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Netflix Circles the Drain

By Taylor Marvin

Netflix is splitting itself in two. From CEO Reed Hastings:

“So we realized that streaming and DVD by mail are becoming two quite different businesses, with very different cost structures, different benefits that need to be marketed differently, and we need to let each grow and operate independently. It’s hard for me to write this after over 10 years of mailing DVDs with pride, but we think it is necessary and best: In a few weeks, we will rename our DVD by mail service to ‘Qwikster’.”

It’s easy to understand why Netflix felt like they had to break up their company: content providers have been making it increasingly clear that they won’t keep licensing their products at the low price Netflix customers have become habituated to. But it’s hard to see how dissolving Netflix into a streaming and DVD-mail order business is going to help. From Megan McArdle:

“But regardless of whether you think the content providers are wrong, the fact is, they own the content, and Netflix can’t stream it unless they pay for it.  That meant that prices were going to go up, or quality (measured by availability of content) was going to go down–and in fact, both of those things happened.  Unfortunately, users had been conditioned to expect unlimited free ice cream; they didn’t like having to pay for it.  Subscriptions dropped instead of rising, as analysts had been conditioned to expect.  And analysts didn’t like that.  Netflix stock went into the sort of rapid decline that usually only plagues the heartbroken heroines of Victorian novels.

So I understand that Netflix was in a bad place.  But I don’t understand how Qwikster solves any of these problems.  It doesn’t improve their bargaining position with the content providers (though contra Tim Lee, I don’t think it makes it any worse, either.)  It doesn’t soothe angry customers who don’t like having to pay for stuff they used to get for free–indeed, if some critics are right, and the websites don’t inter-operate, it just makes those customers madder.”

I really don’t understand what Netflix’s plan here is. They’re behaving like they’re a business without substitutes, which is partially right: as Kevin Drum notes, over the last decade Netflix has been remarkably good are underpricing and bankrupting all of its direct competitors:

“Oh well. Nothing lasts forever. But with Blockbuster gone, Redbox mostly limited to newer releases, and streaming services offering only a tiny selection, where am I going to go if I want to watch some movie made more than a decade ago? I guess I’ll just wait for them to show up on cable until the content providers figure out what to do.”

But this isn’t true — for a large portion of its market, Netflix faces a massive direct competitor that can continually under price it: pirating. The difference between my Dad’s and my TV watching habits is a good example of this. Despite being very computer literate, my Dad doesn’t stream pirated content: he streams the shows he likes on the network’s websites, and rarely uses Netflix to rent or stream movies. Though he probably could learn to stream pirated content if he wanted to, my Dad’s willing to accept the networks’ streaming services’ ads and limited selection in return for their convenience. I’m different. I prefer to watch content on Neflix, but if it isn’t available there I’m prepared to put up with the hassle of steaming it on a pirated site. I think this is a pretty normal generational differentiation. The real question is how Netflix’s customer base breaks down. Younger Netflix customers comfortable with pirating content are likely leave the service entirely in favor of pirating movies that they intend to watch alone on their computer, and taking advantage of Redbox’s expanding selection for DVDs they want to watch on a TV with friends. Older customers are likely to either continue to pay for Netflix’s convenience, or like Kevin Drum switch over entirely to cable. If a enough of Netflix’s customer base is the former, they’re in trouble. I can’t imagine any way this divide won’t decimate Netflix’s market share.

I understand Netflix and content providers are in an impossible situation: over the last decade they’ve habituating internet customers to massively underpaying for content that’s increasingly expensive to produce. But the dissolution of Neflix places the content providers in the same position the music and newspaper industries were a decade ago: once people have become accustomed to consuming your product for free its very difficult to convince them to start paying the market rate for it again, especially if there’s an illegal competitor waiting to steal customers willing to put up with some inconvenience. Interestingly, today’s media companies are in an even worse position than the music industry, because unlike music consumers have been generally habituated to thinking that TV is naturally consumed for ‘free’. This is only anecdotal, but though I personally don’t have a problem illegally streaming TV I don’t pirate music: it feels too much like stealing from artists. Of course, this is ridiculous: networks and movie studios deserve to be compensated for their work, and if I want to consume it I should have to pay a price they dictate. But I can’t help wondering how many media consumers are like me. If many are media companies are in for a rough decade.

Web comic The Oatmeal has a more succinct explanation of just how much is wrong with Netflix’s plan.

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