Let me start with a confession – I am a technology geek and understand (almost) nothing about economy. I also do not have any special insight into the thought process of Netflix or its competitors. As such, this is not a recommendation to buy or sell any specific stock but rather my speculative observation.
With that said, the last few months were a complete “free fall” for the Netflix (NASDAQ:NFLX) stock. The price of a share fell down for more than 55%. From $298 on closing of July 13th to $129 on closing of September 23rd. A lot was said about the miss handling of changes that Netflix did on their pricing, the bad news about Starz change of heart and lastly Reed Hastings, Netflix’s co-founder and CEO, “personal” apology coupled with new announcement of a split of the business. Most of the comments were very negative. A lot of comments were made directly to Mr. Reed, wondering if he lost the mojo. Some comments also stated that the old, thought to be dead, competitor Blockbuster will be able to revive itself on the expense of Netflix. All of the fear and the concerns are understood.
But here is another perspective – The same brilliant team that started Netflix from nothing, that reinvented Netflix multiple times, is telling us now that they have been thinking about this change for five years and that there is no other way but to perform another major and painful change, what we like to call a pivot, and that this is simply a must have for the long term success of the their company. All the concerns and the risks are valid but the potential gains are also amazing. We have to remember that , historically, each time they did a pivot before, the investor community (or should I say chorus) stated that this is the end of Netflix and that they are insane.
Back to the first line, I am just a technologist, and in pivots like this there are so many risks that I personally can not assess, but it is possible that Netflix is going to come out of this better and stronger than ever before. The separation between the two businesses allow them to focus on the future, and the future of streaming is way more than movie rentals. The future of Netflix may be in the Cable industry.
Let me explain: The cable industry is in defense mode right now and from a very good reason. Their traditional business model has to change. Traditional subscribers were buying triplet subscriptions – TV content, phone and internet. And they were (or are) charging us a lot of money for these services. In the future, these services may be split and may no longer be at the hands of the cable industry.
Let’s look at these services one by one: The internet is a costly service for the cable companies as this must have physical infrastructure to the subscriber house. This is a $40 service for high speed internet.
On the other hand the phone service is much more lucrative. At the cost of $30 per month for the subscriber, the cable company is providing us a phone over the internet service. The cost per subscriber from the cable company perspective (assuming the physical infrastructure is there for the internet) is almost nothing. Meaning that if I have to guess, almost all of these $30 per month is going straight to the cable company bottom line – profit! But these good old days are rapidly disappearing. Despite many attempt to stall this process there are many alternatives for consumer telephony services. Phone over the internet is available today, and already dropping the income per subscriber from $30 per month to $15 per month to zero per month if you are willing to use your laptop and use Skype or other similar services. For the cable industry this is scary. This is dismantling a gold mine that they have preserved for multiple years
The TV content is an even older service and even more core to the Cable industry. It is also a $30 per month line item on your bill and if you opt to get more channels or DVR service the cost can be even doubled. In the past Cables were the only provider of visual content to the average household. But the high speed internet changed all of that and video streaming directly to a chosen device is a lot cheaper and happening everywhere. But here is a catch. Most households are still paying for the cable to stream TV content to their TVs in addition to the internet streaming.
So why is that?
The main reason is the quality of content and the way it is organized (24*7 new content in pre-defined channels). Well, Netflix with its $8 per moth consumer cost and other services such as Hulu and Amazon can change all of that. If they get enough of quality content, if they organize it in better, channel like fashion, and offer all of that in a fraction of the costs, with no dedicated DVR or cable box, they will become a mainstream alternative to the Cable TV.
On that ground the Starz dispute and the Netflix-HBO-Dreamworks move is very interesting. It looks like Netflix competitors are the cables and the traditional content owners rather than the old beaten Blockbuster. That is a long term huge potential for Netflix and that is why it may be just the beginning for this amazing company, that keep surprising and disrupt the home entertainment industry. That is at least a possible scenario for the rational of the Netflix pivot and may become yet another one of these wonderful business cases taught in many MBA programs of the future.