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Netflix has Problems, but Customer Churn is the Least of Them

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October 25, 2011

Netflix has Problems, but Customer Churn is the Least of Them

By Gary Kim, Contributing Editor

Reed Hastings has faced lots of criticism over the viability of the Netflix business model, and not just recently. Facing higher content licensing costs, global expansion and subscriber losses from the recent change of retail plans, the storm of controversy is about as high as many of us ever have seen it. Netflix expects losses for all of 2012

Netflix posted third-quarter user losses that were worse than its September 2011 forecast and predicted more cancellations over a price hike. The shares plunged 26 percent in extended trading.

Domestic users fell to 23.8 million as of Sept. 30 from 24.6 million three months earlier. Netflix quarterly results

It’s pretty simple to present the “bearish” case. Netflix is liable to competition both from rival online services, some with business advantages, while its cost of licensing content inevitably will increase. Netflix challenges

Tighter data caps won’t help, either, as long form video, and video in general, is a huge driver of bandwidth consumption by consumers.

But the real problem is not customer defections because of higher prices. Higher prices are inevitable. The big problem is that the DVD by mail business has a cost structure that is much lower than the streaming business, and not because of delivery costs. Whatever Netflix might save in postage costs by streaming video ultimately will be an immaterial cost compared to content licensing costs.

And that’s the big challenge, not delivery costs.

Even now, some would say the real problem with the streaming product is that the “good stuff” isn’t readily available, compared to what a consumer can view using the DVD by mail alternative. Ultimately, that can be remedied if Netflix offers enough money to the content owners. But that is going to dramatically change the Netflix business model.

True, some argue that Netflix has lower fulfillment costs when it offers streaming, compared to mailing DVDs. But the bigger problem, for any content business, is lack of sufficiently compelling content. Right now, the DVD catalog vastly outstrips the online catalog.

DVD-by-mail business worked well because Netflix founder Reed Hastings was able to buy the DVDs in a retail store and then rent them.

Unfortunately for Netflix, it’s a far different proposition to build a successful online streaming business. That’s because content acquisition arrangements for streamed content are quite different. Netflix could buy a DVD and rent it many times without paying any additional content licensing costs.

Streamed content requires an additional payment for every viewing or delivery instance.

The other issue is that where Netflix historically has been a provider of movie content, the company says its future is the TV business, in particular the sorts of content now viewed by subscribers to cable TV, satellite or telco video subscription services. That is going to be an ever bigger shift for Netflix, in terms of content costs.

That probably cannot be accomplished unless Netflix can charge substantially more than it now does. And anybody can see the furor caused by raising monthly prices by a modest amount, compared to what people pay for subscription TV.


So the big problem for Netflix is not the immediate subscriber churn because of higher prices. In the future, if Netflix succeeds, content costs and retail prices will be substantially higher. The big problem is getting content access and then convincing consumers to pay what that will require.
Gary Kim (News - Alert) is a contributing editor for TMCnet. To read more of Gary’s articles, please visit his columnist page.

Edited by Rich Steeves

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