How Remarkable is the Netflix Move into Streaming?


In the discussion on Groupon and Price Discrimination, commenter Chris365 said "What is acutally surprising to me is that who ever runs 'Value Pak' or whatever brand has been so dismally negligent with both vendors and consumers that they didn't start offering online coupon-emailing services sooner."  To which Bronx Cobra replied:

"The transition from buggy whips to starter motors? Has that ever happened in the annals of business?"

My instant response was "Netflix".  BronxCobra is right that most companies are more like Blockbuster--they refuse to change to new technologies because they don't want to risk cannibalizing their current sales.  By the time they're forced to change, it's usually far too late--as Blockbuster's bankruptcy shows.

But Netflix made a bold move: they moved to online streaming even though their core business was doing very well.  And even more boldly, they built up some very expensive streaming capability ($115 million on streaming rights just in the 3rd quarter of 2010), but didn't try to charge customers extra for it.  This is pretty remarkable.

Or is it?  The obvious rejoinder is that Netflix benefits when its customer base moves to streaming instead of mail.  Netflix sends its DVDs by bulk mail, so I don't know exactly how much it spends per movie, but the total spend on postage is somewhere north of $600 million.  Meanwhile, the bandwith costs to stream a movie are considerably lower than postage, about $0.05 to $0.10 by one estimate, which is well below any per-piece bulk rate that I'm aware of.  So just getting its customers to consume fewer physical DVDs is probably a money-saver.

Yes but . . .  developing streaming still imposed substantial costs.  As long as customers are still ordering DVDs, Netflix still needs to maintain an expensive network of warehouses and physical movies.  And a lot of people are still ordering those DVDs, either because they don't have a computer hooked up to their large TV, they don't have sufficiently fast internet, or they want to watch the first-run movies or television shows that Netflix has still been unable to license for streaming.

That means that streaming capacity still represented a big added expense, with an unclear payoff.  Netflix did it anyway, first and best, in order to prevent its sales from being cannibalized.  It's maybe not quite as impressive as giving up buggy whips to manufacture automobiles.  But it's rare enough to nonetheless be worth remarking upon.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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