iTunes

Why corporate America needs more Reed Hastings

July 14, 2011: 11:24 AM ET

Forget the consumer backlash. Reed Hastings deserves accolades for taking Netflix into the future even if it ruffles feathers.

Reed Hastings

Reed Hastings, visionary.

FORTUNE -- Reed Hastings is a visionary. Let's just get that on the table up front. It's been said before -- Fortune named the Netflix CEO the Businessperson of the Year in 2010, painting a portrait of a man who has made a habit of taking big risks that have paid off time and time again.

First, he saw the possibility for a massive DVD-by-mail business, which revolutionized the movie rental industry and was one of the first nails in Blockbuster's coffin.

Then, he saw that the future was streaming video and boldly positioned Netflix (NFLX) to be the industry leader, even at the cost of cannibalizing a big chunk of his wildly successful DVD business in the process.

And now he's made another audacious move. On Tuesday, the company announced a whopping 60% price increase for its least-profitable customers, those who were paying just $9.99 a month for one-DVD-at-a-time plus all-you-can-eat streaming. Netflix decoupled the two, and will charge $7.99 for each. So if you want the combo, you're going to have to ante up $15.98 a month.

Because a righteous sense of entitlement is the way of this land, customers took to the web in outrage, flooding the company's message boards and customer service phone lines, and starting a Twitter trend that began "Dear Netflix." You know what came after that.

A ridiculous number of people, including some technology industry analysts, predicted that Hastings would back down as a result of the furor. Fat chance. If there's anything we know about Hastings, it's that he does not move hesitantly. Netflix spokesman Steve Swasey told a reporter that, "We knew there would be some folks that would not be pleased with the change in the price," before comparing it to the price of a latte. But he also said the disaffected were a minority.

Aren't the people who populate message boards with their armchair vitriol always a minority? The time it takes to write threats of subscription cancellation or worse is probably worth more than $6 anyway. And here's the thing: Netflix was losing money on the DVD portion of that customer relationship. If those customers loved what Netflix offers so much as to go ballistic about a price increase, they surely want it to stay in business, right?

Reversal of a backward strategy

Nat Schindler of Bank of America Merrill Lynch points out that Hastings would have been exercising poor business judgment had he not made the change. Because Netflix pays an average of $0.80 to ship each DVD, and the average customer on the one-DVD-at-a-time plan watches three DVDs a month, that puts the company's shipping costs for the plan at $2.40 a month. With streaming-only at $7.99 a month and streaming-plus-one-DVD at $9.99, that means Netflix was losing $0.40 a month in shipping DVDs to those customers. Say what you want about a 60% price increase, but Netflix isn't a charity. (See also Netflix to U.S. Post: Drop dead)

Unlike those irate customers, Wall Street was unfazed by the move. Goldman Sachs analyst Ingrid Chung's only problem with the news was that it didn't come on the day the company reported earnings, which would have given management more of an opportunity to explain the reasoning behind it. She's got a price target of $330 per share, or about 10% higher than today's price of $299.

Most see this for what it is, a continuation of Hastings' take-no-prisoners competitive instinct. "Like all of his competitors, he faces the innovator's dilemma," says Barclays Capital analyst Anthony DiClemente. "Some companies try to preserve their cash cows and they're slow to innovate. But Hastings clearly sees that clinging to DVDs is a backward strategy. He has also shown a disdain for the plodding reluctance of traditional media companies, and I think that drives him to act with even more boldness and an eye to the future."

DiClemente does note that this is the second price increase for Netflix's core-DVD offering in less than a year, and will likely therefore increase churn in its customer base. But he doesn't see it stopping Netflix's relentless gathering of subscribers. While the company had 20 million in 2010, DiClemente is projecting almost triple that amount, or 53.5 million, by 2013.

And those that are complaining need to get with the program anyway. More than half of Netflix's new 2011 subscribers are streaming only. The company has been investing heavily in new content, going so far as to produce some of their own, and the selection gets better by the day. As soon as Hollywood's content producers finally admit that Netflix has them all over a barrel and concede to stream their top quality and recent content, no one's going to want DVDs anymore anyway. So he's a little early to the party. But Hastings is usually early. And this time, he's once again a step ahead of everyone else, headed into the future.

In January 2005, Wedbush Securities stock analyst Michael Pachter called Netflix a "worthless piece of crap." He was talking about the business model, and he was wrong. A lot of people called the company a lot worse yesterday. Are they really going to follow through and cancel their subscriptions? Really?

Netflix has 23 million customers. They might lose 50,000 for all I know. A proportion like that is known in mathematics circles as a rounding error. And where are they going to go? Hulu? Amazon (AMZN) Prime? A la carte from iTunes? Please. Anyone who uses Netflix knows it's the best game in town. Take your ball and go home if you want over a measly $6. But you'll be back.

Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.