Netflix’s Growth Challenges

September 15, 2011

Today, Netflix issued guidance stating they expect one million fewer subscribers than originally projected for the end of this quarter, Q3. The lower estimate came mostly from the DVD area. This would be Netflix’s first drop in total domestic subscribers since Q2 2007. At the end of Q2, Netflix reported a total of 24.59 million domestic subscribers. The estimate for the end of Q3 is 24 million subscribers. So, a net loss of 590,000. The letter issued from Netflix can be found here.

Netflix’s new guidance on 2011 Q3 Subscribers

Netflix says it will not change its Q3 financial guidance. With a million fewer subscribers projected, that’s a significant loss in revenue. Netflix must have found a way to make up the lost subscriber revenue by cutting costs. Netflix’s largest cost is licensing streaming content.

The obvious culprit here is the splitting of mailed DVD and streaming into separate plans, since this is effectively a price increase. It’s not a surprise that most of the subscriber loss is on the DVD side since DVDs are yesterday’s technology and most consumers want the convenience of streaming. Furthermore, Netflix hasn’t done anything recently to market its DVD by mail business (Netflix says that setting up a seperate DVD division should change that, but we haven’t seen any dedicated marketing yet).

What’s more surprising is the lack of growth of streaming subscribers. While streaming subscribers get a good value at $7.99 a month, the Hub doesn’t think the price increase and content breadth are the only factors affecting the subscriber numbers. With its growth, Netflix has faced a number of operational difficulties.

Convenience is the main driver for the streaming plan. You can watch whenever you want and, in some cases, wherever you want. Instant gratification is what sets Netfix apart from Blockbuster retail stores and Redbox kiosks. Customers are willing to sacrifice some audio and video quality for it. However, when the service doesn’t work as advertised, the convenience factor is gone.

Some of the operational problems Netflix customers have endured lately include:

  • Outages: The Netflix service has suffered several noticeable outages lately. Focusing on the month of August, Netflix suffered significant outages on August 2nd, 8th, 11th, 22nd and the 25th. (sources: @NetflixHelps, CNET, HackingNetflix).
  • Audio and Closed Captions: We’ve come across a few shows that have had audio syncing problems or subtitles not functioning properly. In particular, we’ve come across the closed captions problem on a number of well-known shows. Mad Men, Sons of Anarchy, Law & Order SVU and Brothers and Sisters have episodes listed as having subtitles but they do not appear to be working. 
  • Data-feed: Netflix provides a data feed to developers so that they can develop applications to browse and present content from the Netflix catalog. For several weeks, Netflix was sending out an incomplete feed to these sites. This made it appear that Netflix had fewer titles on these third party sites such as Clicker. The feed was recently fixed.

We asked Netflix to comment on the outages and how they are being addressed, but they declined to comment for this story. When there is any sort of outage, we have found that Netflix support is transparent and helpful. Their twitter account @NetflixHelps does a good job responding to customer issues.

It’s our theory that these outages are one of the main reasons we haven’t seen 1080P and Dolby surround sound come to more Netflix-ready devices. Both consume more bandwidth and put more demands on Netflix’s infrastructure. We think that DRM demands from the studios have also slowed down the roll out of 1080P to other devices besides the Roku 2 and the PS3.
When streaming was bundled together with the DVD plan, customers were more willing to put up with these types of problems. Customers thought of “Watch Instantly” as a free bonus. Now, when they’re paying specifically for the streaming plan, customers may not be as tolerant of outages (Netflix projects there will be almost 22 million of you at the end of Q3). Continued outages will be damaging to the brand equity they’ve built up. To be fair to Netflix, no other video streaming service has this many subscribers or has grown this quickly. On the other hand, maybe Netflix should have caught up the infrastructure before raising the tolls.

Tags: closed captions, Netflix, Sons of Anarchy, streaming

One Response to Netflix’s Growth Challenges

  1. JohnOCFII on September 15, 2011 at 7:57 pm

    Nice analysis.  The next six months for Netflix will be very telling.

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