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Quick Thought on the Netflix Split

September 19th, 2011 · 9 Comments

As the Internet scratches its Hydra-head over Netflix’s announcement that it’s splitting off its DVD-by-mail rental service under the unlovely heading of “Qwikster,” Tim Lee tweets that Bill Gurley’s speculation is the most plausible explanation he’s seen for a move consumers seem to be universally panning:

So here is what I think happened with Netflix’s recent price change (for the record, I have no inside data here, this is just an educated guess). 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 likely started with a “percentage-rake” type discussion, but then evolved into a simple $/user discussion (just like the cable business). Hollywood wanted a price/month/user.

This is the point where Netflix tried to argue that you should only count users that actually connect digitally and actually watch a film. While they originally offered digital streaming bundled with DVD rental, many of the rural customers likely never actually “connect” to the digital product. 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.

What still has Tim puzzled is: Why would Hollywood try to insist on that?

It does sound bizarre at first blush, but I think it makes a certain amount of sense when you think about substitution effects, and the real reason people choose to own movies rather than rent them.

The simplest answer might be that it’s a straightforward function of how many times you expect to watch a movie. If the price of purchase is lower than the number of expected viewings multiplied by the rental cost, it will be cheaper to buy. 

Except I don’t think that adequately captures why people buy movies. I have a reasonably large DVD and BluRay collection—somewhere in the ballpark of 100 movies and TV seasons. There’s a handful I never seem to get sick of—The Big Lebowski, The Dark Knight, Brazil, episodes of Firefly—and maybe 20 all told that I’ve watched (or am likely to watch) five or more times, which I’d guess is the average rent/purchase break-even point. If that were the only consideration, the other 80 might seem like irrational purchases. Quality is another factor—a BluRay still looks and sounds noticeably better than a streamed movie on a big screen with good speakers. But that’s not all there is to it either.

Perhaps the biggest advantage of purchase over rental is having ready access to a collection. That is, if I’m lounging around with my girlfriend on a rainy Sunday evening, and decide we want to watch a movie right then, we have a pool of 100 movies to choose from without either of us having to truck out to a store or rental kiosk. Maybe we’ll never get around to watching Apocalypse Now or Repulsion five times, but the point is that we could watch them anytime

Netflix streaming changes the calculus by giving you a huge pool of instantly-available movies without requiring you to own a large collection. For the 20 or 30 favorite movies, I might want to own them anyway, especially if they’re not necessarily going to be perpetually available to stream. But the “long tail” of my collection consists of a lot of movies that I own because I want to have the option of watching something pretty good in that genre anytime, not necessarily that particular movie. With Netflix available, I’m more likely to buy the 30 percent of favorites, and then assume they’ll have something acceptable streaming when we want to watch something new. There’s no need for a big collection of physical discs.

Now it’s easy to imagine the studios initially seeing streaming as primarily displacing rentals. That’s pure gravy for them, because the First Sale Doctrine means they’re not making any revenue from rentals after the initial purchase. Then—whoops!—they realize it’s actually displacing sales, because ready access to a pool of movies is actually a pretty good substitute for ownership. So it’s not so mysterious that they might suddenly want a fee based on the total number of subscribers with access to a streaming film. Because some percentage of those, even if they don’t end up watching a particular movie more than once or twice, will think: “I could buy it, but why bother if I can just stream it whenever I feel like seeing it? Even if that one movie gets pulled from streaming, there will be plenty of others about as good to choose from.” The mistake—perhaps natural for folks who spend their time making and marketing individual films—was not seeing that consumers often aren’t so much interested in watching some particular movie as they are in the ability to watch something. Just as many people spend hours “watching TV” rather than watching any particular show, people often just want to “watch a movie”—de dicto, rather than de re, as the philosophers say—or rather have the option to watch any one of a number of movies, more than they want to see any particular one.

