“Different” Businesses

Netflix announced today that they are going to run their video-streaming-over-the-Internet and mail-a-DVD-to-your-house businesses separately, and brand them separately, as “Netflix” and “Qwikster”. CEO Reed Hastings says that it is becoming “increasingly clear” that they really are separate businesses, and (hence) need to be operated separately.

What makes businesses “the same”, or “separate”?

• Customer base
• Customer benefits
• Suppliers and supply agreements
•  Teams / skills required
• Technologies /products to be used or developed
• Equity market and/or acquirer perspective

I can recall how hard it is, especially in a startup, to serve two different customer bases. As a business-focussed startup, if we tried focussing on large-enterprise, we were pulled into the special services that those customers required; whereas mid-sized businesses needed a standardized low-cost-to-implement solution. The two different kinds of customer needed different sales teams, different support organizations, even different product. We just had to focus on one or the other, or we would have never been able to succeed at either. We did most of our sales in mid-sized eventually, mainly due to their shorter sales cycle.

In a larger company such as Netflix, the opportunity is there to setup and run two operating groups.

How convincing is Reed Hasting’s argument that the DVD-by-mail and streaming-video business are separate?

They do offer different benefits. DVD-by-mail provides a massive catalog and high-quality (Bluray) video, whereas streaming offers instant delivery from a smaller catalog with low-to-moderate video quality. DVD-by-mail targets living-room viewing, whereas streaming can address the living room and is a natural fit with other more portable viewing methods, such as tablet-computers.

From a content-supplier perspective, the suppliers are the same, but might be willing to offer different terms to a video-streaming business vs. a DVD-by-mail business. Given the challenges Netflix has been having with licensing content, the opportunity to present streaming and mail as “separate” in Hollywood negotiations may be part of the motivation.

Technology and financial-model wise, Netflix may want to be able to invest in the streaming business without having to show the immediate returns that would be demanded for less-exciting DVD-by-mail business.

Product-focus-wise, having two separate teams can help each focus on producing the best experience they can, without having to be concerned about compromises with the other group.

Having two separate operating groups also provides the opportunities to sell / spin-out one of the business if desired. I do wonder if this is really the primary motivation – the two businesses are going to bill separately, which does suggest that ultimately they will split. Relatedly, it makes it easier for Wall St. to see the value of the two business separately.

The problem with all this is that it doesn’t include enough customer perspective. Many customers – especially those who are heavy consumers of video – will want both DVD-by-mail / high-quality / big selection and streaming / instant / mid-sized catalog / medium quality. They want to manage their video selections as one, and receive one bill.

What’s worse, the DVD-by-mail business is the perfect onramp to streaming video as streaming goes mass market. How much of that advantage will Netflix be sacrificing by separating the businesses?

Surely it would be possible to organize internal teams, and internal management accounting, so that both businesses could develop appropriately, without having to degrade the customer offer and streaming-transition strategy?

If Reed Hastings is planning to sell one or both of the business in next 18 months, then separating them could make sense. An acquirer might be willing to pay a high price for the video-streaming business, but not want to take on DVD-by-mail. Beyond that, the negative effect on customers of full business-unit-level separation just doesn’t seem worth it.