Netflix Splits Operations… Another Strange Move (NFLX, AMZN, WMT, BBY, DISH, CSTR)

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According to Netflix Inc. (NASDAQ: NFLX) CEO Reed Hastings, the company’s recent diving stock price reflects a failure on his part to communicate clearly what the company is doing. That sort of statement always calls to mind the scene in ‘Cool Hand Luke’ where Strother Martin tells Paul Newman, “What we have here is a failure to communicate.” Then Martin administers some form of corrective punishment.

That’s what Netflix is going to do as well. Hastings’ statement on the Netflix corporate blog says the company did the right thing by splitting is DVD and streaming services, and just to prove it, now the company is going to separate the DVD service into a new business called Qwikster.  Hastings is pretty blunt, saying he should justified the decision to separate the DVD and the streaming services earlier this summer and increase the company’s overall pricing. Then he says, “It wouldn’t have changed the price increase, but it would have been the right thing to do.”

So, Netflix has done the right thing and all those customers who walked away would have been willing to stay if only Hastings had explained better that they were going to have to pay more for less. Not likely.

Consumers know when they’re getting a bad deal. Charging separately for DVD service and streaming service forced Netflix customers to choose between paying more for no benefit or walking away. After all, (NASDAQ: AMZN), Wal-Mart Stores Inc. (NYSE: WMT), Best Buy  Co. Inc. (NYSE: BBY), Dish Network Corp. (NASDAQ: DISH), and Coinstar Inc. (NASDAQ: CSTR) are among the Netflix competitors that offer either cheaper DVD rentals with no contract obligation or streaming video at no extra charge (Amazon Prime for example).

So, when the competition heats up and prices begin to fall, Netflix decides that’s the right time to raise prices. That’ll show ’em.

Hastings invokes the argument usually identified with the innovator’s dilemma. That is, in order to retain a leadership position, an innovator must cannibalize its old business in order to create a new business that will carry it forward. That’s nonsense. Streaming video is not disruptive in the textbook sense — it is complementary. Hastings and company have missed that basic point.

Netflix’s strongest competitive advantage is its huge customer base. Now the company’s going to split that, and it’s going to allow the larger part of that customer base to die a slow and needless death because it thinks that’s innovation.

As more and more customers walk away from either or both of the Netflix services, the company’s leverage with the content providers diminishes. How does that help Netflix or its customers?

Splitting into two businesses is really a non-issue. It’s neither necessary nor sufficient. It simply underscores the damage done a couple of months ago. Now, instead of offering a unique service, Netflix is operating a couple of also-ran businesses. This is more than just a failure to communicate.  What is next, brick and mortar video rental stores?

Paul Ausick