What if Netflix Is Wrong?

Stand still for a sec while I draw an entrepreneurial chef hat on you.

There!

Let's say you have a restaurant. In order to promote your new line of desserts, you begin to include the tasty treats with every paid entree at no additional cost.

The move is a hit. Patrons begin lining up to eat at your place, and the bonus finishing touches are a major reason for your success. Your dessert menu is limited, but the value proposition is too rich to ignore. You're a recessionary darling, and folks that don't normally even order sweets after a meal can't ignore your simple appeal.

Rival restaurants aren't pleased with your success. Pastry chefs argue that you have devalued their craft. Cynics argue that your "free" desserts aren't as fresh as the premium delicacies that can be found elsewhere. It doesn't matter. Success is the ultimate scorecard, and you have 23 million people happy to crack the burnt sugar shell of your day-old creme brulee.

After a few years, you get cocky. You begin selling your desserts in Canada, and you see that they're willing to pay as much as some of your cheaper entrees for your piecemeal treats. Your desserts have ridiculously better margins than your entrees, and they're also easier to prepare.

You decide to make the biggest gamble of your life. You shave a couple of bucks off your entrees, but the desserts are no longer free. You want people to pay for dinner and a pricey desert, but in reality you just want them to come for the sweet stuff.

In a perfect world, you would change your name to Just Desserts and only sell the high-margin treats that you were practically giving away for years.

Your name is Netflix (Nasdaq: NFLX  ) , and I think you better think twice before you invest in more dessert spoons.

No thanks, I'm stuffed
Netflix's decision is brazen, but not as bright as it -- and some bullish analysts -- think it may be.

Goldman Sachs analyst Ingrid Chung sees most of Netflix's subscribers staying put. She feels that those on plans that include two or more discs out at a time will simply absorb the $6-a-month hit and move on. The real churn will take place at the entry level, and even there she still sees two-thirds of those penny-pinchers opting to pay for the "streaming only" at $7.99 a month, with the other third paying $7.99 a month for the DVD plan.

Piper Jaffray's Michael Olson also believes that splitting the plans will accelerate Netflix's streaming service. Merrill Lynch's Nat Schindler also feels that the move will eventually find DVD renters migrating to Netflix's streaming service.

In short, they see this as a joyous occasion.

Forget the restaurant. Let's view this as a couple splitting up. Mom and Dad are getting divorced; who will their kids choose?

Right off the bat, that's probably the wrong question to ask. A better query would be: Are the kids happy?

In Netflix's case, they're not.

Audiences are rumbling
In a TheStreet.com poll, 53% of the nearly 4,700 voters (as of last night) claimed that they would quit Netflix altogether. An additional 38% argued they would trade down to either streaming or DVD.

In a slightly larger HackingNetflix.com poll, 34% of the 7,800 respondents indicated they would be ditching the service. A mere 20% would stick to the current plan that offers a combination of optical discs and streams.

It goes without saying that these straw polls are highly unscientific. They tend to bring out bigger complainers, so they're not indicative of Netflix's audience as a whole. The real test will come in two months when the pricing goes into effect for existing subs during the September billing cycle. Even most of these poll voters that bent on bailing are likely to stick around.

However, I don't tend to agree with the popular thinking that those choosing between the two options will stick to the streaming plans. The digital catalog is woefully incomplete, and that may never change.

This isn't an immaterial price hike. It's the kind of seismic shift that may reverse the cord-cutting fears that cable providers have been fearing. Perhaps that's why Comcast (Nasdaq: CMCSA  ) (Nasdaq: CMCSK  ) -- the country's largest cable company -- had no problem having its majority-owned NBC Universal renew its streaming deal with Netflix the day after the announcement.

Shares of Netflix may have inched higher yesterday on the pricing news, but why did Blockbuster parent DISH Network (Nasdaq: DISH  ) and Redbox parent Coinstar (Nasdaq: CSTR  ) also rise higher than the general market? It could be that the market feels as if the pricing elasticity of video rentals is improving or -- more likely -- that these are the companies that will be there to catch the Netflix defections.

I hope Netflix knows what it's doing, but I keep thinking that the one thing that this will do is grind the digital streaming revolution to screeching halt. Couch potatoes will regress back to optical discs.

The future will be the past, and Netflix's dreams of chunky margins through streaming will fall right through the burnt-sugar shell of a clumpy creme brulee.

To DVD or not to DVD? Will you be sticking to DVDs, streams, or both when the Netflix hike kicks in? Share your thoughts in the comment box below.

