Why Wall Street is (still) wrong about Netflix

Why Wall Street is (still) wrong about Netflix

Summary: The trouble with trying to adapt a big and growing business to disruptive technologies is that the process is... well, disruptive, as Netflix has demonstrated beyond the shadow of a doubt.


The trouble with trying to adapt a big and growing business to disruptive technologies is that the process is... well, disruptive, as Netflix has demonstrated beyond the shadow of a doubt.

But "disruptive" doesn't mean "impossible," and it's way too soon to count Netflix out--although that hasn't stopped Wall Street from trying.

Since announcing yesterday that it shed 810,000 net subscribers in the third quarter, the purveyor of DVDs-by-mail and video-by-streaming has been the goat of Wall Street. Its share price plunged 35 percent today, to $77.37, knocking a cool $2 billion or so off its market cap.

All because Netflix's attempt to distance itself from its slowly dying DVD business in favor of instant and far more scalable video streaming has been rockier than anyone expected. While the company has made more than its share of mistakes, that doesn't change the fact that it's still got the right strategy, even if its execution has so far left a lot to be desired.

Recall that in Clayton Christenson's classic formulation, technology giants are frequently topped by "disruptive" technologies that erode seemingly impregnable businesses, often with startling speed. This is partly because it's easy for incumbents to dismiss the disruptive potential of a fledgling technology--a classic hazard of linear thinking--and partly because adapting to the new world would itself disrupt existing, and usually highly profitable, business relationships.

Thus did steam-shovel firms give way to startups that had grasped the early potential of hydraulic shovels. The same thing happened to disk-drive makers, to the makers of traditional cameras and film, and even to the mainstream media. Almost invariably, the giant companies of the time found themselves unable to successfully transition to the newer, cheaper, and ultimately much bigger businesses made possible by disruption.

So Netflix CEO Reed Hastings deserves some major credit for trying to buck this trend. With the high fixed-cost DVD business on the verge of stagnation, Hastings took the almost unprecedented step of effectively blowing it up in order to speed the transition to streaming.

On Wall Street, however, you're either a hero or a goat. So long as it seemed to have the best of both worlds, Netflix was a hero, with a near-$300 stock and a growing streaming business that made it the biggest source of Internet traffic in North America. Then came the company's steep and sudden 60 percent price hike on its existing subscribers, who'd grown used to paying the same low fee for both DVDs and streaming. Soon afterward came its bizarre--and, thankfully, hastily discarded--plan to spin off the DVD business as a separate company to be called "Qwikster."

And now Netflix is such a goat investors were primed to punish it severely for losing a third more subscribers in the quarter than it had warned. Suddenly the air is thick with talk of Netflix having irreparably damaged its brand, blown its shot to lock up access to valuable Hollywood movies and TV shows, or even started a death spiral.

OK, deep breath time. Truth is, Wall Street was wrong when it thought Netflix had mastered its disruptive transition, and it's wrong now for thinking the company has biffed it but good.

Here are a few things people tend to overlook about Netflix:

  • The company is still profitable, and in fact managed to beat Wall Street profit expectations yesterday despite its dismal customer numbers.
  • Yes, Netflix is projecting a loss early next year, but that's largely because it's spending heavily to launch its streaming service in the U.K. and Ireland--not because of U.S. customer trends.
  • Netflix launched its streaming service in Canada a year ago, and claims it already has more than 1 million members and 10 percent household penetration in the Great White North.
  • DVD customers are upset with Netflix--and understandably so. But they are the past, not the future, so far as the company is concerned. All the company really needs to do is stanch the bleeding on the DVD front while its streaming future takes root.
  • Netflix couldn't close a deal to continue streaming films from Starz, but that says more about Hollywood's greed and short-sightedness than it does about the opportunities for Netflix. Hollywood still needs Netflix more than the other way around, given the speed with which cord-cutting and piracy are eroding the traditional distribution of entertainment.
  • More broadly--and perhaps most importantly--Netflix is surprisingly well positioned to capitalize on a basic economic fact, which is that in a perfectly competitive market, a product's price will tend to fall to the marginal cost of distribution. Entertainment is far from perfectly competitive, of course--but it's growing more so every day. And the marginal cost of distributing digital video is... zero! (Or pretty close to it; you still need bandwidth and servers, of course.)
None of which is to say that Netflix has a lock on the future of streaming entertainment. It surely faces some tough competition, particularly from Amazon's Prime video-streaming service.

