Netflix's saga: The dark side of creative destruction

SAN FRANCISCO, CA - OCTOBER 24: A U.S. Postal worker holds a stack of Netflix envelopes at the U.S. Post Office sort facility on October 24, 2011 in San Francisco, California. Online movie rental company Netflix reported third quarter earnings of $62.5 million, or $1.16, per share compared to $38 million, or 70 cents per share one year ago. (Photo by Justin Sullivan/Getty Images) Getty Images

Commentary: Netflix CEO Reed Hastings had it all figured out. He wasn’t going to be caught up in the innovator’s dilemma and planned to navigate the transition from DVDs to streaming better than anyone. The creative destruction just looked great on the white board.

Unfortunately, Hastings dropped the creative and was left with destruction—lots of it. Netflix has lost subscribers, market capitalization and its reputation for a series of botched moves.

Now all Hastings can do is apologize repeatedly. In Netflix’s third quarter investor letter, the company said “we’ve hurt our hard-earned reputation and stalled our domestic growth.” “Amazing service” would bring people back. In the meantime, Netflix’s bottom line will see some red in 2012 as it expands internationally.

On the surface, Hastings’ plan sounded almost reasonable. Hastings was going to bet the ranch on his streaming service and raise prices to boot. After all, Netflix was worth the money right? Who can argue with $7.99 for streaming and $7.99 for DVD service. The DVD-by-mail service would be segmented—even quarantined—and Netflix would ultimately be rewarded for being a streaming entertainment company. The plan: To manage the transition from DVDs to streaming gracefully and profitably.

The math could work too. Hastings would destroy a low margin business in DVDs and grow a high-margin global streaming service.

Netflix’s timeline resembles a horror movie script.

I messed up. I owe everyone an explanation.

It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming, and the price changes. That was certainly not our intent, and I offer my sincere apology.

The fix: Launch Qwikster. Customers called it Qwikstupid. Customers were right.

  • On Oct. 10, Hastings said in a blog post: “It is clear that for many of our members two websites would make things more difficult, so we are going to keep Netflix as one place to go for streaming and DVDs.”
  • Fast forward to Oct. 24 and Netflix is cutting its fourth quarter outlook and indicates things will get worse before improvement. Netflix lost more than 800,000 domestic subscribers in the third quarter. Netflix delivered a domestic churn rate of 6.3 percent in the third quarter, up from 4.2 percent in the second quarter. Historically, Netflix churn has been between 3.8 percent and 4.5 percent.

The rub: The fourth quarter is when Netflix thought customers would be over the price changes.

Cheers to Hastings for attempting creative destruction. Jeers for botching the execution. Creative destruction has been a theme in recent weeks. Gartner analysts implored technology executives to blow up their infrastructure and start over. If it were that easy we’d all deploy creative destruction.

As Hastings is quickly learning creative destruction has a dark side and things get ugly once you drop the “creative” part of the equation.

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