Investors are fleeing Netflix's stock and many subscribers have turned their backs on the Web's No. 1 video-rental service.
A combination of skimpy selection in Netflix's Internet-streaming library, problems acquiring content, and an unpopular price increase have led the company's leadership to what appears to be a crucial moment. Observers are beginning to wonder if Netflix's stunning growth of the past two years is coming to an end.
Netflix said today that it expects to report 1 million fewer U.S. subscribers in the third quarter than previously anticipated, a 4 percent shortfall. That number includes almost 800,000 fewer DVD-only subscribers than expected.
If you're one of those who cancelled a subscription hoping it would send a message to company managers, well, they got it and so did Wall Street. Netflix's stock closed trading today at $169.25 a share, down $39.46 or 18.9 percent.
Today's revised expectations raise important questions about the company. Netflix is supposed to have near perfect customer data and is supposed to be better than competitors at gauging customer tastes and trends. So, how could it set up Wall Street for disappointment by being overly optimistic about reaction to the price increase?
And with fewer subscribers and less subscription revenue coming in, will that hurt Netflix's ability to acquire content, which already appears to be flagging?
Two weeks ago, negotiations between Netflix and Starz, the premium pay-TV provider, broke down. Starz owns the Internet rights to titles from Sony and Disney, so it is an important source of films and TV shows for Netflix. But Starz is reportedly asking for a $300 million deal, or 10 times the $30 million agreement it penned in 2008 and Netflix doesn't want to pay.
A deal could still come together, but this was only the latest content provider to dramatically jack up prices. Some of my sources at the Hollywood studios have said for a while that they don't want consumers buying their films and TV shows, which cost millions to make, in bulk and at a discount. They want them buying and renting on a per-title basis.
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Netflix's model just isn't popular with many content creators.
Count Michael Pachter among those who saw trouble coming for Netflix. Pachter, a financial analyst with Wedbush Morgan Securities who has covered Netflix for six years, told me two weeks ago that he believed Netflix would miss its subscribers numbers. He argued, however, that Netflix would fall short by 2 million subscribers. Still, he says that Netflix is in a precarious position.
He says if Netflix fails to continue adding subscribers and if more subscribers choose to pay for just one of the two subscription plans, each of which costs $8, rather than paying for both at $16, it could hurt the company's revenue.
He said that this could further limit Netflix's ability to pay for content. Fewer sought-after titles in the streaming library will then lead to even fewer subscribers and less revenue and you have a self-perpetuating downward spiral.
Already, the gaps in Netflix's streaming library are hard to ignore. The service recently recommended that I watch the classic Western, "High Noon." It's a great film about honor and courage and measuring yourself against your own standards, but it is also nearly 60 years old and is regularly on cable and broadcast TV.
Heck, maybe Netflix CEO Reed Hastings feels an affinity for the film's protagonist, Sheriff Will Kane. All the townspeople are fleeing and want Kane to run too before gunslinger Frank Miller rides in and seeks revenge on them all. Despite serving them well, Kane is left to face Miller and his gang alone.
Hastings too has served consumers well, offering them the best rental prices and the most convenience for years. He did away with late fees and long lines which were common at traditional rental stores. When it comes to investors, he has kept his costs down and margins high and got the jump on everybody when it came to streaming movies over the Web, but he still can't silence the doubters.
However, Netflix can point to one important subscriber area that remains strong and unchanged from the company's predictions of July 25. The number of people who are willing to pay for access to both DVDs and streaming video is unchanged at 12 million.
Netflix can take that to the studios and note that more of the people who didn't want to pay $16 to acquire streaming as well as DVDs, still chose streaming over discs. Netflix managers can show the studios chiefs more proof that streaming is the future of home video and no other service is as equipped or as popular for streaming than Netflix.
For Netflix's sake, let's hope that will be a powerful bargaining chip. Remember, the last scene in "High Noon" (spoiler alert)--Kane defeats Miller, tosses his badge into the dirt, and leaves in disgust.
Update 1:03 p.m. PT: To include information on decline in Netflix's share price.