GRACE NOTES

Netflix customers are hopping mad, and the company predicts it will lose a million customers. Its stock price has tanked. Has its CEO, Reed Hastings, lost his mind, or is this merely a speed bump along the path of a much grander strategy?

First, a quick recap: Not so long ago, Netflix was cool. It had a huge library of DVDs and was willing to share them with a few million of its closest friends. The red envelopes in the mailbox meant one thing: cheap and convenient entertainment. In contrast, driving a mile to the nearest Blockbuster store seemed tedious and horrible. Even better, Netflix added streaming. Netflix ruled.

Then, in July, Netflix announced that it was raising its prices by as much as 60% and unbundling its services. Where a single bundle cost $10/month, the two services now cost $16. In September, as if to drive home the misery, Netflix announced it was formally splitting the company into two parts: The streaming part, and the DVD rental part. The latter will be called Qwikster. The two parts will not be integrated, so customers will need to maintain two accounts. Many customers felt betrayed, and lamented that in one month, Netflix had burned through ten years of customer goodwill. Some were pretty pointed with their ridicule for the company.

The conventional wisdom says that Netflix screwed the pooch. In particular, Reed Hastings is being blamed for his arrogant treatment of his customers. His apology smoothed things a little, but hardly healed the rift. Next in line behind the pissed off customers are the ticked off shareholders. In July, the stock’s share price was about $300. Today, it’s about half of that. Through a recent stock buy-back program, the company lost about $47 million. Coincidently, by selling personal shares, Reed Hastings recently made about $41 million. Very uncool.

Conventional wisdom says that Netflix will never regain its luster. Its marketplace has changed. Netflix was great at renting DVDs, and had a head start on everyone else. Now, you can cheaply and conveniently rent from Redbox. The future lies in streaming. But outfits like Apple, Amazon, Hulu and Comcast as well as the movie studios themselves, will be tough streaming competitors. Wisdom says that Netflix was heading for trouble, and these missteps just made things worse.

But what if conventional wisdom is wrong? What if Reed Hastings, the guy who brilliantly made Netflix into a household name, is now brilliantly positioning the company for the next step? He knows what can happen to powerful companies that become complacent; for example, AOL went from industry giant to struggling has-been when it failed to adapt to a post-dialup world. In Hastings’ world, discs are like dialup. They will soon be lame and old-fashioned. He wanted to cut the cord while the cutting was good. Note that the streaming part got the valuable Netflix name while the DVD part got the Qwikster name. My bet is that he sells off Qwikster as quickly as possible, so he can focus on the future – streaming.

In fact, he’s not losing any time in formulating the future of Netflix. At the Facebook F8 developer’s conference yesterday, Hastings (a Facebook board member) showed how Facebook members will be able to watch Netflix movies that their friends are watching. That is part of the ongoing movement toward the socialization and sharing of entertainment, and cleverly attaches Netflix’s 20-million users to Facebook’s 800-million users.

Now, there’s a catch. Because of the Video Privacy Protection Act, the feature won’t be available to US Facebook users. But, it’s immediately available in 44 other countries, and the Act is under review and might be overturned. Hastings is gambling that it will be.

Hastings knows that discs are yesterday’s technology. And, he sees that social media is the future. Jettisoning discs and plugging video streaming into social media is the perfect solution. The recent dustup is minor compared to the growth he envisions for Netflix.

Hastings committed a corporate no-no: in the process of positioning his company for the future, he hosed his current customers. He should have handled it better, or maybe he should have been handled better. But the important point he that he did what had to be done. If companies like Blockbuster and Sony had been as gutsy, they would be players today, and not has-beens (though both are working on big comebacks).

To make an omelet, you have to break a few eggs. And piss off a few million customers.