Netflix: can growth be restored?

Will Netflix spiral downward, or will it find the way back up? That is the question, after its latest not very well received step. Let's first look at what is going on over the recent past:

• Decoupling the pricing for the Watch Instantly (streaming) and the DVD-by-mail service to 8 $/mo each. This effectively amounted to a price hike (from 10 to 16 $/mo) for the people taking both, roughly half of all subscribers.
• International expansion. First Canada, next latin America and Europe set for 2012.
• Ongoing distribution deals, such as Netgear (for the NeoTV 200 streamer).
• Content deals (such as Discovery and Lionsgate for the UK), but Starz was lost.
• Netflix lowers its 11Q3 guidance by 1m subs
• The DVD-by-mail business will be split off into Qwikster, which adds games. No spin-off/IPO or sale yet.

The market responded in a very negative way, claiming that customers will be frustrated because they like to subscribe to a bundle of physical and digital delivery. DVDs aren't going away that quickly after all. The share price is down around 60 percent from its July high at $305.

Here's one of the rare positive comments It's from one Mark Suster and his views can be summed up as this:

• Netflix rightfully breaks through the 'innovator's dilemma' "to attack his core assets by building new ones". They had already done that.
• "Focus". Same.
• "DVDs won’t die quickly". Not sure why this is put forward as a reason to split the business.
• "Charge the right prices for the right services". Again, doesn't look like a reason to split because Netflix had already put separate pricing mechanisms in place.
• "Transparency for investors". As long as there is no spin-off or sale of Qwikster, this doens't make much sense.
• "Positioning for the Future". Same.

All in all, it looks like textbook arguments ('innovator's dilemma', 'focus') that analysts like to put forward, but as long as there is no sale of Qwikster, adjusting the pricing mechanisms appears to have been enough.

Now look at the other side, for instance Will Richmond's views here, that is hard to argue with:

• "... first shot itself by announcing an onerous price increase without any real attempt to explain itself or soften the blow"
• "Rather than separating streaming and DVD, Netflix should be doing the exact opposite - integrating them as tightly as possible."
• "My sense is that Netflix has too quickly fallen in love with streaming, and forgotten how critical DVDs still are to their current and future success."
• "Without DVDs Netflix is going to going up against far bigger competitors without much of an advantage. As to Qwikster's prospects, marketing a DVD only service in the digital media era? Good luck with that."

Conclusions:

• Defending Netflix' split plan using analyst speak ('focus') makes little sense. The arguments for keeping the businesses together are stronger.
• Qwikster is not actually being sold off. Possibly not much will change after all. And there is still the possibility to have the customers experience little or no difference. The combined company can even decide to (re) introduce a discount for customers taking both services. The split-up can be limited to the back-end operations.
• The Q3 results will give limited insight into further subscriber erosion, because the price hike kicked in late in the quarter. Watch out for between the lines statements and further unexpected moves.

As always: the proof of the pudding is in the eating, and it looks like it will take a while before we can see if growth will be restored. In the meantime, competition increases (Amazon, Blockbuster, Google, Apple, Redbox, Hulu, even Facebook), connected TV expands and content producers are finding new ways to the consumer. But you never know if Reed Hastings has a brilliant new move up his sleeve.