What Netflix Needs to Learn From Amazon


Like many others, I took a shameful pleasure in watching Netflix (NAS: NFLX) CEO Reed Hastings' sad-yet-hilarious bungling of yet another major service change. Not satisfied with its recent, customer-alienating moves of jacking up prices 30% to 60% on long-time members -- and reaping a big drop in membership along with a huge fall in stock price -- Netflix had, Hastings said, finally decided to make amends.

The peace offering? A long-winded explanation that the price increase was actually part of an even bigger company initiative, one that will split the subscriber experience in two. Hastings explained that the disc business will abandon a decade's worth of branding to rename itself the horrible "Qwickster," while the smaller streaming catalog will keep the Netflix brand. Best of all, and worst of all, the service site would be split in two! No more automatic or simplified moving content from one side to the other! Now, members could not only pay more, but do more work, run content searches multiple times, and juggle extra URLs to organize and expand their daily dose of online-enabled entertainment. And the split will be good for the business, which has different needs and a different cost structure! How awesome is that? Guys? Awesome!?

Hastings is finding out.

Pride increaseth after a fall
Hastings wrote that he believed past success had helped him slide Netflix into arrogance, yet his apology seemed to me to a lot more arrogant than the price increase. A price increase is, at least, impersonal. Not so, the splitting of the business and the way the announcement was handled.

Subscribers -- especially those getting DVDs -- identify with the Netflix brand. To them, Netflix has for years been a trusted companion in entertainment, helping them enjoy themselves in ways beyond the narrow parade of box-office-topping drivel that they could get on demand from much reviled cable companies like Comcast (NAS: CMCSA) , Cox, and Verizon (NYS: VZ) . For loyal members, waking up to see the disc business tossed aside and given a moniker reminiscent of a toilet bowl cleaner is like waking up to find out their favorite, fun, hip friend has taken a middle management job at Staples and doesn't want to hang out anymore because his new friends -- the streamers, the ones who don't mind a small catalog filled with sub-par entertainment choices -- are much cooler, and they're the wave of the future anyway. (But don't worry, you can hang with my cousin Kletus, here. He's hip, I swear, and he wears the same clothes as I do.)

Netflix seemed to understand the intimate nature of this relationship, but not enough to do things right. While I've never been a huge Netflix promoter, even I was stunned by the clumsy way Netflix tried to deliver the breakup note.

The announcement was delivered to subscribers like me as if it were an email from Hastings himself. It was written in a very personal tone, beginning with what seems like a direct apology, "Dear Seth, I messed up. I owe you an explanation." The return address in the email didn't read "Netflix," but was ginned-up to look as if it came from Hastings' own email account. Yet, if you hit "reply" as I did, and typed a note back, you were treated to a bounceback, no-reply email, revealing that this wasn't a personal apology from Hastings (granted, with a large CC list). Instead, it was corporate damage control masquerading as personal communication, and it was designed to be the end of the discussion -- at least so far as your inbox was concerned.

At least we mere plebs were invited to take our concerns to a Netflix blog page, the proper venue for such rabble, I suppose. There, incredibly, Hastings continued to alienate members by only responding to the minority of posters who praised Netflix, ignoring the majority of the comments (now more than 22,000), most of which told him that he screwed up big time.

Wall Street vs. Main Street
And therein we find a strange divergence. While members seem overwhelmingly negative on this decision, a plurality of opinion (that I have read) from stock and business wonks is that this is somehow a good decision. Why the difference? Because investors and Netflix subscribers have different needs, and Netflix is catering to Wall Street now.

Sure, subscribers hate the idea of splitting the business in two like this: They no longer get a unified browsing experience between discs and streaming. They don't know if the ratings they spent so much time entering over the years will propagate to the new sites.

A lot of investing and business wonks, on the other hand, see another bit of sheer genius! Split the businesses apart! Let independent management on either side run things as they see fit! Empowered teams dedicated to bettering their specific portion of the business will innovate, blah blah blah, shareholder value, individual strengths, boo boo boo, still harvesting synergies ... I've read all that. I get the logic. But I don't buy it. And I don't think it's a slam-dunk way to increase shareholder value in the short or long term.

