If Everyone Else is Such an Idiot, How Come You're Not Rich?

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Today, while idly scanning Google News for articles about Netflix, I came across this from Colette Martin at Forbes:


I can't help but wonder if the company has a strategy.

A lot of damage has been done. In just one quarter, the company has suffered a serious toll, losing 800,000 members. While they still count me as an active member, I am reconsidering whether the single DVD that sits around my house collecting dust is worth $7.99 per month. And I am exploring other (less expensive) streaming services.

The most critical problem for Netflix is a failure to recognize what business they are in. Hastings second letter defines DVD mailing and streaming as two separate businesses, and as soon as he did that he opened the door for trouble. Netflix was singularly poised to be able to serve all of our movie-watching needs (short of the theatre), and they have now opened the door for other streaming services (like Amazon Instant Video) to poach their business.

A word of advice for Netflix: Recognize that the movie-watching experience needs to continue to evolve as technology evolves, and that, while the list is important, it's not really about a list - it's about the experience and allowing me to watch what I want, when I want, how I want... easily.

I don't want to pick on Ms. Martin, particularly, because I've read some version of this lament about Netflix about a thousand times. And indeed, I completely agree that the Qwikster disaster was nothing short of debacletacular. 


 But how do we get from "that was a bad idea" to "Reed Hastings doesn't understand what business he's in?"  When internet commentators see odd behavior that they don't understand, why do they assume that the most parsimonious explanation is that management must be a bunch of drooling morons?

I mean, Reed Hastings did manage to build this rather large and successful business that killed off one of the most successful retail operations of its day.  It's possible that he just sort of did this by accident.  But is this really the most likely explanation?  That he didn't understand the first thing about how people watched movies, or how to run a business?

The available evidence seems to indicate that at some point, Reed Hastings was a smart guy.  Smart enough to count to twenty with his shoes on. Smart enough read pages 1-15 of the kind of introductory strategy text where they solemnly tell you to figure out what business you're really in.  Smart enough to grind Blockbuster into a pile of gleaming blue-and-white sand while launching a streaming service so popular that it now accounts for something like 20% of peak-load internet traffic.  If you want to write an article on how he's a big fat idiot who couldn't find his ass with both hands in the dark, then you should probably have a theory of the transition between these two states of Reed Hastings.  Did he suffer a stroke?  Start dating distractingly gorgeous supermodels?  Has he been licking the paint chips in his gloriously restored Victorian mansion?

If you do not have a theory--if you believe that Reed Hastings just suddenly and for no apparent reason became an idiot--then one of two things is likely. Either there is some undiagnosed medical condition that Mr. Hastings' doctor should investigate immediately, or you are committing the fallacy of Chesterton's fence.

When I catch myself thinking along these lines, I try to stop and ask a simple question:  "If everyone else is such an idiot, how come I'm not rich?"

If you see a person--or a company--doing something that seems completely and inexplicably boneheaded, then it's unwise to assume that the reason must be that everyone but you is a complete idiot who is blind to fairly trivial insights such as "people desire inexpensive and conveniently available movie services, and will resist having those services made more expensive, or less convenient".  While it's certainly true that people do idiotic things, it's also true that a lot of those "idiotic" things turn out to have perfectly reasonable explanations.

And in fact, if management of all these large public companies really were the staggeringly malevolent yet totally hapless lackwits that so many seem to believe, it should be really, really easy to get rich by outwitting them.  Oh, sure, they'd probably get all their rich friends in Congress and Kiwanis to gang up on you, but since, according to the internet, almost all those people are also too dumb to come in out of the rain, you should be able to defeat them with a couple of well-placed banana peels.

If you've found it maybe not quite that easy to make a pile of money by outguessing all these benighted fools, then perhaps you should consider the possibility that they aren't quite as stupid as you are making them sound when you sniffily ask "Why don't they just . . . ?

Quite often, the answer to that exasperated "why don't they just . . . ?" is green, and it folds.  So in the case of Netflix, where most of the analysts who follow it closely seem to agree that Reed Hastings is not actually dumber than the proverbial bag of hangers, nor crazier than their cousin, the snake's armpit.  II'm sure that  Reed Hastings is well aware that Ms. Martin, like everyone else, liked things better the way they were.  And I'm quite sure that he knew this when he launched Qwikster on its brief and tragic life.

More likely an extremely non-crazy and non-stupid Reed Hastings is casting around for a way out of a very, very tight spot.  The DVD business, while less convenient, and more expensive to run, relies on something called "first sale doctrine": once you buy a DVD, you can rent it out as many times as you want.  Reed Hastings didn't need much help from content owners to get into that business.  Digital streaming rights, on the other hand, have to be negotiated.

Those negotiations were fairly easy when streaming was a marginal business.  But now that it's big enough to cut into other revenue streams, like DVD sales and cable television, the content providers are demanding that Netflix make up for that lost revenue by paying them more money.

Netflix understands quite well that its customers would like them to deliver on-demand content at prices much lower than said customers used to pay for cable.  The problem is, the owners of that content are not going to let them do that.  The most common--and plausible--theory of why he tried to split the businesses, even though it was completely obvious that this was really going to upset his customers, is that content owners were demanding a per-user fee for the streaming rights, and that Hastings wanted to get the DVD-only customers off of Netflix so that he wouldn't have to pay for streaming rights they weren't using (or paying for).

That's why they raised prices.  That's why they've split the businesses.  That's also why there's less content on Netflix. The content providers probably don't care much if Netflix kills cable . . . but they're only going to allow Netflix to do it if Netflix replaces that lost revenue, which is to say, if your Netflix streaming account costs about what your cable subscription does.  And everyone who says "I'll show them--I'll go to a better streaming service!" misunderstands the problem.  If those streaming services get big enough to substitute Netflix, they will run into the same problem that Netflix has.

That doesn't mean, mind you, that Qwikster was a good idea.  I thought it was stupid at the time, and the fact that the company killed it off quickly seems to indicate that Reed Hastings agrees.

But not irrational, "Why is that man licking paint chips?" kind of stupid.  More like garden variety "People sometimes do stupid things when they don't have any very good choices" kind of stupid.  In fact, I think that Reed Hastings is a very smart, very capable CEO bumping up against a very, very difficult strategic problem.  I wouldn't bet against his cracking it, either.

But cracking it doesn't mean that Colette Martin, and millions of other disappointed Netflix consumers, will get what they want, which is to say, what they had.  If they're expecting that Reed Hastings--or anyone else--can deliver them a good cable substitute at 1/5 the price . . . well, I'd say that they don't really understand what business Reed Hastings is in.
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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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