Netflix (NFLX) Struggles to Find A Hollywood Ending

We all make mistakes, and when we do, it is usually best to accept responsibility and try to set things right. Sometimes, however, our best efforts only make matters worse.

Netflix (NFLX) CEO Reed Hastings and his company are having a terrible month, and the problems are mostly of their own making. But I feel sorry for Hastings. I think he is trying to do the right thing, even though his attempts keep blowing up in his face.

The troubles began, as business troubles often do, with a price increase. A few weeks ago Netflix restructured its pricing, charging customers more to receive the company’s DVDs through the mail, while offering better rates for those who get their video entertainment exclusively by streaming it over the Internet.

Most people understand that it costs more to ship physical disks. Many customers understood the reasons for the change, but others objected. Some people just didn’t want to pay more. Others observed that Netflix is a subscription service; you pay a flat monthly rate to keep a certain number of disks at home at one time. Customers who keep those disks for extended periods do not cost Netflix much money on postage and handling, though they do force it to maintain a larger inventory of disks.

Still, the price hike triggered significant customer blowback. Netflix announced last week that it expects its subscriber count this quarter to be around 24 million, a 1 million drop from prior projections. The company blamed both the price increase and its high-profile loss of content from Starz, which will affect customers’ queues by next February.

News of the customer defections, in turn, caused Netflix’s stock price to take a big hit.

Then Hastings tried to make things better. Late last Sunday, the CEO sent an email to Netflix subscribers, which he also posted as a blog entry, apologizing for losing subscribers’ trust. He then announced that Netflix would break its streaming and DVD-by-mail services apart completely, rebranding the latter “Qwikster.”

After the change, customers will have to manage two separately billed accounts if they elect to keep both services. They will also need to maintain two separate queues of programming they are waiting to see. It appears that users of the streaming service will lose the ability to queue programming that is not yet available online; until now, they could choose a DVD-only title and put it in their streaming queue for viewing when, and if, it became available online.

Users had a lot to say about Hastings’ announcement, and they said it in comments to his blog post. Not much was positive.

Brian Bram wrote, “in our house, as in most homes, we always used the queue as a de facto database for storing titles of movies we plan to watch sooner or later.” Cindy Gonzalez added, “I used [my viewing history] as a kind of journal – I rated movies I’d seen elsewhere, it helped Netflix know my preferences, and it was a way I could remember what I’d seen and enjoy some nostalgia for old movies.” They and other streaming-only customers stand to lose benefits that the company didn’t seem to think they particularly wanted.

Or, as NPR columnist Linda Holmes pointed out more succinctly: “The inconveniences, in other words, are real and tangible and instantly noticeable, but the advantages are cosmetic.”

Much of users’ frustration results from the fact that, for the moment, much less content is available for streaming than on DVD. Netflix is trying to bolster the streaming library – it announced a new deal with Discovery Channel this week – but it is an uphill battle. Studios and networks are reluctant to lose possible revenue by making deals that allow unlimited access to their content. Perhaps more threateningly, cable companies like Comcast, which became majority owner of NBC and various cable network affiliates earlier this year, are not eager to give viewers a way to access entertainment without going through their services.

I am sure Hastings is correct in predicting that streaming will eclipse DVD as a distribution mechanism. It is not at all clear, however, that Netflix or any other third-party distributors will be able to maintain their market share after that transition is complete.

The video-rental business flourished in a legal environment that protected Blockbuster, Netflix and other third-party distributors. Under the law’s “first-sale doctrine,” which was established as early as 1908 and was codified in the Copyright Act of 1976, purchasers cannot duplicate DVDs or other copyrighted media, but they are free to resell, lend, or rent them to others without paying royalties. The first-sale doctrine probably has limited, if any, relevance when it comes to streaming, since no physical object is involved.

Nevertheless, Hastings seems determined to forge ahead with Netflix’s push into streaming, because that is where the future of the video-distribution lies. I understand his reasoning. I don’t understand the needless disruption of customers’ current Netflix experience. Right now, the company’s best customers sometimes use the streaming service and sometimes use the DVD service. Why make their lives more difficult by separating the two?

I wonder if Netflix has ever heard of trial balloons. It would have helped if, say, they had leaked their plan to separate the two services before they formally announced it. Customers would have voiced their objections, and Netflix would have given itself a chance to change its mind before it made another mistake. Now it is set to lose more customers, many of whom were willing to put up with a price increase, but who see no reason why they should have to juggle two accounts from a single provider.

People often pay a premium for simplicity and convenience. Apple understands this principle. The iTunes store aims for the widest possible selection of media, and the tightest possible integration with viewing devices (the word “television” does not apply here anymore), in order to give customers a seamless experience. Netflix’s new structure provides an opening for Apple, Amazon, Hulu and others to poach even more of those 24 million remaining Netflix customers.

We all make mistakes.At least we can benefit when we learn from them. Netflix made a mistake when it misjudged customer reaction to its price increase, and rather than learning, it compounded the error by springing yet another unwelcome surprise on the people who keep it in business.

That is not the way to give this picture a happy Hollywood ending.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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