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Netflix’s Misstep And The Golden Rule Of The Subscription Economy

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About eight billion dollars. That’s how far Netflix (NSDQ: NFLX) has fallen – half of its overall market cap – since announcing its new pricing and subsequent service division just three weeks ago. Overnight, Netflix has gone from subscription economy poster child to everyone’s favorite punching bag. Irrespective of signing a just-in-time deal with DreamWorks, Netflix has pissed off its customers, conservatively estimated that one million will cancel its service, and even created an opportunity for its once vanquished competitor, Blockbuster (NSDQ: DISH), to rise back from the dead.

How in the world did Netflix let this happen? In the subscription economy, the focus for businesses shifts away from producing and selling as many widgets as possible, to building and monetizing long-term customer relationships.

This is a fundamental shift in how companies operate. In the old world, the tie between vendor and customer was tenuous. I build a good product, get it into the store shelves, and it’s up to you whether you want to buy it or not.

In the subscription economy, it’s about the relationship, and relationships are a two-way street. Customers want to feel in control of that relationship. They want to be able to be able leave just as easily as they joined. Continue delivering me value, and I’ll stay in the relationship. And for years, Netflix mastered this, providing growing value (more titles, streaming, more plans) and building an incredibly loyal customer base as a result.

However, if the provider forgets this golden rule of the subscription economy — protect the trust of the relationship — the whole business model starts to fall apart. That’s what happened — Netflix made a unilateral decision to raise prices and lessen its service, without consulting its partners or customers. As a result, Netflix irreparably violated its customers’ trust.

With this in mind, let me share a subscription economy lesson, this one from my own experience. As the Chief Marketing Officer at salesforce.com years ago, we decided to raise prices on Salesforce CRM from $50 per user per month to $65 per user per month. Customers and investors alike hated the move instantly, and we were widely criticized. But it was a key, positive learning experience for our team. In the 10 years since we learned that lesson, salesforce.com has never raised prices again, and has never taken functionality away from existing customers.

Why did Netflix feel compelled to do what it did?

Because as the subscription economy, and consumers’ preference for “membership” rather than “ownership,” grows rapidly, several billion-dollar industries – communications, cloud computing and entertainment, among others – are on a collision course to deliver digital content as a subscription to consumers across every platform and device. The New York Times summarized the pressure Netflix is facing this week:

“Still, the competitors (Netflix CEO Reed) Hastings says he fears most are big media, cable and satellite operators who already have relationships with consumers. Time Warner’s HBO (TWX) currently delivers movies and TV shows for free online to its pay-TV subscribers, and satellite operator Dish launched a service of its own after acquiring Blockbuster, which gave it contracts with most of Hollywood.”

Add to that the fact that Amazon Prime, a $79 free shipping subscription, now boasts 5 million users with access to thousands of films and TV shows online at no additional cost. Just this this week, Amazon added another 11,000 streaming videos courtesy of a new deal with Fox.

That’s the power of packaging and pricing in the subscription economy. At salesforce.com, we were able to regain our customers’ trust over time. Netflix’s members have lots of choice and very little barrier to make a change. Netflix has its work cut out for it.

Tien Tzuo is CEO of Zuora, a subscription-billing company based in Silicon Valley. Previously, he was the chief strategy officer and chief marketing officer at Salesforce.com.

Disclosure: Zuora does not have as customers any companies that compete with Netflix or any companies mentioned in this piece.