The Netflix split

Posted by Tatyana Deryugina on Sep 20, 2011

Filed Under (Other Topics)

Netflix has been in the news quite a bit in the last couple of months, in a way that should provide a good case study for the question “Is any publicity good publicity?” In July, Netflix announced a significant change in its prices, which left some subscribers facing a 60% price increase. Then, late this Sunday, Netflix announced that it is splitting into two companies. One will be focusing on streaming content and will keep the name Netflix. The other will be for mailing DVDs and will get the new name “Qwikster”. In the announcement, the CEO of Netflix, Reed Hastings, said that the company felt that splitting up the streaming content from the physical DVDs was going to help them become better at both. The reaction of consumers is illustrated quite amusingly in this comic.

How can this possibly be a good move for Netflix? In general, it may be true that by specializing, companies can perform better in each area. But is there no economies of scope from combining online streaming with mailing DVDs? For example, Netflix spent a non-trivial amount of money (and probably effort) on creating its system of recommendations. Once Netflix splits into two websites, one of two things will happen to the recommendation system. Assuming Netflix still has subscribers that get both streaming and DVDs, one possibility is that the quality of recommendations will be lower (unless the websites will share information with each other, which doesn’t seem to be the case). Alternatively, the cost of getting quality recommendations to customers will be higher because those that subscribe to both services will have to rate movies on both websites.

The set of customers who subscribe to the online content and get the DVDs is large as a fraction of total subscribers. According to one website I found, Netflix expects to have 9.8 million streaming only subscribers by the end of the third quarter, 2.2 million DVD only subscribers, and 12 million users who subscribe to both services. Thus, a lot of people seem to treat streaming and DVD as complements, not substitutes, even AFTER the price increase that made it more expensive to have both services.

However, this move may make more consumers rethink their Netflix subscriptions; I would bet there are many subscribers out there who pay for the service but almost never use it. By making the cost of having the subscription more salient, the firm might cause people who otherwise would have gone on paying for a service they don’t use to cancel or downgrade.

Even assuming that the number who cancel or downgrade is small, it’s not clear that the split is worth it unless it helps Netflix improve its streaming content. It seems to be at the forefront of the pack in its streaming technology. I can vouch for that as someone who’s compared Netflix to other streaming websites on devices ranging from laptops, iPads, and Blu-Ray players to Wiis, Rokus and Apple TV’s (yes, I have access to lots of technology). The image quality and continuity of streaming is better than any other website. Its physical delivery system also seems to work well. I would be surprised if splitting the two services can help Netflix improve along these dimensions.

To summarize my two cents, the only way this move makes sense to me is if Netflix is planning on selling off its mail-in DVD business completely, in which case this is a reasonable transition step.