Netflix divorces discs, now what?


Video streaming and video rental giant Netflix rocked its world for the second time in as many months on Sunday, announcing the company will be spinning off its DVD rental business into an independently-operating new business dubbed Qwikster. Qwikster’s CEO will be Andy Rendich, who has served as Netflix’s chief service and operations officer.

The announcement follows on the heels of a controversial restructuring program that significantly raised fees for customers who use both streaming and DVD rental services. In a letter to shareholders (PDF), Netflix forecast the changes would result in the loss of some 800,000 DVD rental subscribers and about 200,000 streaming subscribers.

Explaining Qwikster’s spinoff, Netflix CEO Reed Hastings took responsibility for alienating customers and attempted to outline the case for separating the businesses, noting that “companies rarely die from moving too fast, and they frequently die from moving too slowly.” But the moves leave several questions: where are Netflix and Qwikster headed in such a hurry, and will customers get whiplash from Netflix moving “too fast?”

The deal for customers

The Netflix-Qwikster split will have a very real impact for existing Netflix DVD rental customers, very soon. Netflix’s existing DVD-by-mail and video streaming businesses will be separated into two separate Web sites, with separate accounts, separate queues, separate recommendations, separate reviews, and separate billing. What used to be an integrated experience of browsing both streaming content and material available for rental will become two completely disconnected services. Qwikster will launch with a snapshot of customers’ Netflix account data, but from there the services will diverge. Where customers used to receive one bill, they will receive two; if a film or TV series is reviewed on one service, that review will not be available on another service; and neither Netflix nor Qwikster will consider selections on the other service when making recommendations or helping users manage their queues. However, streaming customers will no longer be frustrated searching for content only to find it’s only available via DVD (or not available at all): For streaming customers, unavailable content simply won’t exist.


Equally importantly for consumers, Qwikster is not changing the recently-increased prices for DVD-by-mail service: an unlimited one-at-a-time DVD-by-mail service will still run $7.99 a month. Customers can add Blu-ray options to their choices for an additional $2 per month, and Qwikster will actually have an option not available under the existing Netflix DVD-by-mail service: video games. Like Blu-ray, users will be able to pay an additional $2 per month to rent game discs for the Xbox 360, PlayStation 3, and the Nintendo Wii.

The bottom line for many of Netflix’s 12 million customers who subscribe to both DVD rental and streaming services is that prices just increased from a minimum of $9.99 to $16.98 per month back in July. Now, on top of that price increase, the services will be more difficult to use, thanks to separate accounts, separate sites, and separate billing. It’s a move that hardly smacks of “innovation.”

The deal for Netflix

Netflix is positioning the Qwikster spinoff as the best way to handle the divergent businesses of streaming and DVD rentals. There’s little doubt they are different. Where DVD-by-mail needs warehouses, inventory management, mailing services (and the goodwill of the postal service), plus all the paraphernalia of dealing with a business shipping physical goods, streaming is a more-global business that has to deal with data centers, content delivery networks, and software — whether that be for tablets, smartphones, smart televisions, set-top boxes, or old-fashioned PCs. Netflix argues that by separating the businesses, both can innovate separately without worrying about ramifications to the other. “Our view is with this split of the businesses, we will be better at streaming, and we will be better at DVD by mail,” Hastings wrote by way of explanation.

Innovating the streaming business will likely mean insinuating Netflix into even more consumer electronics devices, as well as striking new deals for digital content distribution that don’t have to be tied to DVD rentals. Netflix has already been forced to grant studios windows of exclusivity on DVD releases, and recently lost its long-term agreement for streaming content from Starz. Separating the streaming business will enabling Netflix to negotiate with studios separately from DVD release windows, and possibly offer new types of streaming availability, like limited release windows or even pay-per-view or per-title rental options for premium content.

Netflix has been operating for 14 years; in that time, Hastings has always been clear that the business he wanted to build was literally Netflix — video delivered online — rather than DVD-by-mailflix. The DVD rental business, although a mammoth success, was just Hastings’ leg up until a streaming-only business became a practical reality. Separating out the DVD rental business enables Hasting to focus on what he really wanted to do: create an industry-leading online video service.


And Netflix’s streaming is a practical success: even by its downwardly-revised estimates in the wake of price hikes, the company expects to have 9.8 million customers to its streaming-only service, compared to just 2.2 million who will subscribe to a DVD-by-mail service. Factoring in customers subscribing to both, Netflix’s streaming business is considerably larger than its DVD rental business: 21.8 million subscribes, compared to 14.2 million for DVDs. In other words, over 60 percent of the company’s customers currently pay for streaming service.

The Qwikster spinoff seems designed to make sure the majority of those 12 million DVD-and-streaming subscribers stick with Netflix. Already stung by a price hike and now facing separated accounts, services, and billing, many of those dual customers will cut their losses by choosing one service or another. Although adding video games to the DVD services may sway some rent-by-mail subscribers, it’s a good bet the majority will choose to stick with the streaming service  —after all, streaming customers are already the majority of Netflix’s overall customer base. Short of lowering prices, or increasing the number of DVDs available at different price points, it’s not clear how Qwikster can “innovate” the DVD-by-mail business much further. (However, Qwikster will be able to advertise its service separately, which may eliminate some confusion over what, exactly, Netflix is.) And even Hastings concedes Qwikster’s days may be numbered. “DVD by mail may not last forever, but we want it to last as long as possible,” he wrote.

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