Seeing Red (Envelopes): When Contrition Doesn’t Work

Those of you who follow me know that I'm a big fan of the "radical transparency" campaign that Domino's Pizza designed almost two years ago — an advertising initiative that is still going strong, and continues to build customer loyalty, quarter after quarter (view my other blog posts about Domino's Pizza here, here, and here).  One of the key most appealing aspects of the radical transparency approach was the admission by the company that, in the past, its pizza just wasn't very good.  By admitting its mistakes and using that platform to explain why its "new and improved" pizza was better, Domino's Pizza was able to attract customers who had long-ago given up on the company and its product.  This strategy of contrition proved extremely popular with consumers and was adopted by a slew of other companies, including Starbucks.  

Now Netflix (or should I say Netflix / Qwikster) is the latest company to jump on the contrition bandwagon.  In a recent blog post, the company's CEO and co-founder, Reed Hastings, announced to the world that he "messed up" and that he "owe[d] everyone an explanation."  He went on to admit that the company had made a significant mistake when it announced, two months ago, that it would be significantly increasing fees for the majority of its customers.  In the revised fee structure, customers who were previously able to get a limited number of DVDs-by-mail each month as well as unlimited streaming from Netflix's library for one low fee (about $9 a month) would now have to pay more than $15 a month for the same basic service.  With that sudden and dramatic change, Netflix managed to alienate a significant portion of its subscriber base — more than 1 million subscribers dropped the service in the wake of that announcement.  And the company's stock price took a significant hit, losing about 40% of its value. 

But the contrite blog post by Mr. Hastings didn't seem to quell subscriber or analyst concerns about Netflix.  This is because, at the same time Mr. Hastings was apologizing for his company's past mistakes, he was announcing a plan to make what could be another significant mistake: splitting the Netflix service into two.  Under the new plan, the company is being split.  The entity you know as "Netflix" will be devoted only to streaming video, which many believe is the wave of the future.  And a new company called "Qwikster" will be created to handle the DVD-by-mail business that Netflix pioneered in 2002. 

It comes as a surprise to no one that Netflix is facing some significant challenges.  The home entertainment industry is rapidly evolving from being a DVD-focused business to focusing instead on video streaming.  A large percentage of Netflix's customers watch almost everything through streaming and watch very few (if any) movies on DVD.  And responding to this sea change in customer viewing habits, the content owners are becoming more and more stingy with licenses.  For example, Starz, one of Netflix's longest streaming partners and a significant source of online content for Netflix, recently refused to renew its contract with Netflix.  Many content owners (primarily the big movie studios) are refusing to work with Netflix as they become more and more concerned with the rapid decline of the DVD business (which was a significant source of revenue for the studios throughout the late 90s and 2000s).  And the studios that will work with Netflix are charging significantly more to license the content than they charged during the last few years.  As a result, Netflix can't afford to keep the same levels of pricing and service and continue to deliver the same level of content that its subscribers have come to expect.  

I get that.  And, I think, if the new licensing paradigm was and is explained properly to them, I think the majority of Netflix's subscribers would get that, too.  But the company made a critical mistake by: (a) not taking the time to make sure its subscribers understood why the price hikes were necessary; and (b) making the fee increase so dramatic, all at one time.  Mr. Hastings understands these mistakes and acknowledges them in his blog post, telling the world that he realizes that he needs to be "extra communicative."  That's true, but communication alone — even when it involves an apology — isn't enough.  Something fundamental needs to be done to address the customers' concerns that led to the problem that necessitated the apology.  Domino's Pizza understood that.  But Netflix, apparently, doesn't.  If it did, it would not have made such a fundamental change in its business (splitting the two services) before gauging possible customer reaction and determining the potential subscriber fallout.  As I mentioned above, it's obvious that the company's model is shifting rapidly, but rapid change in the industry should not automatically mean ignorance of the fundamental truth underlying any business: a company should ensure that changes in its business don't result in alienating a large portion of its customer base.

Both subscribers and Wall Street have reacted negatively to the new announcement.  Scroll down on the Netflix blog page and you'll see customer reactions.  Most of them are negative.  The company's stock price continues to slide, having lost 57% of its value (as of this morning) since the price-change announcement. Subscriber fallout won't be known for another several weeks, but it's safe to say that Netflix is going to see another substantial decline in its customer base.  In other words, Netflix's use of the contrition approach has had exactly the opposite effect that it had when it was used by Domino's Pizza.

And now — if you have made it this far — my personal opinion on the change.  As an early adopter of Netflix and longtime subscriber, I think the company's latest announcement shows that it is all too eager to jettison its DVD-by-mail business in favor of streaming. The problem with streaming is that the offerings have been, and continue to be, subpar — in fact, the offerings were poor even before the company lost its contract with Starz.  Streaming business has a long, long way to go before it will come even close to DVD in terms of the amount of content available. And as someone who cares a great deal about movies (my wife and I watch about 200 movies a year), I won't even seriously consider streaming as an option until it is a reliable source of content for movies that I actually want to see.  But I fear that puts me in the minority of viewers.

One very interesting aspect of what has transpired over the last couple of days is that Blockbuster appears to be well-positioned to arise from the ashes and capitalize on the fallout from Netflix subscriber disenchantment.  In fact, the company has announced a press event for this Friday, in which the company will announce "the most comprehensive home entertainment package ever."  I will be watching that event closely.

UPDATE: In response to what can be described as overwhelming customer backlash, Netflix has reversed course and announced that it will not separate its DVD-by-mail and streaming businesses.

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