Tags: Art & Culture · Economics



9 responses so far ↓

  • 1 Pete // Sep 19, 2011 at 1:43 pm

    Excellent analysis and I think dead on with regards to the effect of streaming vs. rentals on customer purchases. I know I have dramatically cut my buying habits since the availability of streaming (Netflix and others) has become more widespread. For me, the interesting part will be seeing if you can ever go backwards. If streaming becomes less available, will people start buying again. Or, do people now feel entitled and will just start pirating more and blame it on the industry for taking a step backwards.

  • 2 Mike // Sep 19, 2011 at 2:00 pm

    For me, personally, streaming has mostly had the effect that I watch a *lot* more movies.

    Renting has never been worth the time and cost to me. We would buy movies from used stores when we knew we liked them, but almost anything new we watched I either downloaded or we reserved from the library.

    With netflix streaming, I just put on a random foreign film/ B-movie/ cable only TV-show in the background. It has lowered the barrier to entry for new media finding me by so much, it’s completely changed the way I consume media.

    I have no idea how that factors into media corporations calculations… because really, prior to streaming video, I wasn’t a customer of theirs at all.

  • 3 Don // Sep 19, 2011 at 2:06 pm

    This is a logical explanation for Netflix’s splitting the two services.

    For those who buy movies, the rational response is to stop doing so if a movie will always be available by streaming. But the handful of my friends who buy DVDs do so to collect them. Have a large collection of movies is what motivates them. These people will likely not change their habit of buying movies however economically irrational that might seem.

  • 4 Julian Sanchez // Sep 19, 2011 at 2:42 pm

    I think something similar is true of me as well. Even before Netflix, I don’t think I’d actually rented a movie on disc (or even had a rental account) in many years, precisely because watching a movie at home was something I always did when I was looking for something to do and didn’t feel like leaving the house. If I *were* going to go out to pick up a disc, I’d just as soon go see something in a theater.

    Some people, to be sure, do buy out of a pure collectors’ impulse, but I think for most people the POINT of a collection is having options around the house when you don’t want to go out. DVD by mail wasn’t really a good substitute for this, because the point is to be able to see what you feel like watching when you’re in the mood to put a movie on, and not having to plan what you’re going to want to watch in a few days when the Netflix envelope arrives.

  • 5 K.Chen // Sep 19, 2011 at 3:23 pm

    For myself, I watch a lot more TV after Netflix than I did before Netflix, but my actual purchasing practices for my collection have not changed significantly.

    I generally only buy the top tier of movies and seasons, ones I especially want to see again and again, want to loan out, or want to support. I’ve stopped buying the occasional “always-wanted-to-see-it-and-now-its-bargain-priced” DVD but that was already a rare purchase.

    The real change however, is that the wife and I no longer have cable, since the best of last decades TV is available at our fingertips. And partially due to that, we don’t watch many movies in theaters anymore. The wife and I can usually buy more durable forms of entertainment for the same price as a movie date night and I don’t watch a lot of movie trailers anymore.

  • 6 Roger // Sep 19, 2011 at 10:30 pm

    Netflix is Doing the right thing by splitting their DVD and Streaming services! The problem is that they should have expected this reaction from customers. And should have been more reassuring and gental in doing so!
    Their Streaming service has come light-years from what it was before! (quality, reliability and content)
    Pricing is fair for both services @ $7.99 for each.
    I have received broken DVD by mail and I realize that Netflix was indeed losing money sending DVDs by mail @ $2/mo for unlimited-1 disk out

    Now Netflix can get subscribers throught out the world for their Streaming services and not have to worry about configuring the site for each customer depending on his/her location.

  • 7 Samantha Joy // Sep 21, 2011 at 5:15 pm

    I recently came across a discussion with another idea of why Netflix might have done this. Rather than summarize here, I’ll point you to the first several comments on this post ( http://theferrett.livejournal.com/1662325.html ) and say that the speaker, bart_calendar, is someone whom I trust to be accurate. I know it’s just LiveJournal, but I thought you might find it interesting.

  • 8 Sanchez on Netflix « Knowledge Problem // Sep 21, 2011 at 6:02 pm

    […] business. Foresightful or bad business decision, PR nightmare, or all of the above? The best analysis of its likely drivers and impacts is from Julian Sanchez: Just as many people spend hours “watching TV” rather than watching any […]

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