Netflix: Bruised but not Broken

Netflix - bruised

I love the Netflix distribution model.  They are everywhere you want them to be.  Got a networked gaming console?  They’re there.  How about a new blu-ray player?  There!  A tablet?  There!  You don’t need an installation technician.  You don’t need any new equipment.  Just turn on your devise.  Connect it to your (wireless) home network.  Sign up.  And, you are in!  If you don’t have any of the approved devices, Netflix won’t leave you out!  Get DVDs by-mail.

Stop paying your cable company or satellite provider for VOD when you can just turn on Netflix.  Your cable bill is already sky high.  Yes, Netflix streaming library is a bit limited but you can supplement it with their great DVD-by-mail service.  Oh, the possibilities!…until

The price hike.  Two months ago, you could get a combined streaming and DVD-by-mail subscription for just $10.  Outstanding value—even with Netflix’ streaming content deficiencies.  Then, Netflix decided, if they took a 60% increase on the combined subscription, they could grow revenue and buy more content.  At the same time, they lowered the cost of streaming only and DVD-by mail only to $8.  Did they do this to keep loyal streaming only or loyal DVD-by-mail only customers?  No, they’ve told us in the past that combined service subscribers are the most loyal.  They probably lowered the price to keep an attractive price point for new customers—which most marketers know are more price-sensitive than existing customers.

So, if you take a big percentage increase (and a relatively small dollar increase) on your most loyal customers, will they stay?  To be sure, you will lose customers but the smart folks at Netflix figured out that you can grow revenue and still lose a few of your most loyal customers.  (And, don’t they need the money for more content?)  Here’s the problem:  These loyal customers were also Netflix evangelists. They told everyone in their circle about their Netflix experience.  And, now, they tell everyone how Netflix treats loyal customers.

I know the Netflix guys think the cable and satellite guys are dinosaurs but maybe they ought to hire a few dinosaurs; because the dinosaurs will tell you how important customer satisfaction and retention is as the business matures.  Retention is always the long term play.

So, the Netflix stock was badly bruised today, and, as an investor, I’m disappointed.  As a customer, I like the wake up call.  But, all is not lost.  Now—not 2 years from now—is the time for Netflix to think about improving retention and loyalty.  The plan:

  1. Go ahead and split the services.  Each business unit needs to focus on their unique customer experience and better understand their customer segments.
  2. Stop saying customers are disappointed in the decision to split the services.  They are not and it seems disingenuous.  They are disappointed in the size of the price increase.
  3. Repair the brand damage.  See #2 and hire a brand guru.
  4. Get more content.  It is much of the experience and more content equals more loyalty.  (Isn’t that why combined subscribers are more loyal?)
  5. Anticipate your competitors.  They are not too happy about Netflix’ effect on their ARPU.  Sounds like a pet, but it’s a measure of average revenue.

Netflix took a hit today, but they have time to turn it around.  As an investor and a customer, I am so ready for the turnaround.

I Love to Get My Groupon, but…

Groupon deal

Like most people, I love a good deal.  I tell my mother, my sister, my friends, anyone who will listen about any bargains I find and snag.  So, I signed up for Groupon and I’ve opened nearly every email they’ve sent me.  BUT, I just took a look at the new Groupon IPO filing and I’m not sure it makes sense to add “Groupon” to my Microsoft Word dictionary.

Here’s the problem.  Now that the creative accounting has been adjusted, it’s very clear that the company isn’t making any money and they have much to do to get to profitability.  According the filing, Groupon spent $6.40 to acquire new subscribers in first quarter of 2011.  (That was $208 million in marketing expenses for the incremental 32.5 million customers added in first quarter.)  But, Groupon’s gross profit—the money it gets after paying merchants from gross proceeds—is just $3.25 per subscriber.  (Compare $270 million in gross profit to 83 million total subscribers.)

How will Groupon close the gap?  They have several options:

  • Reduce marketing spend (Highly unlikely.  As Groupon notes in its filing:  “[W]e expect our operating expenses to increase significantly in the foreseeable future.”)
  • Increase the number of subscribers who become actual Groupon purchasers
  • Increase the number of Groupons each customer purchases
  • Increase the average revenue on each Groupon sold
  • Increase the number of relevant deals offered
  • Demand a higher percentage of the merchant deal (though this strategy is fraught with danger, given that the company currently extracts about 50% of revenue on every deal)
  • Focus the marketing spend on prospects that yield the highest conversion (subscriber-to-purchaser) rate
  • Optimize the presentation of deals so that more deals are sought out and “opened”

Here’s the tough part, Groupon purchasers are, by definition, looking for a deal.  They are accustomed to finding good deals and are being conditioned to do seek them out as more online couponers enter the market.  Deal-seekers aren’t usually brand loyalist.  So, when Yelp or OpenTable or Livingsocial or your local direct mail vendor-turned-online couponer presents a deal, the lowest-priced, relevant deal is the winner.  So, competition can and will significantly lower margins in this business.  The question is: Can Groupon get profitable and sustain profitability as more copycats enter the market?  We will soon see.