Tuesday, December 6, 2011

Is Netflix Business Model Broken?

Wedbush analyst Michael Pachter has downgraded Netflix to "underperform" from "neutral," with a $45 price target.

“In our view, the company’s business model was broken when it raised prices for its hybrid customers, and continued customer defections will require it to invest ever increasing amounts on marketing,” he says. “We estimate that Netflix will spend $800 million on streaming content in 2011, and expect streaming content costs to rise to at least $1.7 billion in 2012, partially offset by approximately $200 million in DVD and postage savings.” Wedbush Downgrades Netflix

One wonders, though. Retail price adjustments happen all the time. It is not so clear that a simple price change, even a change that arguably involves creating two new products where there once was a single product, can break a business model. 

One might argue that becoming a provider of substantial amounts of original content, where the original business had been video distribution, can break a business model. Some have pointed to potential price increases of as much as 60 percent for some Netflix customers. But we are talking about a video entertainment product that costs, at most, about $16 a month, even assuming the biggest price increase.

Before the changes, consumers had been paying about $10 a month for both DVD and streaming access. 

To keep both features costs about $16 a month, and providing users with one DVD at a time and unlimited streaming. Given prevailing prices for a subscription to a service such as HBO, or renting DVDs from kiosks, that really is not an outrageous amount of money. 

One might argue that what "broke" was investor expectations that had bid Netflix up into the $300 per share range. Irrespective of the merits of operating costs around delivery of discs, versus streaming, what really has changed is the Netflix decision to become a provider of more original or unique content, which is a different business than simple video distribution.

The retail pricing changes, and the differences in online distribution compared to postal delivery arguably cannot "break" the business model. But becoming a distributor of unique or differentiated TV programming is a different business from distributing rental movies. 

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