Netflix (s NFLX) has angered much of its user base and heavily disappointed investors over the last several months by raising its prices and splitting up its DVD-by-mail and streaming businesses, causing users to quit and leading to a freefall in its share price. But co-founder Marc Randolph wrote in a blog post Monday that he thinks the separation and re-branding the DVD business Qwikster is “one of the smartest, most disciplined and bravest moves [he’s] ever seen.”
Randolph, who was Netflix’s founding CEO and served on the board of directors until his retirement in 2004, compared the decision to split up the company’s operations to early decisions made in Netflix’s history, before it had settled on its legacy subscription DVD-by-mail pricing model. In the days shortly after they founded Netflix, the company had all the makings of a traditional rental operation; it had due dates and late fees. More importantly, Netflix also sold DVDs, and those sales made up perhaps 95 percent of the company’s early revenues.
But the founders knew that DVD sales weren’t the future of the business, and made the difficult decision to turn away from those revenues in an effort to stay focused on the bigger, long-term opportunity. Randolph wrote:
[B]y trying to run a business that did two things well, we inevitably were forced to make an endless series of compromises that resulted in us doing neither of them well. Our landing page and sign up flow had to accommodate two different paths. Our checkout process needed to handle two types of transactions. Our shipping process had to accommodate two different types of products (one that had to come back and one that didn’t). Our content system had to accommodate titles we could only rent, ones we could only sell, and ones where we could do both.
In the short term, dropping DVD sales might have hurt its revenues, but Netflix benefited from the decision in other ways: According to Randolph, the sign-up flow improved, and conversion rates went up. The company was able to clarify its positioning, which meant customer acquisition costs went down. Engineering became more productive, and QA testing became easier. Ultimately, all of that led to more innovation and the development of what Netflix came to be known for: unlimited rentals and a no-due-dates-no-late-fees business model.
While getting rid of DVD sales lowered revenues and likely angered three-quarters of its user base who bought DVDs from the company at the time, it also had the effect of streamlining processes and improving the end product. “[H]ard as each decision was in the short-term, I never questioned whether it was the right thing to do for the long-term success of the company,” Randolph wrote.
Now fast forward a decade to Netflix’s current re-positioning of its business, and you can see Reed Hastings taking on the same sort of hard decisions that the company faced early on. While Netflix has a more diverse revenue picture and DVD rentals don’t make up as large a percentage of revenue as DVD sales had during those early days, Netflix is dealing with a much larger user base — which means many more users to upset.
At the same time, Randolph sees the Qwikster decision as necessary to ensuring the long-term viability of the streaming business. By separating operations and giving it a different brand, the company was able to cut down on operational inefficiencies. Not just that, but Netflix can focus on where it believes its future lies — and that’s in the streaming business.
While acknowledging that Netflix handled PR around the whole situation poorly, Randolph ends with a tribute to current CEO Reed Hastings and the courage it must have taken to make the decision and go through with it:
[W]hat is truly mindblowing, is that when I was CEO trying to screw up my nerve to walk away from selling DVDs, I risked alienating tens of thousands of customers. Reed is showing that he has courage and conviction to do the right thing despite having tens of millions of them.
This is why this guy is the best entrepreneur on the planet.