Agile VC: 

My idle thoughts on tech startups

Netflix / Qwikster Split Was Brilliant (and Necessary)… 2 Long Term Impacts

Lee Hower
September 19, 2011 · 2  min.

Reading Time: 2 minutes

Lots of us woke up this morning to an email from Reed Hastings about Netflix splitting it’s streaming and DVD-by-mail businesses into two separate operations (each w/ it’s own brand).  If you haven’t seen it yet already his more in depth blog post is here.  

Bill Gurley described why content rights issues in digital and physical realm is a key driver of this decision and Mark Suster talked about how Netflix is trying to avoid the Innovator’s Dilemma of moving too slowly with a new model to avoid canibalizing an old one.

They’re both right.  I have to say that I’m not a fan of the brand “Qwikster” for the DVD-by-mail service, though I think it’s good that group will expand into other media types like video games (a la Gamefly).  But overall this was both a move that Netflix had to make and is brilliant if only because most large companies never take these kinds of hard decisions as their core business faces innovative threats.  

Gurley, Suster, Techcrunch, and others have pointed out the near term reasons for and implications of this split.  But I think there are some two longer term impacts that we will see in the 1-5 year time horizon.

1) Qwikster May Have Different Owner in Longer Term – It was obvious before and it’s explicit now… the future of Netflix is digital distribution.  By rebranding, creating separate team/ops, and separate user experience for DVD-by-mail business, it’ll be vastly easier for Netflix to sell Qwikster at some point in the future.  A slow-growth, but cash rich business like this could be a better fit for a retailer, private equity fund, or other type of owner in the longer run.  And a large cash infusion from a sale may be more valuable to Netflix than simply owning a cash-generating unit, as Netflix looks to acquire more digital rights or produce more of it’s own content.

2) Pay TV Providers Strengthen Their PPV Position – MSOs (cable/phone companies like Comcast, Verizon, et al) and satellite TV providers will look to strengthen their position in pay per view movies.  Historically movie studios operated on a “release window” whereby a film first appeared in cinemas, then VOD/PPV through cable providers, and finally DVD.  That notion is blurring today but is unlikely to die anytime soon, if ever.  In an earlier round of negotiations over digital rights, Netflix gave up the right to rent DVDs by mail for 28 days after the DVD format release.  Then a few months ago DirecTV, Comcast, and others got the right to show movies 60 days after their theatrical release at a “premium” VOD/PPV price.  

If you’re a Netflix subsriber with a mediocre bandwidth connection (DSL, esp in rural areas), DVD format will remain a must have for awhile.  But for more urban markets with fast broadband, most Netflix subscribers will only want DVD/Blu-Ray for recent movie releases (if at all).  At present, streaming will be the format of choice for back catalog films (e.g. older movies) and TV shows.  As Qwikster becomes a more expensive and conceptually separate product (remember, you’ll have to manage queues on 2 separate sites for both DVD and streaming) to consumers, I suspect you’ll see at least some turn to their pay TV providers for the occasional recent blockbuster instead of getting DVDs by mail from Qwikster.  And presumably pay TV providers may step up their marketing efforts along these exact lines as they seek to avoid the “dumb pipe” fate.

Lee Hower
Lee is a co-founder and Partner at NextView Ventures. He has spent his entire career as an entrepreneur and investor in early-stage software and internet startups.