Seemed like the world was in an uproar today over Netflix’ announcement that they are separating their streaming and physical delivery services.  For customers that are using both parts of the service I’m sure it came as a big surprise.  But I’ll bet that’s a small percentage of their users.

I’ll claim its a smart move on their part and shows why Reed Hastings (Founder & CEO) understands that in order to stay on top you have to continue moving.  This inevitably will alienate some customers.

I’m a Netflix subscriber but I only use the streaming service.  I’m guessing that if we could see their internal metrics that this part of their business is the growth engine.  Besides customer uptake there are other compelling structural/business model issues with the opposing services.  According to previous interviews with Reed Hastings they always wanted to be in the streaming content business.  Technical and licensing issues forced them to start with the physical DVD model.

When Netflix started shipping DVDs to your home it was a creative way for them to not have to procure distribution rights to any of the content.  They skirted copyright violation of distributing any movie they wanted to carry and offer to their subscribers by actually purchasing commercial DVDs in the same way you could at Walmart.  Not the same with their streaming service.  Netflix has to negotiate the rights to steam content directly with the content owners.  This is why there is a wide discrepancy in the Netflix catalog between what you can stream and what you can have delivered via DVD.  It’s frustrating to the end users of the service but makes sense when you look at how different the models are of procuring the content.  I think this is the main reason they are separating the services.  

The cost of shipping the atoms on the DVD side will continue to produce thinner and thinner margins as those costs continue to rise while the cost of streaming you a movie (approximately 5 cents per 90 minute movie) will continue to decline.  But the bigger difference is in the attention to procuring and delivering content.  They need to separate (and eventually purge) the DVD business so they can concentrate on procuring content for their streaming services.

Rumor mill has it that Netflix is pursuing licensing original content for the network.  At that point they are a little MSO and a little HBO :)  They’re a new form of MSO (Multisystem Cable Operator).  Negotiating the content rights is a tricky business and will take several more years to completely shake out.  The traditional MSOs (Comcast, Time Warner Cable, Insight) pay large upfront fees to the content providers.  The content providers are addicted to these fees which makes it difficult for Netflix to compete for the streaming rights.  If a content owner like HBO makes their content available to Netflix they know the MSOs can then argue they can’t pay the upfront guarantees they have in the past.  This is why you see the content rights staggered.  The traditional staging of content by an owner goes from Theatrical release to DVD release to streaming release which has normally been over several months.  Netflix is pushing the time cycle of these releases and in some cases is negotiating streaming rights ahead of DVD rights.

Sound confusing?  It is, and it will take several more years to straighten out.  Multiple parties with billions of dollars at stake.  I say we should praise Netflix for pioneering these changes.  Don’t chastise them too much for separating these two very different sides of their business.  And remember… it’s only $8!  Unbelievable value.