Motley Fool newsletter services have recommended buying shares of Coinstar and Netflix and buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


Read/Post Comments (14) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 14, 2011, at 2:58 PM, vchi345 wrote:

    It reminded me to finally do what I've been meaning to do for a year (after actually watching 2 dvds in 2 years, and streaming only a few)---so I cancelled. Not because of the change, but it was the catalyst for getting around to cancelling.

  • Report this Comment On July 14, 2011, at 3:20 PM, eliscoming wrote:

    It's interesting that the analysts keep comparing Netflix to Redbox and Blockbuster. When individuals look at staying or leaving Netflix, they'll most likely compare the cost of adding HBO, Showtime, or other movie services to their cable offering vs. the cost of Netflix.

  • Report this Comment On July 14, 2011, at 3:35 PM, retired2soon wrote:

    like vchi345, i was reminded to do something i had thought of some time ago. i kept the one disk plan for 9.99 simply because it was only two bucks a month more than just streaming but rarely got a disk. now i will drop the disk plan and stay with streaming. still i think the numbers will work out in netflixs favor. i got in in the $20's and am not bowing out yet.

  • Report this Comment On July 14, 2011, at 4:03 PM, AeroFjavazzastad wrote:

    I think they are in for a rude awakening. There are other options. Redbox is convenient and costs $1 to rent. Comcast (our cable provider) has free on demand, and lot's of new movies for only a few bucks (as long as we stick to one or two a month, same as our netflix pattern it's not that much more).

    I think those who don't cancel outright will stick to either DVD or streaming, but not both, not for double the cost, and not with the poor choice of streming video offered. Netflix should have offered an option for keeping both that was marginally more, but not double.

  • Report this Comment On July 14, 2011, at 4:11 PM, Meinolph wrote:

    When I started with Netflix, it was the 2 DVD plan. I'll probably go back to that, with Blu-ray option, and drop streaming. Streaming was a great add-on, but not worth $8 to me.

    When I work the numbers, Netflix still is a better deal than any of its competitors, in my opinion. I'm very interested in how this will play out.

    You are right--the deal was just too good to turn down. Now, one must at least think about it.

  • Report this Comment On July 14, 2011, at 4:12 PM, sdentuco wrote:

    My husband and I will be canceling all together. We currently have direct tv with all of the movie channels. We added netflix because we wanted to watch old episodes of certain TV shows. However when we signed up we quickly realized that what was advertised as shows on streaming were actually DVD only shows. However we did not cancel because really what was offered was still pretty inexpensive and we liked some of the shows on streaming plus we liked the one DVD. However when HBO came out with HBOGO which is free with my subscription I no longer needed netflix. We kept it because it was still pretty inexpensive and we liked it. When they decided to raise the price we decided it was no longer worth the price.

  • Report this Comment On July 14, 2011, at 4:26 PM, javagal51 wrote:

    I will be dropping streaming and sticking with the DVD option until I see their streaming library improve. I watch so few DVD's and stream so seldom that I think paying on demand for streaming when I want it will be more cost effective. If Netflix iimproves their streaming library, I'll switch plans and drop the DVD option.

    I hate driving to get/return DVD's so I'm lazy enough to pay a few bucks for home delivery.

    I really just ought to drop the service entirely and stick to reading ;-)

  • Report this Comment On July 14, 2011, at 4:40 PM, Borbality wrote:

    I think the trend will more likely be to lose more cable customers, who will keep netflix (or something similar if anything comparable comes along).

    I upgraded my internet service mostly just so I could stream Netflix better. We have no cable and netflix is still a much better deal with USER-SELECTED content and no commercials.

  • Report this Comment On July 14, 2011, at 5:08 PM, knockaroundguy2 wrote:

    Raising prices on their fabulous product of DVD(s)-by-mail AND limited selection but uncapped streaming was inevitable, and had they just upped the price on this product, it would have been palatable or at the very least it would have made sense. But they basically destroyed a great product by splitting the 2 features. Their streaming content is simply not worth the price as a stand alone product. It was the combination of supplementing DVDs for content they have not been able to license for streaming yet that made it a complete product. By splitting the 2 they are essentially claiming that there is more value in their streaming product than there really is yet. I love the execution of streaming whatever they have whenever I want, but I need to be able to get the content I want by DVD when they cannot provide what I'm looking for. Now they want to separate the 2 entities and act like they stand alone? Premature, Netflix. Try again when you have SIGNIFICANTLY increased your online library and can also keep titles on there indefinitely and stop cycling them on and off the availability list. Very disappointed with this move.

