Exodus? Netflix Subscribers Signal Intentions to Cancel Subscriptions

It does not appear that CEO Reid Hastings’ mea culpa for mis-communicating the recent changes in the operations of Netflix Inc. will quell the anger caused by the announcement that the company is splitting its DVD-rental and streaming video businesses. It is not the unnecessary split as much as it is the 60 percent price hike that is sending subscribers looking elsewhere for their movie fix.

Media research firm Frank N. Magid Associates Inc. surveyed both subscribers and non-subscribers to the Netflix services just prior to Netflix’s price hike announcement. A full 9 percent of current responders said they would cancel their subscriptions instead of switching to the new Netflix pricing plan and another 7 percent said they would cancel their subscriptions for reasons unrelated to the price change. Another 14 percent are “seriously considering” cancellation.

That is 30 percent of Netflix subscribers who have cancelled, will cancel, or are likely to cancel. The chief beneficiary of the cancellations appears to be Coinstar, Inc., operator of the ubiquitous Redbox $1/rental machines. Magid’s research indicates that 60 percent of Netflix subscribers already use the Redbox machines, and 30 percent of these subscribers plan to use Redbox more because of the Netflix price hike.

According to the Magid research, customers are primarily unhappy with the selection available from Netflix’s streaming service. When Netflix split its subscription fees to separate streaming and DVD services, the streaming-only subscription price was set at $7.99/month and the cheapest DVD-service price was set at an additional $7.99/month. Before the price hike, a combined subscription cost $9.99/month.

To exacerbate the matter, Netflix announced on Sunday that it was splitting its businesses and that customers of both services would now be getting two bills instead of one. It is perhaps not prudent to charge more for no improvement in service or quality and then make it more difficult to pay the bill.

Arguably, Netflix’s price hike has been a disaster to which everyone in the company’s management should probably share the blame. Moving more of its business to a streaming model, on the other hand, is perhaps the right strategy. Perhaps Netflix management thought it could afford to lose a percentage of its customers if it is was compensated by higher fees.

Now the company can choose to stay on its current course or try to repair the damage. The latter course seems the most sensible, but Netflix might have already burned its bridges. About all it can do to repair them is to declare they made a big mistake and cancel all their plans and revert to the good old days of the $9.99 subscription fee.

Netflix might not be able to do that though, or its revenues and profits will suffer, even if all 30 percent of the departing customers come back. The company needs to come up with a way to staunch the bleeding. And that’s what Hastings and his management team get paid for — not for issuing self-serving, badly-reasoned blog posts.

And if you are wondering why in the world Netflix would have tampered with what was so apparently a winning model, this bit by Bill Gurley at Above the Crowd via Hotair is one of the more interesting theories we have seen:

Netflix has for the past several years been negotiating with Hollywood for the digital rights to stream movies and TV series as a single price subscription to users. Their first few deals were simply $X million dollars for one year of rights to stream this particular library of films. As the years passed, the deals became more elaborate, and the studios began to ask for a % of the revenues. This likely started with a “percentage-rake” type discussion, but then evolved into a simple $/user discussion (just like the cable business). Hollywood wanted a price/month/user.

This is the point where Netflix tried to argue that you should only count users that actually connect digitally and actually watch a film. While they originally offered digital streaming bundled with DVD rental, many of the rural customers likely never actually “connect” to the digital product. This argument may have worked for a while, but eventually Hollywood said, “No way. Here is how it is going to work. You will pay us a $/user/month for anyone that has the ‘right’ to connect to our content – regardless of whether they view it or not.” This was the term that changed Netflix pricing.

With this new term, Netflix could not afford to pay for digital content for someone who wasn’t watching it. This forced the separation, so that the digital business model would exist on it’s own free and clear. Could Netflix have simply paid the digital fee for all its customers (those that watched and not)? One has to believe they modeled this scenario, and it looked worse financially (implied severe gross margin erosion) than the model they chose. It is what it is.

Netflix shares are down by about -9 percent in the early afternoon today, at $131.39, after posting a new 52-week low of $129.50 earlier this morning. The stock’s 52-week high of $304.79 may be in the rear-view mirror for good now.

(Paul Ausick/Becket Adams- 24/7 Wall St./The Blaze)