But Netflix is still in the right place at the right time, with a very competitively priced service. Maybe its offerings will shift a little more toward the Long Tail side of the catalog for a while as it works to consolidate its footing in the streaming business. But there are worse fates, and it's not at all difficult to imagine things shifting back in Netflix's favor as some of these other trends play themselves out.

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About David Hamilton
David Hamilton is the assistant managing editor of CNET News. He has been writing and editing business and tech coverage for about two decades -- the majority of that at the Wall Street Journal in both Tokyo and San Francisco.

Topics: Software Development, Browser, Hardware, Mobility

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  • RE: Why Wall Street is (still) NOT wrong about Netflix

    Wall Street is NOT wrong about Netflix, Netflix is wrong in how they handled the process. Of course the change would be disruptive, but it could have been done slowly with small easy to grasp changes, NOT highly disruptive changes that made the company look like it DID NO PLANNING. Netflix's change was like a KNEE JERK response, Oh I should have started this change two years ago response.
    • RE: Why Wall Street is (still) wrong about Netflix

      @TBeckner <br><br>Bingo. "Failure to plan is a plan to fail". I would count what Hastings has done to be a failure to plan. Leading by kneejerks doesn't give the customers or the stockholders either one the impression you have a long term plan of any kind. If customers do not see a long term solution/commitment, they leave, and stockholders do as well.
    • Agreed, and it has started a death spiral

      @TBeckner Agreed.

      If I had any stock I would be dumping it
      Schoolboy Bob
  • RE: Why Wall Street is (still) wrong about Netflix

    Articles like this cause investors to lose lots of money. Wall Street is not wrong about Netflix. Netflix's path moving forward is very clear. More competition and more options for customers causes a huge problem for Netflix's subscriber base in the coming year. They do not have a goto move, nothing separates them from the competition now. This boat have a leak and will continue to sink until Netflix does something drastic or is aquired by one of there competitors. The way the stock keeps droping I expect that to be sooner that later.
  • RE: Why Wall Street is (still) wrong about Netflix

    The fact that the Netflix service was novel at its outset led to its great success. However, the decision to focus on the streaming business by doubling the cost to their subscriber base with a poor selection of available streaming titles during a severe economic downturn with ever present competition that could provide more for less is a clear indication that Netflix management is not up to the task of running a successful business. Survival of the fittest. Netflix is out. Wallstreet is not wrong.
  • Poor management - Greedy Wall Street

    Whether the DVD business is making money or not, that's where the business was born. You don't throw your founding customers under a bus.

    Anyone with an ounce of common sense would have quietly allowed the DVD side to naturally decay over the next 5 years. If that generates small losses so be it - call it "buying goodwill".

    Instead we have the greedy wall street types who want to spin everything off to "maintain shareholder value". I hope people got burned in the Netflix stock slide. Once there are enough victims, maybe we'll go back to some common sense investing.
    • Exactly right.

      Exactly. Wall Street often encourages poor management decisions -- to the detriment of investors, customers, employees, the public.

      It's not obvious, but it is obvious.

      It encourages and makes money from inflating bubbles, from squeezing profits from the next quarter (eg: excessive cost cutting at BP in order to meet high dividend expectations contributing to poor decisions that let to the Gulf Coast oil spill crisis), at the expense of the next decade. It makes money from collapses of bubbles (eg: CDS against the mortgage bubble, forcing the spread of financial contagion to banks), etc...
    • RE: Why Wall Street is (still) wrong about Netflix

      reminded me of the reason of sun's demise and near-death experience of hp recently... investor's greed basically make or break even feasible company of any size!!! investor's greed made apple the biggest tech flavor of the month, sun's investors hosed and killed it. wait until a mini-Enron debacle come to a head. we can see it looming on the horizon, like a super storm.
  • RE: Why Wall Street is (still) wrong about Netflix

    I don't particularly care about the DVD business (I have only streaming, & if I really want a DVD there are local alternatives). But their streaming content needs serious updating, and IMHO they should address this before they try to move into too many other markets. If they don't make a lot more content available soon, Amazon and others will eat their lunch.
  • RE: Why Wall Street is (still) wrong about Netflix

    I was one that cancelled my service with Netflix and the other people here are right it's Netflix that was wrong NOW if they had updated their movies to include newer titles and ocasionally had a first run movie it might have worked.
    We had the service for about a uear and there was hardly anything left to watch except some British TV series and most of them were BAD!
  • RE: Why Wall Street is (still) wrong about Netflix

  • RE: Why Wall Street is (still) wrong about Netflix

  • RE: Why Wall Street is (still) wrong about Netflix

    Given Netflix's demonstrated complete lack of executive common sense - why would wall street NOT price in further stupidity?