  • Report this Comment On July 14, 2011, at 6:50 PM, morningstara wrote:

    NOTHING IS EVER FREE. Netflix was a super deal and now we face the reality of their costs forcing an increase for us. It is STILL a deal. With rentals 4.95 or the 1.00 Redbox only available in cities, most who live a commute away will stick with Netflix. I have streamed so many obscure, foreign, and british shows I'd never heard of that were EXCELLENT! If I had a choice, I stick to streaming only, and redbox for recent flicks--but, it is a long commute, so--nope. I believe it was inevitable to raise prices but they should have kept it at a 3.00 or so to let us gradually get used to it! Stock down 12.00 today! ouch!

  • Report this Comment On July 15, 2011, at 7:38 AM, MrChapel wrote:

    Here in the Netherlands, the traditional videostore is practically non-existent. DVD/BluRay/CD sales are dropping like flies. Studios are doing everything they can to prop them up, going so far as to offer free DVD versions with the Bluray version and selling them in places like supermarkets and chain pharmacies on first day of release. Until a year or two ago, you could find movies like the Harry Potter series, Iron Man etc. in those places about a year AFTER initial release.

    Netflix is looking at the demographic. Most of those between 18 and early 30's are more tech savvy. They download their music/movies/TV shows rather than go to a store and buy or rent it. Network media players have been big sellers here for years now. Popcorn Hour, AC Ryan, Sitecom, Asus, Logitech etc. Asus alone sells five different models of HD media player. Spotify is gaining marketshare in online music.

    Personally, I'm 41 but have always been a bit tech savvy. In my new apartment, I pulled networking cable through the walls, set up my NAS in a closet and have several media players in different rooms. Almost all my discs have been ripped to the NAS and I can play any movie/song I want all over the house. I don't buy discs anymore because paying 20 Euros (almost 30 US$) at current exchange rates? In this economy?

    I expect that within a decade, discs will be gone. They won't even get the treatment of vinyl records, which are making a comeback with audiophiles. They will be just gone. Netflix knows this, it's why they're expanding abroad WITHOUT disc-by-mail. So, keep selling and pushing the price down, I'm waiting for a nice price point to jump in.

  • Report this Comment On July 15, 2011, at 11:08 AM, Squip wrote:

    Streaming is the future and Netflix is leading all of us there. DVDs aren't dead, but like VHS, they're made of atoms, not bits. As the world continues to go mobile, DVDs just don't travel that well. I also think lots of folks here in the U.S. forget there's a great big world out there full of other folks who like to watch, too. Netflix's future simply isn't limited by whether or not the American consumer is angered by a price increase. Some of Netflix's formidable competitors may have deep pockets, but so far, they've chosen to only put a toe in the streaming waters. The possibilities for the future in this space are many, but whichever of them you might choose, Netflix still sits at the head of the pack.

  • Report this Comment On July 18, 2011, at 4:45 PM, jmkdiva wrote:

    Netflix really needs to improve their streaming library to make it worth paying for on its own. They recently removed all their Sony streaming titles while they hash out that agreement--and there's no guarantee they will get an agreement. I've been a huge Netflix fan and investor. I got my entire family to sign up. All of us are angry at the big price hike. With the poor selection of streaming titles and VOD from cable, I will be choosing to keep the DVD only option, but will probably choose fewer discs a month, so Netflix will be losing several dollars a month from me. As others have said here, Netflix just got everyone to evaluate whether they really should be spending money each month on the service. Not a smart choice.

  • Report this Comment On September 16, 2011, at 4:22 PM, LEWBOWEN wrote:

    THE ONLY WAY I'LL KEEP NETFLIX STREAMING AND DVD IS IF IT STAYS UNDER TWENTY DOLLARS. (20.00) I DECIDED TO GO WITH NETFLIX BECAUSE I COULDN'T AFFORD TO TAKE MY FAMILY TO THE MOVIES ANYMORE. NETFLIX GAVE THE OPTION OF WATCHING MOVIES AT HOME MY FAMILY HAVE OUR HOT DOGS AND POPCORN AND FUN AT HOME. BUT IF THEY DECIDE TO RAISE THEIR PRICES TOO HIGH I'LL CUT THEM OFF TOO. IF IT BECOMES UNAFFORDABLE FOR ME I WON'T HAVE THE MONEY TO PAY. WHEN CORPORATIONS GET TOO EXPENSIVE FOR I JUST CUT THEM OFF AND TRY TO FIND ANOTHER AVENUE OF ENTERTAINMENT FOR MY FAMILY, ONE THAT I CAN AFFORD

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