Thank You, Netflix. And No, That’s Not Sarcasm.

“What’s that? You’re going to cancel your subscription?! That is an issue of great national import!”

People are never satisfied.

2-year old Netflix replaced standard movie rentals with its famed subscription model in 1999. The model worked almost the same way that it does now: you paid $x a month to rent as many movies as you wanted, but no more than three simultaneously. Those movies were then, in a sense, yours. You could hold onto them until the Cubs win a World Series and never incur a late fee. The only incentive you had for ever returning any movie in its postage-paid envelope was to receive the next movie in your “queue”. (Well, that and the monthly fee, a sunk cost.)

No one remembers this, but the original x was 26. At the time even that seemed almost self-destructively low, being the price of 2 or 3 standard movie rentals + late fees from Blockbuster. Here you had this upstart company that seemed to have more ambition than business sense (standard operating procedure at the height of the dot-com bubble), and which for a miniscule price let you watch as many movies as mailing speeds would permit.

You probably remember that Blockbuster was the immovable leviathan of the movie rental business back then; and that largely thanks to Netflix, within a few years Blockbuster filed for bankruptcy and today is as good as dead. What you might not remember is that Netflix simultaneously defeated a competing unlimited-rental service founded by the Goliath of American retailing, Walmart. The Bentonville Bruiser fired the initial volley in a price war, offering a similar service for $19 and relying on sheer girth to sustain any short-term losses.

Netflix was small and wiry enough to withstand hits, though. It didn’t require its customers to commit to contracts, but by getting a credit card number and billing customers automatically, Netflix had a sure revenue source. (It’s amazing how many people will agree to automatic billing then never think about it again, rather than taking the easy steps to cancel.) Plenty of Netflix’s $26-a-month subscribers were paying for nothing, or next to nothing.

If a company can profit delivering nothing for $26, it can profit delivering it for $18. Or $12. For a disinterested observer, it was fascinating to watch Netflix’s response to undercutting and see how low it could go.

The answer was $6, later $7. Netflix reduced its prices to the point where movies-by-mail became almost the least expensive entertainment available, surpassing street musicians and closing in on porch-sitting. If you wanted to receive movies via download and disc, you paid $10. (NOTE: Netflix prices vary by plan – for instance, the company offered $5 plans for people who wanted to rent no more than one disc at a time. This post largely refers to the company’s most popular plans.)

This is more a rule than a generalization, but for a company to stay competitive – especially one built on price – it has to:

  • anticipate technology
  • cut costs.

DVDs and Blu-Ray discs are enjoying a great run as the dominant physical media in their genre, but in the long run they can’t compete with instant downloads. Especially not as the medium of choice for a company such as Netflix: after all, those discs still need to be mailed to customers, and postage accounts for almost ¼ of Netflix’s expenses.

So a couple of weeks ago, Netflix took the logical and ineluctable step of steering customers toward instant downloads and away from discs. Instead of getting unlimited downloads and 3-at-a-time physical rentals for $8, you had to pick one or the other. Netflix then halved the company into a DVD unit and a streaming unit, each of which will profit or lose money on its merits. All in all, an eminently reasonable way to conduct business.

The public outcry would have been quieter if Netflix had replaced its entire catalog with snuff films. 80,000 people registered their opinions on Netflix’s Facebook page, most of which were negative. Analysts, whose business is more to issue opinions than to analyze data, estimate that Netflix’s forward thinking could result in 2 million people unsubscribing. Let’s assume that’s true, which it isn’t, and that all 2 million cancel tomorrow. That means that Netflix will still have added more than half again as many subscribers over the past year (15 million to 23 million.)

By Netflix’s own numbers, three-quarters of new subscribers never take possession of a disc. Within a couple of years, the idea of receiving DVDs in the mail will be as quaint as that of riding your horseless carriage to the general store for dry goods.

Netflix’s transient status as America’s most hated company will be over before you know it. (BP still sells plenty of gas.) Consumers with a sense of entitlement will either realize what a great deal they have with Netflix, or fall for Blockbuster’s aggressive new last-ditch courtship. Either way, they win.

In the meantime, it’s shocking to see how demanding customers can be. “Offer me an inexpensive, efficient, convenient means for watching movies? One that my grandparents would have killed for? One where I don’t have to trudge to a store, and possibly not even to my mailbox? No, that’s not enough. I want more.”

Here’s a prescient passage from a December 2002 Wired column by Jeffrey M. O’Brien:

In five years, (Netflix CEO Reed) Hastings sees Netflix as a $1 billion company with 5 million customers. Along the way, he may move beyond the US Postal Service — but not until broadband penetration increases and delivery costs come down. Today, it can cost more than $30 to send a DVD-quality film over the Internet. As that figure drops, Hastings will consider going digital. “In five to ten years, we’ll have some downloadables as well as DVDs,” he says. “By having both, we’ll offer a full service.”

(You can’t help but think that the success of Netflix might have something to do with Hastings’s conservative growth estimates.)

If you’re a business owner, never hesitate to embrace advancement. Netflix isn’t taking a gamble on an unproven technology here: they already did that years ago. Instead, Netflix is staring inevitability in the face and dealing with it. It’s the customers who are slow to adapt who’ll be left out.

If you’re a customer – I figure at least a few of Netflix’s 80,000 Facebook critics are reading this – be grateful and try to look at this objectively. Entertainment isn’t a utility. You don’t have an inalienable right to extremely cheap movies instead of merely cheap ones. (Technically, you can argue that this isn’t even a price increase anyway.) Companies don’t try to maximize revenue just to inconvenience you. In fact, it was all that revenue Netflix gathered from you and your ilk over the years that allowed them to reinvest the proceeds and provide you with such a desirable service in the first place. One that logic says will get even better in the years to come.

And if you still don’t like it, you can always just read a book.

 **This article is featured in the Carnival of Wealth-The Change of Guard Edition**

**This article is featured as an Editor’s Pick in the Totally Money Blog Carnival #31**

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