Netflix: It wasn't you, it was me

Netflix's fall from grace has been swift and abrupt, today falling to a new 52 week low following an unusual apology email from CEO Reed Hastings yesterday and an announced restructuring of the business. Netflix will now be separated into two businesses; Qwikster, the traditional DVD rental business now including video game rental, and Netflix, now simply the online streaming business. The rationale behind the split according to Hastings is to let “each (business) grow and operate independently,” presumably allowing investors to value the higher trading streaming business completely separately from the lower trading DVD. Streaming only now represents 40% of subscriptions and this business appears likely to continue to quickly grow, while the DVD business' growth trails off.

The company's slide began in the middle of July when they changed their pricing from a $7.99 option to purchase just streaming and a $2 add on to get DVDs as well. The company then somewhat slipped in a new pricing structure that completely separated the streaming and DVD business with each costing $7.99. The slide furthered when Netflix cut their guidance for subscribers late last week as a result of a backlash to the new pricing structure.

There have been numerous missteps and oversights throughout the last 6 months that have led to Netflix rapid decline. Dividing the two businesses was the logical next step for the company, but the initial step to getting there (the pricing switch) and the timing was communicated so poorly that it may have done permanent damage. Ultimately, Hastings appears to have overestimated his customers' loyalty to Netflix at the wrong time. Being the first to do something endears substantial goodwill and trust, but that can be quickly evaporate and be irrevocably broken. Competitors were already gaining steam on Netflix's business model and with complimentary products being offered (and losing Starz), Netflix may be left with a great business that set itself up for cannibalization.

America is generally a fairly forgiving country when someone is quick to admit their mistakes. We'll forgive the Hugh Grants and the Bill Clintons because they apologized and didn't ultimately affect the pocket of their fans. Netflix's poor communication struck a nerve as less disappointing but more deceitful, causing a loss of confidence and loyalty that actually hit their supporters financially. The stock is probably undervalued at its current levels, an overreaction to the uncertainty, but the long term future seems bleak with fractured consumer confidence and a leader substantially underestimating customer loyalty.