Everything You Need To Know To Understand Netflix, In One Picture

Posted on October 11, 2011

My friend Ginger left a comment on my post last week:

Did you hear about Qwikster? Are you gonna blog about it? WHAT DOES IT ALL MEAN.

I always yield to requests from my teeming millions of fervent admirers, so here is what it all means.

Everything you need to know to understand how Netflix has behaved over the past few months is contained in the chart above.  Notice how, three months ago, the company’s stock was trading at around $300 per share.  Then in July they announced two big changes to take effect for existing customers on September 1: DVD and streaming rentals would be separated into two plans rather than one plan containing both, and the cost of subscribing to both plans would be 60% than the previous unified plan had been.  This kicked off a slow slide in the stock price, as the market tried to price in the expected loss of customers.

By the time the price hike actually took effect, the stock had dropped down to a little under $250 — nearly a 20% drop in value, which in most circumstances would be bad enough.  But the real bloodbath didn’t come until two weeks later, when Netflix announced that its pricing changes might have cost it more customers than it had originally projected — and that those higher-than-expected losses would turn the third quarter of 2011 into only the second quarter in its history when Netflix would end up losing money.

That announcement sent the stock off a cliff.  When trading closed for the week the next day, it had sunk to $155 per share; that’s half of what it had been trading at in July, and $70 less than it had been trading at two days before. And there was no obvious reason to believe that the tumble would not continue when the stock market reopened on Monday.

This put Netflix management under the gun — they needed to come up with something that weekend that would calm the markets on Monday, or lose the confidence of the company’s shareholders (and their jobs). I wasn’t there, of course, but I imagine they spent the weekend furiously trying to come up with something, anything, they could do that would serve that purpose.

Late that Sunday, they announced what they’d come up with: Qwikster.

In a few weeks, we will rename our DVD by mail service to “Qwikster”…

Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to qwikster.com to access their DVD queues and choose movies…

A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated. So if you subscribe to both services, and if you need to change your credit card or email address, you would need to do it in two places. Similarly, if you rate or review a movie on Qwikster, it doesn’t show up on Netflix, and vice-versa.

My guess is that they thought the DVD-by-mail business was a drag on Netflix’s stock performance, and therefore shunting it from Netflix into an outside enterprise would stop the slide. That turned out not to be the case, though; the move was widely derided as confusing and customer-unfriendly.  The reaction was so fierce that Saturday Night Live even joined in the mockery, in a sketch they aired on their Web site:

http://www.hulu.com/watch/284938/saturday-night-live-netflix-apology

More importantly, the Qwikster announcement didn’t stop the stock from falling further; when the markets reopened on Monday it tumbled down to $130, where it’s more or less stayed ever since.  Which is probably why Netflix announced yesterday that they actually wouldn’t be spinning out Qwikster after all: the whole point of Qwikster had been to keep the stock from dropping further on Monday the 19th; once it failed to do that, there really wasn’t much point to it anymore.

I’ve spent so much time in this account focusing on when things happened because that’s the key thing you need to understand to understand Netflix’s behavior.  If the Qwikster decision seemed irrational to you, I would argue that that is because it was irrational. It wasn’t the product of reasoned, long-term strategic thinking; it was the product of panic. Netflix management spent the tail end of the week of September 12 watching everything they’d built over a decade collapsing underneath their feet; they had just two days to find a way to shore it up; Qwikster was their Hail Mary pass, a play born out of desperation. And like most Hail Mary passes, it didn’t succeed.

I’ll have more to say in a future post about the long-term forces that threaten Netflix’s business, which are part of the reason why they made the initial decision to separate their DVD and streaming services — the decision that kicked off the whole chain of events that led to the abyss.  But to answer the question “what does it all mean?”, you don’t really need to know any of that stuff.  All you need to know is that Netflix is running scared; and scared people make bad decisions.