The best structural and managerial maneuvers in the world don't matter when you alienate and anger your members so much that tens of thousands of them take the time to get online to tell you how bad you've screwed up. Many of them are discontinuing the service, and the breakup isn't that bad because there are a lot of options out there: Amazon (NAS: AMZN) instant video, Hulu, Crackle, Wal-Mart's (NYS: WMT) Vudu, Microsoft's (NAS: MSFT) underrated Zune offerings on Xbox 360, and, of course, Apple's (NAS: AAPL) iTunes.

What would Amazon do?
When I try to imagine the biggest beneficiary of Netflix's self-inflicted wounds, the name that comes to mind is Amazon. I can't help but think that Jeff Bezos and the rest of his team are smiling broadly as Netflix drives its hard-won user base into Amazon's alternatives. I try to imagine Amazon making a massive business and PR blunder like this, and I can't see it happening.

That's because Amazon, quite clearly, seems to understand how to win in the competitive beast that is the online world. In the end, it's a little bit about price and a little bit about the Web experience, but more and more, it's about the simplicity, stupid.

Why do people like me buy everything from books to TVs to large barbecues to toilet flapper valves (seriously) from Amazon? Because it's the simplest way to get what I need. Amazon makes the shopping choice a no-brainer by taking shipping out of the equation with its Prime service. Amazon hijacked the e-reader category not with better hardware, but by making book-buying simpler with free wireless downloading.

Right now, Amazon's streaming video offerings aren't all that easy. I had to install some goofy Yahoo! Widget on my Internet-ready TV to watch Amazon video, and there's no queue and little other organization. On the other hand, a catalog of a few thousand titles comes free with my Prime membership. There's more than enough kid stuff to keep my toddler occupied during her brief periods of TV time, so it's increasingly likely that this Netflix customer will stop subscribing to what remains of my former membership. I don't count myself among typical customers, as I have less and less time for TV these days. But if too many others come to the same conclusion as I have, watch out Netflix.

Foolish final thought
It's not all downhill from here.

Netflix is still the simplest solution in video. The site is slick and intuitive, its streaming catalog's among the biggest, and familiarity breeds fondness, even in the wake of this week's klutzy Netflix announcement. Netflix streaming apps are in more places and on more devices, and that's a big advantage. But moving the member experience away from simplicity -- even just a little -- is the wrong thing for retention, and that, I believe, is ultimately the wrong thing for the business.

The best website in the business cannot support Netflix the company forever, because as we collectively watch Netflix streaming on alternate devices, the Netflix apps begin to vary wildly in quality. (The one for my Samsung TV is pretty awful.) That erodes much of the old Netflix advantage, and it makes sub-par streaming apps -- like Hulu's and Amazon's -- look better by comparison, especially if the price is right, or zero.

Fool co-founder David Gardner likely disagrees with me on Netflix's prospects -- it's a long-time recommendation of his (and current "Best Buys Now" selection) in our Stock Advisor newsletter service. However, in the end, I believe the streaming video business will become a race toward the thinnest margins, as content costs go up and subscriber fees drop. What little room there will be for competitive advantage will go to the company that sets aside its business logic and sees things firmly from the perspective of its customers. Make things tougher for your customers, even just a little bit, and you make it very easy for them to shop the competition.

Netflix shareholders will be in for more pain if Reed Hastings and the rest of Netflix management don't learn what they did to create this week's disaster. Keep it simple, and keep in mind this little rule of thumb: If you are in a service industry and you find Wall Street applauding actions that your customers despise, you should ignore the guys with the rings and the ties.

At the time thisarticle was published Seth Jaysonowned shares of Verizon, but no position in any other company mentioned here, at the time of publication. You can view hisstock holdings. He is the co-advisor ofMotley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool owns shares of Apple, Wal-Mart Stores, and Microsoft. Motley Fool newsletter services have recommended buying shares of Amazon.com, Microsoft, Wal-Mart Stores, Apple, and Netflix. They have also recommended creating a diagonal call position in Wal-Mart Stores, a bear put spread position in Netflix, and a bull call spread position in Microsoft and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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