Netflix's Qwikster Move: Hard-Headed Business, Not Greed

Thu Sep 22, 2011 5:42am EDT

Netflix subscribers are reaching for the tar and feathers over the company’s decision to split the business in two: a streaming model and now a separate DVD-by-mail service.

But furious customers ought to know: the man with the red envelope had no choice.

Also read: Netflix Chief Dogged By Miscues But Still Counting the Stock Profits

The price hike and corporate splintering wasn’t a case of greed-- it was a hard-headed business decision, however clumsily executed.

If Netflix continued offering an all-in-one  package of streaming and DVD at a steep discount, it would be joining Hollywood Video in the home entertainment graveyard.

Netflix was bleeding money because of higher content and postage and costs, studio executives and analysts tell TheWrap. The company was shelling out as much as $1.50 in fees to the studios each time it mailed out a disc.

That figure doesn’t even account for the money the company was spending to mail its films to customers; a cost that will likely rise while the postal service continues to hike up shipping costs as Americans grow ever more comfortable with online shopping.

Also read: I'm Quitting Netflix

For the former all-inclusive price of as low as $9.99 per month, that could quickly turn into a losing proposition.

While streaming licenses used to be a relative bargain for Netflix , those days are gone as content providers extract what they see as their rightful share of the digital pie. Whereas a deal to stream films from Disney and Sony via Starz had formerly carried a tolerable $30-million-a- year price tag, the cable company just walked away from a pact some pegged as worth $300 million annually.

For the privilege of carrying movies from Lionsgate and Paramount, Netflix pays out $200 million a year to the cable channel Epix, and that doesn’t even take into account the service's recent move into original programming – beating out HBO and Showtime for a costly little curio called "Game of Cards," that sports the combined and expensive pedigree of Kevin Spacey and David Fincher.

Also read: Netflix Apologizes, Renames By-Mail Unit 'Qwikster' -- But Keeps Price Hike

Though streaming is no longer cheap, it is clearly where the future lies. To enforce the logic it now must pursue—building the subscriber base  online and slowly choking off the mail model—Netflix’s painful and much-loathed decision was probably necessary.

There’s another upside. By spinning off the DVD-only subscribers from the streaming users, Netflix is cutting down on the amount of money it shells out for digital content. The fees it pays to stream movies are calculated on a per-subscriber basis, much as they are for pay-TV companies, so treating the groups separately will drive down costs.

Wall Street has been brutal in its assessment of the manner of move: Michael Pachter, an analyst with Wedbush Securities, told The Wrap, “it’s the dumbest thing I’ve ever seen.” But studio executives say not to bet against Netflix, its co-founder and CEO, Reed Hastings, or the underlying rationale.

“Reed’s brilliant,” a studio executive told TheWrap. “It could be he’s hastened the demise of [Netflix’s] DVD business and it works out for his shareholders perfectly.”

That’s not to say that Netflix didn’t misstep in the way it rolled out its new subsidiary. Mixing the launch with a mea culpa to consumers about price hikes robbed Qwikster’s debut of sizzle and was evidence that Netflix has a major messaging problem.

“You want to introduce a new product with great fanfare, not a dated name and an apology,” Howard Belk, co-president and CEO of the global strategic branding firm Siegel + Gale, told TheWrap.

Belk said the moniker dredges up unpleasant memories of dated Internet brands. Other analysts groused to TheWrap that Netflix should have experimented with a riff on its current name such as NetflixDVD or Netflix By Mail, instead of striking out in a new direction.

“It harkens back to Friendster and Napster, things that are passe,” Belk said. “To me Qwikster connotes a slipperiness.”

Also, as the recent blow-up with the pot-loving owner of the Qwikster Twitter handle shows, it’s probably best to have all the ducks, or in this case profiles, in a line prior to launch.

Here’s the good news.

Even as Netflix struggles to get costs under control, studio executives tell TheWrap the subscription service still stands a chance of expoliting a number of potential new revenues. In particular, video-on-demand offers enormous upside for a company that boasts one of the best platforms for online video and millions of movie-loving users.

To work, it would require studios to loosen the 30-day delays many have imposed on Netflix for new releases, but some of the majors are willing to lift the restrictions for the right price.

“There’s lots of stuff they can still be doing to broaden their film offerings,” one studio executive said.

In some respects, the fault lies with Netflix, which the executive said has been more focused on building its subscriber rolls and less intent on breaking into the VOD business.

There’s also more the company could potentially do to piggyback on UltraViolet, the cloud based video anywhere platform launching in the fourth quarter of this year. There’s no reason Netflix couldn’t integrate titles its customers already own onto its platform and make recommendations based on subscribers’ film libraries.

Like Pandora, the company could also potentially integrate UltraViolet sales into its site, creating a one-stop shopping experience for cinephiles and adding both value and profits to the service.

If the company can finally get control of the mounting public relations disaster, all that red could quickly turn to green.  

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