Netflix and the cost of doing business

Licensing Netflix really, really doesn’t want you using both its streaming service and it’s DVD-by-mail service. As of this month, it costs subscribers 60 percent more to use both services than it used to, thanks to the company’s recent price changes. As of today, it’s a bigger pain in the ass as well.

In a post on the company blog Sunday night, CEO Reed Hastings announced yet more changes that will force subscribers who want both streaming and DVDS not only to maintain two, separately billed accounts, but manage them on two entirely separate web sites, one of which is not even branded Netflix anymore. To order a DVD, users must now log on to the newly christened Qwikster web site, while their streaming business will be transacted through the Netflix site at a different URL.

There’s more:

A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated. So if you subscribe to both services, and if you need to change your credit card or email address, you would need to do it in two places. Similarly, if you rate or review a movie on Qwikster, it doesn’t show up on Netflix, and vice-versa.

“Qwikster,” Hastings explains, was chosen for the DVD service “because it refers to quick delivery.” Even if it sounds like a chain of  rest-stop mini-marts.

Why is Netflix so anxious to force users to choose between its two services? I can think of two compelling reasons.

First, as Benchmark Capital analyst Bill Gurley explains, it makes things cleaner, and potentially cheaper for Netflix in licensing content.

Netflix has for the past several years been negotiating with Hollywood for the digital rights to stream movies and TV series as a single price subscription to users. Their first few deals were simply $X million dollars for one year of rights to stream this particular library of films. As the years passed, the deals became more elaborate, and the studios began to ask for a % of the revenues…

This is the point where Netflix tried to argue that you should only count users that actually connect digitally and actually watch a film… This argument may have worked for a while, but eventually Hollywood said, “No way. Here is how it is going to work. You will pay us a $/user/month for anyone that has the ‘right’ to connect to our content – regardless of whether they view it or not.” This was the term that changed Netflix pricing.

With this new term, Netflix could not afford to pay for digital content for someone who wasn’t watching it. This forced the separation, so that the digital business model would exist on it’s own free and clear.

Another reason for the separation is to make it easier for Netflix  manage the costs of servicing individual subscribers, by forcing subscribers to do more of the work for them. With two separate accounts and two separate ques, you’re effectively two separate subscribers, each of whose usage and costs are now more predictable.

Putting aside the PR damage the moves have caused — and continue to cause — Netflix may not have had much choice. It may even be, as Hastings argues and Mark Suster at Fortune.com agrees, the moves represent a reasonable, forward-leaning strategy for a company undergoing a difficult transition from one business model to another. Netflix is a publicly traded company, after all, and it can’t just ignore the impact of rising costs on future earnings.

It seems clear though, that at this point the cost side of the business is driving strategy at Netflix, not the opportunity side. If that ends up constraining Netflix’s ability to continue innovating it could impact future earnings just as much as rising costs.