More Smoke and Mirrors at Netflix
We get more customers, we get more money, we can afford more content, we get more customers. - Reed Hastings, June 2011Of course, that blew up in his face last year when he unveiled Qwikster and angered subscribers with a poorly executed price increase. I was never really all that hard on Hastings and Netflix for last year's well-publicized errors. In fact, to this day, I consider them a strange positive for Netflix.
Since last April, I have been yowling about Netflix's broken and unsustainable business model. There was no question in my mind that costs would consume the company, regardless of subscriber growth. No matter how hard Netflix tries to sell it as such, digital content spend is a variable, not fixed cost, at least if Hastings wants to obtain the quantity and quality of content necessary to bring in new customers.
Although Netflix can budget a particular amount of money for content each year, the strategic reality on the ground clearly shows that content creators can effectively force the company to spend more to secure content that it would like to have. While financial discipline can be a good thing, every time Netflix refuses to spend, it runs the risk of a sub-par streaming offering, which will do anything but drive new subscribers.
That aside, the so-called "virtuous cycle" was doomed before it didn't really even get started. Subscriber growth at Netflix would have had to progress onward and upward, unabated, for years, if not forever, for the company to truly execute a virtuous cycle. Ask Time Warner's (TWX) HBO, Sirius XM (SIRI) , DirecTV(DTV) and DISH Network (DISH) , even when you actually offer premium content, it's next to impossible to penetrate the majority of a population's households. That's basically what Netflix needs to do at $8 a month.
When these apparent Qwikster and price increase "missteps" not only brought subscriber growth a premature halt, but threw it for a loop, Hastings, even if he did not know he was doing it, was able to divert attention away from his company's inherently bad business model. Don't worry about the fact that we have billions in off-balance sheet requirements, Starz dumped us because we do not charge enough and we're spending through our nose to expand internationally, this difficult period comes as the result of little more than temporary obstacles. You can always spin temporary obstacles away because humans, particular Americans, like to believe that a little of false humility and hard work can fix anything.
Now, as subscriber growth gets set to take another pause, Hastings throws out another vile of smoke and mirrors. This time he calls it "increased seasonality." First, let's look at what the company expects, as per its Q1 2012 Letter to Shareholders: