Summary:

A court decision throwing out a Netflix class action is good news for the company – but also provides an interesting window into the company’s culture and business model.

Judge with gavel
photo: Rubberball / Corbis

Netflix is flying high these days with a flurry of new content deals and a soaring share price. Now, it has another reason to celebrate: it has finally shaken off a pesky class-action case by investors who accused CEO Reid Hastings and other Netflix executives of lying about profit margins and driving Netflix stock into the toilet in 2011.

The specific accusations turn on the period in which Netflix was attempting to wean subscribers off its DVD-in-the-mail business, and latch them onto streaming services instead. The transition turned into a debacle (remember that weed-smoking Elmo?), and led some customers to quit the service rather than pay double for both DVDs and streaming.

The costs for Netflix of acquiring streaming rights also proved higher than expected, leading the company to lose desirable content from Starz and other distributors and, in turn, leading more customers to bolt. The result was a free-fall in the stock:

Screen Shot of Netflix shares 2013-08-21 at 11.15.04 AM

The arrow points to October 2011, at which the point had fallen to around $77 from a high of $288 in July of that year. The stock has remained a roller-coaster ride but has bounced back nicely in the last year.

In throwing out the investor case for a second time, the judge emphasized that Netflix executives had never provided specific profit margins for the streaming business — but instead made more general claims that the switch to streaming made good overall business sense.

The decision is ultimately more interesting from a business standpoint than a legal one, as it provides a detailed window into the complex process by which Netflix acquires content. It reveals for instance that, like it does for everything else, Netflix relies on algorithms to see if a show will be profitable (emphasis ours):

Netflix would use hours viewed by its streaming subscribers as a proxy for value, and “to the extent that [Netflix uses] regression and other math valuation models” to predict a group of titles’ relative value, Netflix could estimate a reservation price for its deals.

The judge also deconstructs remarks by Hastings to reflect on the different business ethos that prevails in San Francisco and Los Angeles (again, emphasis ours):

Mr. Sarando was talking about the philosophy of Hollywood versus Silicon Valley, characterizing the former as a “relationship town” that focuses on preserving the status quo and the latter as a place philosophically more prepared to make drastic business shifts.

The judge threw out the claim with prejudice, meaning that the investors cannot try again. You can read other highlights of the decision below:

Netflix Class Action Dismissed

Comments have been disabled for this post