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I'm Drew Breunig and I obsess about technology, media, language, and culture. I live in New York, studied anthropology, and work at PlaceIQ.

Netflix won DVDs. It’s time to focus on streaming.

Yesterday, Reid Hastings announced that Netflix is spinning off its DVD business into a separate business unit. Well, Netflix actually sepearted the physical business when they announced their earnings in July, but only now do we see how stark the line between Netflix and, um, Qwikster will be.

I strongly believe Netflix’s move is the right one, because their last spinoff was an inarguable success and because they’ve already won the DVD-by-mail business.

Netflix’s Other Spinoff: The Roku

While Stowe Boyd and others saw this coming I have yet to see any mentions of Hastings’ first spin-off. Let’s not forget the Roku’s origin, as told by Wired in August 2009:

Three days later, at an all-company meeting in the same amphitheater, Hastings announced that there would be no Netflix Player. Instead, he would spin off the device, letting developer Anthony Wood take the technology and his 19-person team to a small company Wood had founded years earlier called Roku. But Netflix, which had already begun streaming movies to users’ PCs, was hardly giving up on the idea of streaming them to televisions as well. Instead, the company would take a more stealthy—and potentially even more ambitious—approach. Rather than design its own product, it would embed its streaming-video service into existing devices: TVs, DVD players, game consoles, laptops, even smartphones. Netflix wouldn’t be a hardware company; it would be a services firm. The crowd was stunned. In half an hour, Hastings had completely reinvented Netflix’s strategy.

I’d say this gamble was remarkably prescient of Hastings. Had Netflix launched their own player they would not possess their current streaming penetration. Walk through BestBuy or cruise Amazon; at times it feels like any device that connects to the web and television sports a native Netflix app. Had Netflix stuck with a proprietary box, they’d be locked in competition with Apple, Google, Microsoft, and Sony, rather than be incorporated into each offering for free.

Meanwhile, Wall Street is currently punishing Netflix for their most recent spinoff. Based solely on the Roku casestudy, I’d give Hastings the benefit of the doubt for at least a year. But beyond Roku, there are many reasons for the split, not least of which is the fact that Netflix has already won the DVD-by-mail business.

DVD Dominance

Dan Frommer has already nicely catalogued many reasons why a Netflix split makes sense. Two cited reasons are especially important:

  • Netflix DVD shipments “have likely peaked” and the company’s DVD subscriber base is declining.
  • Netflix is expanding its streaming-only business internationally, but DVDs are only available to rent in the United States.

Frommer’s citations illustrate that the DVD-by-mail business is stagnant, if not declining. The market is saturated. To his points, I’ll add two more:

  • No serious competitors exist in the DVD-by-mail space. Blockbuster is currently trading at 7.5 cents. And I’d argue RedBox is a flash of a business, one that will thrive until broadband is ubiquitous, audiences are comfortable streaming, and video rental prices stabilize. On that point…
  • Any video rental competitors that will emerge will be streaming. Only an idiot would launch a DVD-by-mail business today. The rise of broadband, fast cellular networks, on-demand cloud computing, and the insecurity of the US Post Office have all conspired to create a market where launching a mail-order subscription service dedicated to a dying medium is a fool’s errand. Plus, Netflix’s fulfillment operations are unmatched and it would take years and a large customer base to build a competitor (just ask a GameFly customer).

When considering all of these points, it’s impossible to ignore that Netflix has won the DVD-by-mail market. This market is in a state of decline, Netflix has the operational and userbase scale, and no competitors are likely to emerge. This business is effectively a monopoly, but one with no future.

Now the branding move makes sense: why invest brand equity into a market that you completely dominate? By removing the DVD-by-mail message from the Netflix brand, Hastings is focusing and simplifying his marketing message. The Netflix brand now aligns to a simple position: your source for streaming movies. Hastings is putting all the wood behind the streaming arrow to increase awareness of their streaming offering. He can comfortably do this because the DVD-by-mail message has peaked: comprehension has reached saturation and new competitors will only be talking about streaming.

The effect of advertising is dependent on the size of your budget, the simplicity of your message, and competitive noise. By divorcing his brand of an obsolete message, Hastings will increase his advertising efficacy through clarity and will remain relevant to increasing competitive propositions.

Netflix’s split is a net good. Hastings’ ability to make tough decisions in service of a longterm strategy will take then far.

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