Who stole Netflix's mojo?

First it was the new pricing fiasco. Now the corporate mea culpa and services split are taking a pounding. Something's wrong here.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
6 min read

Even if you believe that splitting Netflix into two services and raising prices is the right plan for the company in the long term, the moves in the near term have many subscribers asking whether managers value them.

"Reed is the visionary, and Barry was the balanced business guy. Barry was to Reed like Steve Ballmer was to Bill Gates."
--Michael Pachter, analyst

Many Netflix users are outraged for the second time in the past three months. CEO Reed Hastings offered an apology last night in a letter to customers as well as in a video message for the way the company announced a price increase in July. He didn't say he was sorry for the actual price hike, and more importantly, he also said Netflix was splitting itself into two separate services. The new Netflix will be involved in streaming video over the Web exclusively, while the other service, called Qwikster, will oversee DVD by mail.

Some analysts and customers argue that Netflix has made plenty of other missteps in the past several months. The company couldn't close a licensing agreement with Starz, the pay-TV service that owns Web distribution rights to content from Sony Pictures and Disney. That means Netflix's streaming library will offer even fewer films from the top Hollywood studios. Much of Hollywood is lukewarm about Netflix's business model and the company has struggled to acquire streaming rights for popular films.

Then, last week Netflix acknowledged that it was overly optimistic about how the price increase would affect subscriber numbers. Netflix announced two months ago that it would break up a popular hybrid subscription plan that enabled users to rent DVDs as well as provide access to the company's streaming-video library, all for $10 a month. Many customers were angered when Netflix said beginning this month it would split movie streaming and DVD rentals into two separate plans, each costing $8 per month.

That meant for former hybrid users the price went from $10 to $16 each month if they wanted to continue receiving discs and streaming. Netflix underestimated the reaction. Last week the company said that 1 million fewer U.S. subscribers will be around in the third quarter than it initially predicted in July. This marks the first time that Netflix will see a drop in subscribers in sequential quarters in four years.

Nothing, though, is as damaging to customer relations as the latest decision to "complicate" the Netflix experience, says Michael Pachter, a financial analyst with Wedbush Morgan Securities. The simplicity of ordering a disc or watching a movie via the Web streaming service for one low price is one of the reasons Netflix's service was so attractive to consumers. Now, Hastings has done away with that.

Hastings said in his letter to customers: "A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated."

Pachter said: "This tells me that you won't have a connection between the sites. That means at Qwikster you're not going to know what's available for streaming at Netflix and you will have to make two trips to find out. The first rule for marketers is don't make things more complicated for consumers. This is like if Amazon removed the 1-click buying button. This is the dumbest mistake I've seen the company or really anybody make in a long time...it's a joke."

Wow. That anybody is calling Netflix "dumb" is astonishing. This is a company that has seemingly had stardust sprinkled over it for much of the past decade. Hastings and his management team chased much larger traditional rental services Blockbuster and Movie Gallery into bankruptcy. Instead of standing pat with their DVD-by-mail service after their triumph, managers leaped into online streaming well before competitors. The service has seen explosive growth the past two years. Wall Street rewarded Netflix by sending the stock to $304 a share in July.

But as of today, the stock is down more than half that. In midday trading, Netflix shares were down 4.8 percent, or $7, to $147. How did this happen? Why does the company seem to be suddenly stumbling? What changed?

Former Netflix CFO Barry McCarthy Netflix

Here's one place to look: Outside observers note that the management team that was largely unchanged for a decade and helped forge all the victories over Blockbuster and rivals has lost some key members in the past year. First, Barry McCarthy, the company's chief financial officer, left in December and was replaced by David Wells. Ken Ross, Netflix chief of worldwide corporate communications, retired and was succeeded in January by Jonathan Friedland, who was previously senior vice president of corporate communications at Disney.

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Certainly, Wells and Friedland are well-respected but all the indications are that the departures of McCarthy and Ross are being felt.

According to insiders, Hastings listened and respected McCarthy's judgment, and the former CFO often used his clout to stand up to the CEO when he thought he was wrong. McCarthy did not respond to interview requests.

"Reed is the visionary, and Barry was the balanced business guy," Pachter said. "Barry was to Reed like Steve Ballmer was to Bill Gates."

McCarthy's influence might have helped the company avoid the recent goof on its subscriber projections for the third quarter. He didn't oversee that kind of data crunching but he might have had a say in how it was presented and when. This is the kind of thing he would have studied closer, said insiders. Those with knowledge of the company's processes said the company made the predictions public though managers had based them on insufficient data and study. This is basic blocking and tackling for the company. In the past, Netflix has won praise for its ability to use the information it collects on users to help it make smart moves.

A mistake like that is something that insiders say McCarthy might have helped prevent.

After 11 years at Netflix, McCarthy had also earned respect and trust on Wall Street and with the company's major investors. He might have helped soften the blow to the company's stock from some of these setbacks.

Michael Pachter, a longtime Netflix analyst, said he thought it was "dumb" for Netflix to charge higher prices for less content in addition to making the service more complicated. Michael Pachter

As for the change in tone in Netflix's communications to customers, Hastings acknowledged in his post last night that the company's message about the price hike, delivered via a blog post from a mid-level manager and that offered little explanation or insight, was wrong.

"When Netflix is evolving rapidly," Hastings said in his letter to customers last night, "I need to be extra-communicative. This is the key thing I got wrong. In hindsight, I slid into arrogance based upon past success."

But who is supposed to help Hastings sound the right tone with customers? It used to be Ross, but now it is Friedland. That said, it can't be forgotten that regardless of what kind of job they're doing or what McCarthy or Ross would have done differently, Hastings has always held the final say on big decisions, say insiders.

So, the past three months have been a rough patch for Netflix but it was probably unrealistic to expect that the company's attempt to usher in a completely new way to rent videos would occur without some bumps. Acquiring streaming rights for sought after movies and TV shows was always going to be harder than obtaining DVDs, which the company could buy from a multitude of other retailers and sources whenever the studios tried to limit Netflix's ability to obtain them.

To stream content, however, there is no way around the studios.

But Hastings has shown for the better part of a decade that he's one of the most creative thinkers and strategic planners in the tech sector and if anybody can pull off the breaking up of Netflix services and operate a successful streaming subscription offering, it's him.

We can't forget that the online video sector is brand new and its development has a long way to go. There's still plenty of time for Hastings to pull the company out of this rough patch.