Netflix's lost year: The inside story of the price-hike train wreck

Before he angered customers by raising prices, before he became the butt of Saturday Night Live satire for his Qwikster schemes, Netflix CEO Reed Hastings alienated some of his key executives. Influential voices at the company departed just before Netflix embarked on a doomed attempt to spinoff DVD operations.

(Credit: Montage by James Martin/CNET) Reed Hastings stopped listening, and that's when the trouble started.
In the spring of 2011, Hastings, Netflix's widely admired chief executive, held a meeting with his management team and outlined his blueprint to jettison Netflix's DVD operations. Netflix managers would tell subscribers on July 12 that they planned to do away with a popular subscription that offered access to DVD rentals as well as unlimited on-demand streaming video for $10 per month. DVDs and streaming would be separated and each would cost subscribers $7.99 a month, or $15.98 for both, about a 60 percent hike. The changes would take place in September.

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Jonathan Friedland, the new vice president of global corporate communications who had joined Netflix just a few months earlier, asked whether customers on tight incomes might object to the price hike, according to people at Hastings' meeting. Hastings argued that Netflix was a great bargain. He said he knew that some customers would complain but that the number would be small and the anger would quickly fade.
Hastings was wrong. The price hike and the later, aborted attempt to spin off the company's DVD operations enraged Netflix customers. The company lost 800,000 subscribers, its stock price dropped 77 percent in four months, and management's reputation was battered. Hastings went from Fortune magazine's Businessperson of the Year to the target of Saturday Night Live satire.
To Hastings' credit, what he wanted to do made sense. The DVD's best days are behind it. Video streamed via the Internet is slowly replacing the physical disc, and betting a business on a dying product is never a great idea. So Hastings wanted to get ahead of the curve and focus on streaming, to disrupt his own business before someone else did it for him. It was aggressive, far-sighted, and very much in character.
Hastings is someone who knows a thing or two about disrupting businesses. Netflix, after all, is the company that drove the giants of video rental out of the sector with a simple premise: A simple-to-use Web site that delivers DVDs right to your doorstep. Best of all: No late fees. He became one of those executives with the "visionary" label, who can predict where a market is going before it happens, and was asked to join the board of directors of two of the most important companies in tech, Microsoft and Facebook.
But even visionaries can misread their customers when they are blinded by their past success.
Leading up to the first anniversary of the Netflix meltdown, CNET interviewed former and current Netflix employees to find out how a series of missteps turned into a lost year, and whether it has rebounded from those self-inflicted wounds. Most asked to remain anonymous. Netflix declined to comment for this story.

With this change, we will no longer offer a plan that includes both unlimited streaming and DVDs by mail."
--Netflix to customers in a July 12 blog post.

So how did Hastings stumble? Just prior to the attempt to remake Netflix into a streaming-video distributor, there was turmoil in the company's executive offices. Several of Hastings' most trusted lieutenants were no longer as influential with the CEO. Others had left and their replacements did not yet have the clout to convince Hastings he was being too aggressive for a customer base that by 2011 could hardly have been considered on the bleeding edge of consumer tech.
When customers and the press pushed back, the Netflix response was haphazard, culminating with an amateurish, confusing YouTube video heralding the coming of Qwikster, the spinoff that was supposed to be a life raft for Netflix's DVD operations. The Qwikster plan was scuttled three weeks after it was announced.
"Whatever happened to Fortune's Businessperson of the Year?" asks Wedbush research analyst Michael Pachter, referring to one of the many honors Hastings received in 2010. "Whatever happened to the guy who was invited to the boards at Facebook and Microsoft? What happened to that guy? Do you think Facebook would have invited him to their board now?"

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Important dates in Netflix's drive to divide the company.
July 11, 2011
Netflix shares top $304 in midday trading.
July 12, 2011
Netflix kills hybrid subscription plan. Access to DVDs and streaming video will now cost 60 percent more.
September 1, 2011
Starz, the pay TV service, announces that it won't supply Netflix with Disney and Sony Pictures films for streaming any longer.
September 15, 2011
Netflix announces that it expects to report 1 million fewer U.S. subscribers in 3rd quarter than anticipated.
September 18, 2011
Hastings apologizes for how the price hike was communicated but says Netflix will spin off DVD operations. The new company will be called Qwikster.
October 10, 2011
Netflix reverses itself and kills the Qwikster plan.
October 24, 2011
Netflix reports 23.8 million total subscribers, down 600,000 from the 2nd quarter.
October 25, 2011
Netflix stock plummets nearly 37 percent.

DVD Co.

Hastings has an unwavering belief that streaming video represented the future of home entertainment. He argued that in times of technological advancement companies that had succeeded at one business often clung too tightly to tradition and to what had made them successful. And then they were toast. He didn't want that to happen to Netflix. While few people disagree with that assessment, some within Netflix doubted Hastings' assessment of how quickly Netflix needed to shift to streaming.
But Hastings pressed ahead. Around March 2011, he took his plan to his executive team and then to the company's vice presidents. Some of the execs who heard Hastings talk about spinning off Netflix's DVD operations into a new company, referred to internally as DVD Co. and later Qwikster, left the meeting thinking Hastings was only considering the idea.
That impression was quickly corrected. Within about 72 hours, some of the group learned that Hastings had already offered the new company's CEO position to Andy Rendich, Netflix's respected chief service and operations officer. Hastings, it appeared, wasn't looking for debate.
Netflix rapidly began executing the plan. Some employees were stunned by how quickly and unemotionally DVD operations, the backbone of the business for a decade, was split off from the company. DVD Co. was moved out of Netflix's offices to a space a few blocks away. Netflix's leaders stopped discussing DVDs. Those Netflix executives who moved to DVD Co. stopped attending Netflix management meetings. Some of those people included Allison Hopkins, Netflix's vice president of human resources, Liz Coddington, vice president of financial planning and John Robison, vice president of DVD product development.
Few people who had worked for Netflix for any length of time were surprised that there wasn't more discussion about the plan. As Netflix's business blossomed and as he was personally applauded in the press, Hastings had grown much more confident in his own decision making, less receptive to taking advice from his senior management team. What's more, few of the people who could persuade Hastings or tell him he was making a mistake were around anymore.
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