Netflix’s Streaming Dilemma: Too Fast, Too Cheap, Maybe Out of Control

Analysis: Customers are furious about last week’s price hike, but the economics weren’t working out, leaving the subscription movie king no choice

ANALYSIS:

Netflix, the golden child of Wall Street and a beloved brand to tens of thousands of movie lovers, took it on the chin last week. 

By jacking up prices by as much as 60 percent on its unlimited streaming and “DVD by mail” businesses, Netflix found itself in an unusual postion:  being truly hated by its customers.

“Netflix, you just lost my affection and loyalty and you pushed me to start looking for other options!,” one irate subscriber wrote on a Wall Street Journal discussion board devoted to the price increase.  

In fact, anger was running so high that, according to a recent poll conducted by CNET, as many as 55 percent of the former faithful say they will abandon the service entirely.

On Monday, Netflix's stock dropped 2.76 percent to $279 after analysts suggested its share price was too high.

Also read: Is Netflix Streaming Its Way Towards Disaster?

What ticked-off customers may not know is that the subscription giant had no choice. Though Wall Street long ago fell in love with Netflix’s multiplying subscriber rolls and digital pioneering, the fact remains that the Los Gatos, California-based company has been giving away too much for too long while charging too little.

With rivals such as Amazon nipping at its heels and the risk that Internet service providers could soon charge higher prices to sites that offer streaming video, Netflix is feeling the heat for the first time since it began its meteoric rise to digital titan-dom some two years ago. 

In the short term, Netflix could no longer afford to keep offering monthly plans at such a steep discount, analysts and studio executives tell TheWrap. Customers were simply not transitioning away from physical discs and toward streaming fast enough to support the low price points.

In its message to customers announcing the price increase, Netflix acknowledged that it had miscalculated that DVD-to-streaming transition.

“Given the long life we think DVDs by mail will have, treating DVDs as a $2 add-on to our unlimited streaming plan neither makes great financial sense nor satisfies people who just want DVDs,” the company wrote.

Netflix is spending hundreds of millions of dollars to acquire digital content through deals with Epix, Relativity, NBCU and more. And the savings on postage fees from dialing down its by-mail DVD operation have not only failed to meet projections, they are not matching the escalating costs of the digital acquisitions.

Since payments to studios are only likely to escalate, something had to give.

“The company has actually been losing money on a cash basis and has hidden it with accounting treatments,” Tony Wible, an analyst at Janney Montgomery Scott, told TheWrap.

“It certainly marks an inflection point in the company’s growth strategy,” Wible added. “It was a business about low price points, brand recognition, market share, and now it’s moving towards fragmentation and profitability.”

Pulling off the move and putting down any subscriber insurgency will be critical. Smelling blood in the water, moments after Netflix unveiled its subscription changes, an emboldened Blockbuster sent out a press release touting its competitive prices.

Don’t expect the challenges to begin and end with Blockbuster. While Netflix dominates the DVD market, its stranglehold on the streaming market is more tenuous.

For one, Netflix’s streaming catalog is lacking. Though it continues to make make big deals for distributors’ back catalogues, it does not have broad pacts with the majority of major studios for new releases.

Nor will it anytime soon. Studios tell TheWrap that they’re not going to risk cannibalizing DVD and Blu-ray sales by making fresher titles digitally available to Netflix earlier.

In addition to the actual increase in price, the lack of streamable new releases has sparked customers’ ire.

“The Netflix streaming catalog is by and large old and second-tier programming,” one commenter said on the Wall Street Journal’s website. “The beauty of the DVD catalog is its depth of selection.”

Any number of competitors could surge into the market sensing an opportunity, and that will only send costs skyrocketing.

“They’re headed toward competing for digital rights for projects with pay TV networks, and that’s going to be an expensive proposition,” Tom Adams, principal analyst and director of U.S. media for IHS Screen Digest, told TheWrap. “They’re going to have to outbid HBO and Showtime for the rights to show movies over their network.”  

HBO, which has already launched the streaming service HBOGo, could use the catalogs of its fellow Time Warner sibling, Warner Bros.

Amazon, a profitable company that that already operates streaming unit Amazon Prime, could strike new content deals.

Then there are the unknown and unforeseen companies that seem to launch every day.

“Why would people be loyal to Netflix?,” Edward Jay Epstein, the author of “The Hollywood Economist,” told TheWrap. “When you talk about a Time Warner subscriber, for [subscribers] to cut the cost is pretty difficult. You need to find something to replace it. In streaming, you don’t need any reason. Its like going from one website to another. It’s a click away.”

Further muddying the company’s forecast is the possibility of a two-tiered internet. In that case, those companies taking up more of the internet bandwidth will have to pay more, and those costs would likely be passed on to consumers.

David Hyman, Netflix’s general counsel, recently published an op-ed in the Wall Street Journal, criticizing the idea of usage-based pricing for bandwidth.

One reason may be that Netflix accounts for 30 percent of peak-hour internet traffic in North America. A two-tiered internet could sink the streaming business.

Netflix “wants to be able to ride other people’s pipes for free,” Wible said.

Netflix rejects almost everything its angry subscribers and the dubious analysts are saying.

Steve Swasey, a Netflix spokesperson, toed the party line in terms of the company's DVD plans. He said Netflix wants to “give life to the DVD format for a long time.”

Swasey also rejects any suggestion that the company is financially troubled.

“I don’t know how a company with 60 percent year-over-year growth in subscribers … has anything other than a successful model, he said.

“Netflix is a growing, profitable American business,” he added. “The forecast is robust going forward.”

Where that robustness comes from — and how long it will last — remains up for debate.

Already a fixture in America, Netflix is pushing into foreign territories. It has offered a streaming service in Canada for a year now, and has already locked in one million members. Latin America is next, with plans to push into Europe already percolating.

Yet, what makes global expansion a particularly interesting tactic is that it all but confirms the company’s streaming ambitions. Netflix is not shipping DVDs to any foreign countries. That would cost the company even more than the already expensive domestic DVD service.

“For anyone looking to boycott Netflix, the most damaging thing they ould do is have everyone sign up for a DVD plan and rent as many DVDs as possible,” Wible said. “They’ll lose money so fast.”

That is why the massive price hike was necessary.

Netflix must either force people into streaming, make DVD distribution more profitable — or, as is often the case, both.

“The backlash is important to see if the Netflix model works,” Wible said. “Do people see enough value in Netflix at these various price points? It’s a major test for the company.”

Netflix is still king for now, but after last week’s customer blowback, its crown got a lot heavier.