Is Netflix Poised for a Mighty Fall?

This past weekend, the Motley Fool Money radio show featured best-selling author Jim Collins. Knowing that he was going to be a guest, I went to my bookshelf and dusted off a copy of one of my favorite Collins books: How the Mighty Fall.

The book details the five stages of decline that once-great companies go through during their fall from grace. Over the next five days, I'll be detailing the five stages, and some companies that might be going through these stages right now. Today's company in the spotlight: Netflix (Nasdaq: NFLX  ) .

Stage 1: hubris born of success
At the end of each chapter, Collins quickly summarizes the key symptoms to diagnose if a company is in a certain stage of decline. Though I haven't included all of the symptoms, it's fairly easy to see why Collins might be worried about Netflix.

Symptom No. 1: success, entitlement, arrogance.
I think Netflix's problems stem more from PR failures than from bad business decisions. Offering streaming for free, which is what it was essentially doing before, was simply not sustainable.

The problem, then, lay not with its decision to jack up rates, but rather the cold and confusing way in which the company carried it out. This turn of events, of course, led to more defections than the company was expecting, followed by the Qwikster fiasco.

In his apology to subscribers following the decision to raise rates, Netflix CEO Reed Hastings himself diagnosed the company as being in Stage 1 decline: "I slid into arrogance based upon past success."

Symptom No. 2: neglect of a primary flywheel.
By "primary flywheel," what Collins means is the "primary business for which a company owes its past success." All too often, Collins argues, companies become obsessed with the Next Big Thing in pursuit of growth and, in the process, neglect to develop the primary business to which they owe their success.

This is a sticky subject for Netflix. One on hand, Hastings realizes that streaming videos is a disruptive technology that will probably be the future of how we watch media. To be a winner in the battle for streaming, Hastings needs to be able to take on a host of competitors, including Amazon.com (Nasdaq: AMZN  ) and Hulu which is part-owned by News Corp. (Nasdaq: NWSA  ) , Disney (NYSE: DIS  ) , and Comcast (Nasdaq: CMCSA  ) . In addition, several other companies, including Google, and Apple, have more than enough cash lying around to get in the game if they wanted to and as many suspect either eventually could (and should).

On the other hand, DVD-by-mail is what helped make Netflix what it is today. It is the company's primary flywheel. When Hastings announced that Qwikster would be a separate entity responsible for DVD-by-mail, he seemed to be signaling an end to the focus on that side of the business, happy to let others -- such as Coinstar's (Nasdaq: CSTR  ) Redbox division -- pick up the slack.

These dynamics do put Hastings between a rock and a hard place -- not a spot I'd like to be in.

Symptom No. 3: decline in learning orientation.
I included this symptom because it's one that investors need not be too worried about. In fact, during Collins' visit to the Motley Fool Money show, he was asked whether he'd buy, sell, or hold the future of Netflix as a business.

While Collins acknowledged that the company has had its fair share of snafus lately, he stood by its CEO, saying, "Reed Hastings learns." Collins said that everyone makes mistakes and that the best leaders learn from those mistakes and come back even stronger. He believes that Hastings' past has shown him to be a CEO willing to learn from his errors.

This is just Stage 1
Remember, Collins identified five stages of decline, and this is just the first. Solid management, if it's able to diagnose the problem, can quickly reverse this trend. Tomorrow I'll be covering the second stage of decline: the undisciplined pursuit of more.

In the meantime, if investing in technology companies such as Netflix, Google, and Amazon is right down your alley, I suggest you take a look at The Motley Fool's special free report: "Two Words Bill Gates Doesn't Want You To Hear." Inside, you'll be able to watch a video that outlines how we'll all be connected electronically years from now, and the companies that will help bring us there. The report is yours today, absolutely free!

Fool contributor Brian Stoffel owns shares of Netflix, as he too believes that Hastings can right his ship. He also owns shares of Apple, Amazon.com, and Google. You can follow him on Twitter at @TMFStoffel.

The Motley Fool owns shares of Google and Apple. Motley Fool newsletter services have recommended buying shares of Apple, Walt Disney, Google, Netflix, and Amazon.com and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (8)

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 October 17, 2011, at 9:25 PM, TMFWizard wrote:

    In the interview Brian links to in the 1st paragraph, I ask Collins about the future of Netflix. Scroll ahead to about the 16-minute mark for his thoughts on Netflix and CEO Reed Hastings. Collins is, I think, bullish on the future for both.

  • Report this Comment On October 17, 2011, at 9:53 PM, TMFCheesehead wrote:

    @TMFWizard-

    Agreed, hopefully that came through in Symptom #3. It starts at about 16:30.

    Brian

  • Report this Comment On October 17, 2011, at 10:15 PM, megoogler wrote:

    Amazon is the one up to a mighty fall starting from 1st quarter of 2012. Let's calculate: estimated 4.5 million Kindle Fires sold at $50 loss ( including shipping and distribution) is 225 mil loss plus the losses on every Prime member for free 2nd day shipping plus more and more states will ouch Amazon to pay taxes. Amazon is in for a good short!

  • Report this Comment On October 18, 2011, at 9:55 AM, lucasmonger wrote:

    The jury is still out on both Netflix and Amazon (and anyone else for that matter - Hulu, Google, Apple) and streaming media. The first to give you access to virtually everything for a fixed monthly cost (which appears to be $8 right now) will win.

    Gilligan's Island marathon anyone? I'm hoping that Apple can pull off a deal to flip their entire video and movie library to a subscription service, even at a premium over Hulu and Netflix prices, but still less than cable and satellite.

    It's funny, we want devices to be successful, but if the Amazon loses $50 on every Kindle Fire, you've got to believe they'll get the $79/year from most Fire owners if they're not already a Amazon Prime subscriber. So let's not worry about year 1 as it's a wash, but it how many years can Amazon keep people paying $79 year after year (like Costco). They need more content, content costs money, will we see Amazon Prime prices increase as a result of both higher shipping and content costs?

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