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July 28, 2011, 10 a.m.

The newsonomics of Netflix and the digital shift

The print world ends not with a bang, but with price increase after price increase.

Editor’s Note: Each week, Ken Doctor — author of Newsonomics and longtime watcher of the business side of digital news — writes about the economics of news for the Lab.

Netflix CEO Reed Hastings says he is surprised that customers weren’t more upset with Netflix’s digital shift. After all, he expected more upset, in his role as a pioneer, early in the game of forcing the digital shift. That’s the kind of digital shift now confronting news companies, so Netflix’s customer experience and strategy is highly relevant.

Hastings is quite clear in that strategy, telling investors on Monday:

“Believe it or not, the noise level was actually less than we expected, given a 60 percent price increase for some subscribers. We knew what we were getting into, we tried to be as straightforward as we could, and that has worked out very well for us.”

When Netflix shocked everyone by pricing way up DVD-by-mail subscriptions — up to a 60-percent increase — that’s what he was doing: forcing the digital shift. The digital shift is what Hastings wants to happen faster. Right now, 60 percent of his 25 million subscribers are DVD takers, and the majority of the revenue is on that side of the business. He knew when he started the business that he would start with DVDs, but that the long-term business was streaming (“Six Lessons for the News Industry from Reed Hastings“). He just had to wait for the rest of the world to catch up to that vision.

The economics of his business is clear. Charge consumers less (for now) for streaming ($7.99 a month) — and profit more. As he shifts the business, the cost of revenues has already decreased almost two percentage points in a year, from 64.6 percent to 62.8 percent. Lower cost of revenues means higher cross margin, and that’s what investors have loved about the company.

In the new strategy, we can see how Netflix can both push the digital transition faster and manage the DVD decline better. We can assume that the digital customer is worth more in profit to Netflix than the DVD customer. Then, Netflix wants to take out as much of that cost infrastructure (Post Office, warehouses, associated customer service) as possible, as fast as possible. Differential pricing is one way to do that.

In the meantime, if we as consumers really want those DVDs, we’re going to pay significantly more for them, in the neighborhood of $16-20 a month. The Netflix analog customer, used to holding the hunk of burning love in his hands (and increasingly aware of the spottiness of Netflix’s streaming choices, even as they grow monthly), now has a tougher choice to make. Netflix has a better way to manage its business.

DVD-by-mail used to be the whole operation. Now with two years of successful streaming, it’s becoming simply one part of a streaming-focused company.

It’s now a division “within Netflix, with a  P & L”,said  Hastings in an earnings call. “We think it will be a small investment in its growth and sustainability, and we’ll figure that out over the next several quarters. The DVD can last a long time as a successful platform. Growth [of the DVD business] would be overstating it. It will shrink slowly rather than rapidly with a little operating investment.”

We can hear the great resonance in this transition for news and magazine publishers. First the principle: Spend your time on tomorrow, not today. For print publishers, that means moving as much of the thinking and as many of the resources to digital as possible — now. How about making “print” a division of a news(paper) company?

Netflix’s experience is early, and directional for news and consumer publishers. What Reed Hastings is essentially saying is that once a company has figured out its route to digital business model success, it doesn’t want to dally, straddling too long the old and the new. That’s tough, expensive — time- and mind-sharing-consuming. Better to get on with the transition.

For publishers, the path is not yet clear, but at least in the age of the tablet and of mobile generally, they now see the rough outlines of a route. While for Netflix, that route is a simpler single consumer revenue stream proposition, it is more complex for publishers.

The greater complexity for newspapers and magazines involves their two-part business model. The first part is similar to the Netflix consumer transition, though with differing twists.

Newspaper publishers started this process several years ago, saying, “Let’s have these print customers pay more of the freight of creating and delivering print.” Since then, community dailies that used to cost a quarter a day have tripled to 75 cents, and The New York Times goes for $6 on Sunday. They have priced in more of the cost of that expensive newsprint, ink, and delivery.

Now, this year, we’ve seen added in the charging for digital access. We’ve begun to see the answer to this question: How much will consumers pay for digital access? That’s still uncertain, though early evidence is coming in from The New York Times, Time Inc., and Journalism Online experiments, among others. In newspapers and in magazines, we see the interim play: the bundled, all-access subscription — pay us once and get both analog and digital, print and pixel. That’s a move for more consumer revenue in the short-term, but also a longer-term pricing play to get pure digital revenue as readers give up print.

Imagine 2020, and the always-out-there-question: Will we still have print newspapers? Well, maybe, but imagine how much they’ll cost — $3 for a local daily? — and consumers will compare that to the “cheap” tablet pricing, and decide, just as they doing now are with Netflix, which product to take and which to let go.

The print world ends not with a bang, but with price increase after price increase.

These economics of transition have a second, big piece for publishers that Netflix doesn’t have to worry about: advertising. With advertising accounting for 70 percent of newspaper revenues worldwide, the huge question for publishers is how much ad revenue they can make from purely digital customers. In the U.S, newspaper publishers know they make more than $500 a year on a Sunday print subscriber. With reduced digital product cost (like Netflix’s reduced cost of streaming), newspaper and magazine publishers won’t need the same level of revenue, but they will need a substantial part of what they are getting today. Those economics are just being modeled now in 2011, as the promise of higher-priced and higher-value tablet (and smartphone) advertising looks like it may be real and buildable.

Magazine and newspapers aren’t yet ready to more forcibly shift the audience in the direction of digital-only.

Timing is a big question here. Reed Hastings is flipping the Netflix switch more heavily toward digital, even though fewer than half his revenues are yet there. For newspaper publishers, with no more than 20 percent of their overall revenues in digital, the time may be one to three years away.

When publishers flip that switch — pushing customers more heavily toward digital — they want the force to be with them, not against them. The news and feature businesses are different than Netflix’s. Yet the strategies involved — make the old business a division, model out the new business model, move to it as quickly as you can once you’ve got it figured out — all apply. In mid-2011, Netflix is a canary in a (circulation) coalmine, with lessons to be learned.

Image by Laura Fries used under a Creative Commons license..

POSTED     July 28, 2011, 10 a.m.
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