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Business Breakdown: Netflix Splits its Company in Two

Netflix is splitting into two separate companies after a price increase caused customers to walk. What's the deal?

Yesterday, Netflix announced that it will split its DVD-rental-by-mail service from its streaming movie service, creating a new subsidiary called Qwickster to handle the DVDs and continuing to stream movies from the Netflix website. What’s the deal?

Customers voted with their wallets. A few weeks ago, Netflix announced a price hike to at least $8 a month for either DVD deliveries or streamed movies over the Internet, an increase of as much as 60 percent for customers who subscribed to both services. Enough declined to renew their subscriptions that the company missed its forcecast for subscribers by about a million. When the company revealed this information to investors, they voted their way, selling Netflix stock and leading to double-digit reductions in the company’s market capitalization. While company executives say the increase is necessary to license quality content (especially after the news that the company will no longer be partnering with the Starz movie channel), customers weren’t happy.

It’s not too late to apologize. Or so Netflix CEO Reed Hastings hopes. His blog post and video announcing the change begins with the frank explanation that he (and his company) made a mistake in how they handled the price hike. The decision now to follow the increase through to its logical conclusion of having two separate services is a recognition of the different economies of the streaming versus mail business. It will hurt the company’s data collection (ratings will no longer be transferable between the two companies) and remove consumer options (certain movies are only available on one or the other service, and now customers who desire both streaming and DVDs will need to maintain two subscriptions). Still, this deal will also allow the two companies to better address consumer needs at the two businesses: The company will now rent video games by mail, a long-requested upgrade, and other innovations are promised at both services. Customers are basically going to have to deal with a more-expensive, somewhat limited service on the way to something better, and Hastings is betting a fuller explanation will help keep them around through the transition. Fortunately for Netflix, there aren’t many other firms positioned to step in and rob them of subscribers.

This is about the future of film and TV. “For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming,” Hastings wrote in his blog post. There’s a reason that the Netflix brand is staying on the streaming site while the DVD service gets the funny new name. The company is doubling down on what it believes is the content distribution plan of the future, and growth like that comes with growing pains. Despite increasing competition in the sector, Netflix still has the best infrastructure base to own streaming video (especially with the rocky sale of Hulu, the major television content streamer, casting doubt on its future). If Netflix can strike the right licensing deals, which will require convincing distributors to accept a new pay scale, to grow its content library and attract subscribers, this move will look prescient a few years from now. But there is some reason to believe that separating the two businesses may make it harder, not easier, for the the new Netflix to get the best content.

Netflix is using public relations and a strategic shift to weather a storm of customer disappointment and investor concern on the way to creating a better service, or so the company hopes. That’s the breakdown.

Photo via (cc) Flickr User tar0_

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