The story of how Netflix flipped the bit from miraculous stock gains to “Qwikster? LOL! WTF?” is an odd one. In last year’s Top Film Industry Stories, the ascendance of Netflix was named our third biggest story. As I detailed at the time, the technology company went all-in on the premise of streaming media and was rewarded with an unprecedented year over year increase in customers. Netflix roughly doubled in subscribers in 2010 due in large part to a combination of winning the video rental war with now deposed Blockbuster and the sudden ubiquity of Watch Instantly.

After the first quarter of 2011, Netflix totaled 23.6 million users, 3.3 million of them new subscribers. Another million were added in the second quarter; ergo, 24.6 million people were subscribed to Netflix at the start of July, over 10 million more than there had been in March of 2010. Perhaps this is the inverse of always being darkest before the dawn. While sitting on top of the media world, Netflix decided to commit stock suicide.

With the release of the second quarter numbers on July 12th, they announced a decision that effectively alienated their entire customer base. There were two facets to this unwanted declaration. The first was that all members of Netflix were facing a price increase. Depending on the membership plan of the user, their monthly expense would rise by as much as 60%. Also, some plans were terminated, meaning that even if a customer were willing to pay that much more for their current service, Netflix would not let them. There would be no grandfathering of current subscriptions. Instead, if a membership plan were to be discontinued, the Netflix customer was forced to get a new one. Stating the obvious, this is not good customer service.

The bigger bombshell, however, the one from which the company may never recover, is Qwikster. For those of you trapped in an area that lacked Internet for the past six months (which would be Mars, I guess, since even residents of the highest mountain in Nepal know about Qwikster), this is the plan through which Netflix cuts all ties to physical media. Yes, they would own Qwikster, a new company that continues to rent DVDs by mail. But after establishing that business, there was a plan in place to tie it off by selling Qwikster to the highest bidder and thereby place Netflix solely in the cloud.

All of Netflix’s digital media would be served sans physical transactions, a forward thinking plan in and of itself but one that was akin to Wal-Mart closing all of their stores and putting up signs that say “We’re not selling this stuff here anymore. Go to instead.” Actually, that is not quite accurate. For this comparison to be totally accurate, Wal-Mart would have to create an entirely new web site and then direct all of their customers to it, something like, “We’re not selling this stuff here anymore. Go to instead”. And everyone who doesn’t watch Futurama would be going, “What’s an Animatronio and why would we shop there?” Amazingly, no one in Netflix’s board room connected these readily apparent dots with the end result being that overnight, everyone on Earth hated Netflix. And Qwikster. Whatever the hell that is.

Almost overnight, Netflix was inundated with incendiary criticism. Simultaneously, a lot of customers said, “Price increase? I’m out.” After two straight years of quarterly growth, Netflix’s third quarter included 800,000 lost subscribers. The company immediately cut all short as well as long range projections as they came to grips with the fact that the entirety of their decision making had been called into question. Tying off the physical media division of the company was not something that had to be done immediately. Similarly, the price increase was so dramatic that even in hindsight it is impossible to understand why they felt customers would be okay with it. Netflix’s humorous defense of their decision was the following:

“Everything Netflix does is with extensive research and testing and analysis, so we expected some people to be disappointed.” -- company spokesman Steve Swasey

Business classes will be created that meticulously examine exactly what testing, analysis and other “extensive research” Netflix had done that caused them to come to the decision that people would be happy to pay 60% more for the service. I struggle to think of a single instance wherein someone would go, “Oh, it’s fine that you are charging me this much more for the same thing I bought here last month.” And the total elimination of existing plans is equally headscratching. Effectively, Netflix spit at their customers in three different ways with a singular announcement. It boggles the mind.

Perhaps we should not be so surprised by this turn of events. After all, Netflix was a startup company that had experienced unprecedented growth. That in no way changes the fact that it was being run by a man who was a self-described failure in his previous attempt as CEO of a company. Reed Hastings is a fascinating man as well as a mathematical savant. He may not, however, have a mind for business inasmuch as he has a mind for Big Ideas. In a lot of ways, that is much better for us as a people that someone with his intellect is more focused on implementing new creations than he is about squeezing money out of subscribers. The problem is that the people he has hired to be the chief decision makers at Netflix are clearly incompetent. There continues to be a vast divide between the social media generation and the people running new tech businesses as if they were any old widget. Hastings may be another Steve Jobs as an inventor but he is clearly not a Steve Jobs as a businessman and none of the people he has hired to handle these concerns has proven themselves capable in 2011.

The proof is in the stock numbers. On July 13, 2011, Netflix stock peaked at $298.73. To put this number in perspective, consider that Apple stock closed at $358.02 on the same today. As of close of business on December 30, 2011, Apple currently sits at $405. Netflix has fallen to an almost incomprehensible $69.29. This is a loss in stock valuation of $229.44 as well as a decline of 77% in less than six months. Companies that fall this far this fast rarely right themselves.

Netflix now stands on the cusp of total chaos. The company could yet redeem itself as it continues to have a novel, enjoyable product with Netflix Watch Instantly. The potentially fatal dilemma they face is that the expense of retaining the rights to all of their digital content will escalate quickly. They have already lost the rights to Starz Media licensing, the property they leveraged to debut Starz Play and thereby expand their streaming content into the collective consciousness. They face similarly difficult negotiations as they attempt to renew contracts with the various content creators. Expectations are that a company with capital of less than $100 million may need to broker deals in excess of $2 billion simply to maintain their current status. If true, this would be mean further massive subscription plan rate increases. Imagine how that well that will go over with current Netflix members.

After an 18 month period where Netflix could do no wrong, a single July announcement may have irreparably damaged the brand. Seriously, Qwikster? LOL. WTF?