Jag Venugopal's Blog

September 27, 2011

The truth about why Netflix is in trouble

Filed under: Project Management — Jag @ 9:13 pm

There has been a lot of brouhaha about Netflix’s price increase, and then the consequent action of splitting its DVD and streaming business into two separate companies. Customers, and media commentators are up in arms at the company’s strategies. I think the arguments thus far have been tangential to the problem Netflix really faces. The real problem with Netflix is something else.

Film and TV programs are unique goods that cannot be substituted, much like commodities can be. If you want a pound of sugar, you can purchase it from any supermarket in your neighborhood. Producers of sugar do not have much leeway in controlling the price or distribution of sugar. If its too expensive in one place, you can buy it from another.

Film and TV programs are a different beast. For example, if you wanted to watch Star Wars in high definition, you are unlikely to be satisfied with watching a different SF movie. Similarly, if you want to watch Lord of the Rings, you will probably not consider Harry Potter to be an acceptable substitute. Each work is unique, and non-substitutable. This is the case for at least popular Film and TV programs.

Netflix tries to commoditize content by bringing a large number of Film and TV programs under one roof, and making it available for a fixed rate. Once you’ve paid your subscription money, it matters little to them whether you want to watch Seinfeld or Frasier, or anything else. In Netflix’s worldview, everything is substitutable. Cannot find Sopranos? Netflix will provide any number of recommendations for similar shows.

The problem is that so long as demand exists for unique Film and TV programs, Netflix has to negotiate with exactly one supplier for each. For example, there is no way Netflix can stream Star Wars without George Lucas’s consent. Similarly, no streaming the Lord of the Rings until they have an agreement with Warner Brothers’ New Line studios.

Back in the day when Netflix had a huge DVD-by-mail operation, the studios were forced to negotiate with Netflix. And if Netflix did not like the studios’ terms, they were at liberty to go to Wal-Mart and buy up every last copy of whatever DVD they wanted. Streaming was still not commercially viable. And Netflix had worked out the logistics of shipping DVD’s through the mail in a very efficient manner.

In the new world, however, streaming is not only economically viable, but there are many players offering the ability to send programming over the Internet. Hulu, Amazon Video on Demand, iTunes, or Comcast are all competing for the opportunity to push content bits down the pipe. Studios suddenly have a number of dance partners. Netflix no longer has the technological or logistics edge in streaming that it once had in mailing DVDs.

What, then, could be Netflix’s salvation? Only one comes to mind — provide unique content on demand. Which basically means that Netflix has to get into the Movie/TV production business, much like HBO. Doing so is notoriously hard, and companies like HBO are not about to welcome Netflix with open arms. Further, the content distribution skills Netflix has built up in DVD distribution, and to some extent, streaming, are not readily transferable to content production.

So, enjoy your Netflix subscription while it lasts. And hope to heavens you haven’t invested in its stock.

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3 Comments »

  1. The problem is that Netflix has become greedy, too greedy for its customers. They want customers to pay more and they are insulting their customers’ intelligence by telling them that the “increase in prices is good for them” (them means the customers, not Netflix). Netflix is an overvalued stock and is worth only $2 billion as a company, and that’s only if we assume that there will be no competition in the next 10 years or so, which is impossible.

    Comment by Fadi El-Eter — September 29, 2011 @ 4:05 am | Reply

    • Not sure I am in 100% agreement with the greed thing. Basically, they’re king of the hill and the hill (DVD’s by mail) is sinking from underneath them. They’re far from being the only game in town for streaming, and the studios are demanding big bucks from them.

      In some ways, they’re like Kodak, Polaroid, Borders, (arguably) Microsoft, and many others who got done in by the obsolescence of their business model. They’re not that far down the road to doom yet, and have some chance to recover.

      Comment by Jag — September 30, 2011 @ 4:04 pm | Reply

  2. […] I suggested a month ago that this was the only option available to them. Good to know Reed Hastings follows my blog […]

    Pingback by Netflix’s troubles « Jag Venugopal's Blog — October 26, 2011 @ 1:14 pm | Reply


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