    I mean seriously, the people running Netflix sat in a room, looked at "Let's raise our prices by 60% and make it twice as hard and confusing for our users to access what we sell" and they thought "yeah - that's a GREAT idea!"

    Nothing Netflix was doing was "disruptive" - it was simply dumb.
  • More delusional nonsense from the tech press

    The tech press' love affair with streaming seems to blind them to the realities that providers like Netflix are still running a business that depends on content. The article's money quote "Hollywood still needs Netflix more than the other way around" says it all. The article COMPLETELY ignored the issue of Netflix's exploding content costs, claiming that the distribution costs are close to "zero."<br><br>No, quite the opposite -- Netflix is DEAD without Hollywood, and Wall Street is finally waking up to that fact. The article (and nearly everything else I've read from the streaming-obsessed tech writers) conveniently ignores the fact that Netflix's content costs are growing faster than their revenues. The overseas expansion talk is nothing more than a smokescreen for the fact that every time one of Netflix's content deals comes up for renewal, the negotiated fees have gone up 8X to 10X. <br><br>Streaming usage is on the rise, no question about that, but that alone does not cover up for the huge missteps Netflix has made. And their competitive position was already eroding before they pissed off millions of their best customers. <br><br>The article mentions Amazon Prime, but streaming competitors also potentially include Blockbuster/Dish, Apple, and Microsoft. The difference between Netflix and those other companies, is that Netflix has comparative small cash reserves and has no other revenue streams or services that they can leverage. Netflix's weaknesses have nothing to do with the streaming market's growth.<br><br>And the article cites Starz as short-sighted for pulling Sony and Disney content from Netflix, but the article is itself short-sighted because Starz can now use their content rights to start up their own streaming platform, much like HBO has done with HBO Go. HBO Go combines their original programs (which they stream exclusively) with recent movie releases (the rights to which they can show first before Netflix). Surveys have found that the heaviest users of HBO Go streaming have also increased their viewing time on HBO's broadcast networks. In essence, the streaming platform reinforces the broadcast network. <br><br>Starz has original content that they can add to the streaming rights for recent movies. Whether they build their own platform, or combine it into a different platform, they have plenty of options. <br><br>Netflix simply cannot afford to pay top dollar to every studio, and their deep pocketed competitors can easily outbid them for access to content -- and content means everything here. The streaming market is already shaping up the same way that premium cable channels did -- with different channels carving out exclusive access to recent releases from certain studios. Netflix has already fired the first shot by paying big bucks for exclusive streaming rights to Dreamworks' movies starting in 2013. What's to stop Amazon from carving out their own territory, particularly with Sony and Disney's libraries available? End result will be much the same -- if you want to watch every available movie, you will need to subscribe to multiple providers.
  • RE: Why Wall Street is (still) wrong about Netflix

    I disagree with the author. Wall street has it right. Horrible CEO, horrible company.
  • RE: Why Wall Street is (still) wrong about Netflix

    The commentary doesn't address the effect of the number of people who drop only one service when the price was raised. Many netflix subscribers chose to only subscribe to streaming or dvd when the price was raised. This actually cut their subscription cost by a dollar a month. The full effect of the changes has not been reflect on the financials. I should raise a yellow flag for investors.
  • You are wrong, DVD breath!!!

    I dumped the straming because it is virtually worthless as it stands because of the relatively small selection.

    I kept the DVD service but it's getting harder and harder to ffind things to watch. I wait with anticipation for films and TV series to be released to DVD. At one point my queue was down to 4 entries. I almost cancelled then.
  • RE: Why Wall Street is (still) wrong about Netflix

    The streaming business is always going to be dicey for a company that does not own ANY content. The original model of Netflix that pulled the chain of Hollywood was
    1. Buy discs retail
    2. Rent discs without any royalties or restrictions
    3. Rely on established rental law and tell Hollywood to shove it.
    They went off the rails when they started to make deals with Hollywood for cut rate discs, etc. (Including streaming). GO BACK TO WHAT WORKED! NO DELAY. NO ALTERED DISCS.
  • RE: Why Wall Street is (still) wrong about Netflix

    Netflix will be around until there is a reasonable competitor, which there is not. It's still a cheaper and more convenient model than any other (are there any?) competitor, despite the delayed title base they hold. They will likely leverage their installation base (PC's, TV's, Devices, Apps) to regain their lead position. Stocks rarely track actual product, but more often make money shorting or holding based on rumors (some made by those with vested interests in either direction).

    Let it drop a few more points, then it'll become a strong 'buy' again.
  • RE: Why Wall Street is (still) wrong about Netflix