Friday, September 23, 2011

Thoughts about Netflix

There’s been a lot of ink of both the virtual and electronic sorts spilled over Netflix’s somewhat bizarre decision to split itself into two entities, especially after the massive negative feedback that they got after a recent price increase.

I’m a Netflix user from way back.  I set up my account for the first time in 2004 and I’ve been a user more often than not since then, although I have suspended my account on a couple of occasions when I wasn’t using it all that much.  Although ever since they’ve had the ability to instant stream I’ve never really been tempted to cancel service, it’s just too convenient to fire it up.

So the general consensus appears to be that Netflix always considered the future of its business to be in instant streaming rather than the physical mailing of DVDs.  As a technophile I can appreciate this idea, but in the real world as we currently live in it I think they’re making an awful mistake.  Nonetheless, they may not have much of a choice.  At this point there’s the technological ability to easily digitize every single movie and TV show ever made and stream it on demand.  It’s not practically possible for a couple of reasons, though.

First, there’s not really a good regime yet for what we’re going to do in the digital economy, and the way things are looking it appears that most of us plebians will be screwed.  Economics 101 tells us that in a perfect competition in a free market, marginal profit will be at the point of marginal cost, meaning that the profit you make from each additional item is essentially equal to what it costs to make the additional item.  But this sort of economics doesn’t really address the situation that we have now in electronic media, where all the cost of making a movie or television show comes up front and the marginal cost is essentially zero (technically you’ve got to pay for the electricity and storage media, but for all intents and purposes it doesn’t cost anything extra.)  Instead we have the copyright regime, where movie studios and other copyright holders get monopoly power over their products and can engage in rent seeking behavior.

Second, there’s the Internet companies, who in some cases overlap the copyright holders, who aren’t content to simply be common carriers and want a piece of the action too.  This conflict has been spilling out for some time and although we still officially have an open Internet, it may be only a matter of time before some of the providers start trying to charge extra for moving certain bits.  We’re already starting to see usage caps and our service isn’t anywhere near the standard that you can get in other first-world countries – more rent seeking.

So here we have Netflix, which doesn’t own the product that it’s providing and doesn’t own the delivery system that gets it where it’s going.  What they do have is name recognition and ease of use, although frankly their menu system is pretty bad and their selection isn’t all that great either.  Their renewal with Starz fell through because Starz wanted more money, which is going to cost them a significant portion of their library of new releases.  They’re starting to get grief from the ISPs because of the bandwidth that they are using.  So really their decision to spin off their two divisions is a little inexplicable to me.  Since they’ve got the subscriber base, they can use that as leverage to their content deals.  Without their physical subscriber base, they’re in the position of having to outbid companies with lots more cash, such as Amazon, Apple, and Google, while losing a lot of what makes them a market leader.  I don’t see how they’re going to win that fight.

Common wisdom also suggests that they intend to sell or otherwise dispose of the DVD by mail business.  While I’m sure that this is a pretty capital intensive business requiring most of their actual employees and having a lot of infrastructure, this seems to me to be a solid business model.  Streaming can’t compare (yet) to the quality that you get from a Blu-Ray or even a DVD, which justifies the work that people put into their home theaters, and for that matter Netflix’s massive inventory gives them a leg up on anyone who wants to enter this business.  I think that rumors of the imminent demise of physical media are overstated, whether they’re putting optical drives in the new Macs or not.  There’s simply too much of a user base and it still offers tangible advantages over streaming.

So has Netflix managed to shoot itself in the foot?  I don’t know, I guess time will tell.  If the studios manage to force it out of business, though, then they may have just shot themselves higher up, such as in the groin or stomach.  It’s clear that each of the providers wants its pound of flesh, but if their demands make it unprofitable to stream or simply make streaming the less attractive option (either by selection or by price) then it’s not going to take off, no matter what technological projections are made.

Anyway, I require a substantial number of Sesame Street episodes available on demand plus a reasonable selection of Asian action movies, so I guess I’ll be keeping both of these services for the moment.  More price hikes or a change in circumstances may make me change my mind, though, and if it’s one thing that a business doesn’t want its customers doing, it’s actually thinking about the service.

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