Netflix: Two Companies, Double the Headaches?

With Amazon, Apple, Hulu and others quickly gaining ground in the distribution of online video content, Netflix is making a concerted effort to strengthen its Internet streaming service. According to a report in the Wall Street Journal, on Sunday, company CEO Reed Hastings announced that Netflix will be split into two businesses: The original Netflix will now only offer streaming content, while a new company, “Qwikster,” will manage Netflix’s original mail-delivery DVD service.

The move follows a separation of both services by Netflix and price increases for each earlier this summer, which angered customers and caused subscriptions to plummet. (Prior to the split in services, subscribers could view unlimited videos on demand and receive DVDs in the mail all for a flat rate beginning at $9.99. Once the services were divided, fees for each started at $7.99.) In fact, the company stated that it expects to have one million fewer subscribers than it had projected for the third quarter of this year.

In his blog post, Hastings acknowledged that the strategy comes from a realization that streaming video is the wave of the future. “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,” he wrote. “Most companies that are great at something” shy away from new products that people want “because they are afraid to hurt their initial business. Eventually these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.”

But in this case, moving too quickly might only double the headaches for the company. On the customer side, the potential problems are clear: Viewers will now have to visit separate websites and juggle two accounts if they want to keep both services.  According to Stephen Shankland, a columnist at CNET News, the division also highlights the weaknesses in both services. Although subscribers may like the instant gratification of viewing content on demand, the selection is still thin compared to the mail order service. “DVDs offered a better selection, while streaming video offered better convenience,” Shankland writes. “Now, instead of one service with two facets that compensated for each other’s weaknesses, there are two services that each looks half-baked.”

Perhaps more critically, on the company’s side, letting go of its original “legacy business” of mail order DVDs might ultimately harm it, according to Wharton management professor Emilie Feldman, who studies the effects of divestitures and spinoffs. For the time being, Qwikster will operate as a wholly owned subsidiary of Netflix, but the split “exhibits many of the classic features of legacy divestitures,” Feldman says, including “the separation of a business operating in a weak or declining industry (physical media) to focus management attention on businesses operating in relatively stronger or faster-growing industries (digital media)”; “a symbolic shift in the identity of the parent company” (as evidenced by the renaming of the DVD-by-mail business); and “a potential underestimation of the value of the legacy business being separated” (as demonstrated by strong customer sentiment against dividing the services).  

On average, “companies which undertake legacy divestitures experience a sharp decline in their operating performance in the years following those divestitures,” Feldman says. Factors contributing to that decline include a “disruption of the uniquely valuable interdependencies between a company’s legacy business and the remaining segments in its portfolio” and “a dissipation of key intangible resources, such as reputation and name recognition … linked to the legacy business.” For example, Netflix has always been known for its red envelopes in which DVDs were delivered to eager subscribers — but those envelopes are exactly what Hastings wants to move away from.

“These issues [of legacy divestiture] are clearly quite salient to Netflix’s decision to separate, and ultimately to divest, its DVD-by-mail operations,” Feldman notes. “This suggests that the Netflix split … may be a harmful strategy for the company.”