Netflix’ Uneconomics

September 6, 2011

Netflix’ continues to exhibit serious difficulties grasping basic economics, competition and value.

First, Netflix is lowering its value to customers.

  • Netflix now charges its subscribers’ 60% more in September in return for lots less premium content available for subscribers in February, as Netflix just lost Starz, its top premium content provider, which supplies 22 of Netflix’ top 100 movies.

Second, Netflix is shifting its costs to its customers.

  • Netflix used its abrupt and controversial 60% price hike to force many of its core users away from the DVD model that many prefer and have the viewing technology for (but costs Netflix more), to the streaming model, (which Netflix prefers because it costs them less) even if it costs many of their DVD customers to spend lots more to upgrade their viewing technology to view the streamed content in the way they can currently view DVDs. 

Third, Netflix is chasing away the premium content its subscribers demand.

  • Netflix’ abrupt and careless business model pivot from a value DVD business to streaming, signaled loudly to content providers (on which Netflix depends) that Netflix took them for granted in the wake of the demise of Blockbuster’s store business model.
  • It appears that Netflix imagined its perceived market power could force premium content suppliers, like Starz, into a accepting a new online business model that would profoundly devalue their premium content franchises long term.
  • In effect, Netflix wants its premium content suppliers to acquiesce to its demands that they accept a permanent change from a time-limited usage content model (DVD rental), which enables premium content to extract premium value for its content, to a commoditized unlimitedaccess content model where their content reaps no benefit from being premium and being viewed repeatedly.
  • Starz wisely told NetFlix: “No.”
    • Starz and other premium content providers understand that Netflix will not be the only online game in town for their premium content, as Amazon, Apple, WalMart, Dish/Blockbuster, Google-YouTube, and others increasingly compete for premium content with premium content-friendly deals that can be more transaction-based and more remunerative for premium content.
    • Netflix apparently does not grasp that, as essentially a cloud-based video streamer, they face lots of new entrant competition from deeper-pocketed competitors who are likely to be more willing and able to pay more for premium content to provide content differentiation to their online streaming customers — than Netflix.
    • In a nutshell, Netflix has exhibited broad uneconomic hubris, and over time competitive forces will teach Netflix lessons about economics, competition and value. 

Finally, Netflix is claiming entitlement to regulatory subsidies from its main suppliers.

As previous pieces in this Netflix series have documented (see links below), Netflix imagines that the FCC’s net neutrality policy, embodied in its December Open Internet order, should entitle Netflix to operate in a competitive environment where its actual or potential competitors cannot charge competitive usage-based pricing, for competitive bandwidth services.

  • Netflix continues to forum shop for corporate welfare from regulators when the FCC’s December order supports usage-based pricing and both the FCC and FTCChairmen have publicly endorsed usage-based pricing for bandwidth to ensure the nation’s broadband infrastructure remains economic and sound from an operational and investment perspective.
  • As the single largest bandwidth cost-causer in streaming more video than any entity, Netflix needs to become a better steward of Internet usage and invest in much more network management and content caching closer to its customers — as Google-YouTube responsibly did before them when faced with this legitimate bandwidth hogging criticism.
  • Netflix’ naive uneconomic approach to its business seeks to have regulators force its suppliers to subsidize Netflix with uneconomic flat rate unlimited bandwidth, at the same time:
    • Netflix’ competitors are adapting competitively by managing their networks much more efficiently; and
    • Netflix is cost-shifting to its customers and trying to cost shift to its content suppliers.

Conclusion

Netflix, in myopically focusing on subscriber growth, and largely ignoring competitive economics and competitive value creation, has exposed enormous competitive weaknesses long-term.

  • In their its-all-about-Netflix world, Netflix has taken most everything for granted: its customers, its value proposition, its suppliers (content & bandwidth), and its potential regulators.

As I pointed out several months ago at the beginning of this research series, Netflix’ nosebleed stock price growth would not last forever.

  • Given that Netflix is 28% off it high in July, it should answer this wake up call, and stop behaving like a hubristic hot dot.com “it” stock.
  • Netflix should start competing in the real world of focusing on the customer, providing differentiated content, paying competitive prices for competitive inputs, and competing in the free market that is only going to get a lot more competitive with the ramp-up of other cloud-based video-streamers: Apple, Amazon, Walmart, Dish-Blockbuster, Google-YouTube, Microsoft-Skype, etc.

At core, Netflix’ fits of uneconomic behavior are a blinking warning sign that Netflix could have much deeper business problems than the company is letting on. 

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Previous Netflix posts:

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