What went wrong at Netflix

Netflix's stock recently went into a tailspin as the company announced the loss of nearly a million customers in the last few months. Netflix exemplifies a success story going bad because of both external factors related to "creative destruction" stemming from technological change and competition, and internal factors that are related to strategic misalignment of business models and a failure to put customers' needs first. It also shows how good decisions in an earlier environment can come back to haunt you when conditions change.

Let Netflix's recent problems offer the following lessons to entrepreneurs and leaders of technology companies:


•Beware the gales of creative destruction. Netflix became hugely successful and beat out incumbent Blockbuster because it rode the technological wave of the Internet and DVDs successfully. It did this by building a business model around web-based browsing of selections, prompt delivery, online recommendation systems and exploitation of "the tail of the distribution" by stocking DVDs that appeal to a small percentage of the viewing population. However, many of the capabilities and strategies suited for this business model were rendered obsolete by video streaming technology, and competitors such as Amazon that had similar or better capabilities. Netflix's missteps were due to an inability to foresee the consequences of the force of creative destruction, and thus to renew itself in the face of change.

•Don't get caught in the middle. In the last three years, Netflix's strategy was misaligned as it hedged across two different business models. DVD by mail and video streaming had different value propositions, different benefits and different cost structures. One pricing model for both formats created pressure within the organization and exacerbated the inconsistencies between the two business models. The best approach to a new technology may have been to be ambidextrous from the get-go and to think through which capabilities and strategies were synergistic and which ones were at odds with each other.


•Don't lose sight of customer needs. When Netflix did finally try to resolve the issues related to inconsistencies across its business models, it lost sight of what was appealing about the company to customers in the first place. A lack of customer-centricity was evident in Netflix's brusque initial communication about price hikes. The message had to be softer, especially in these times of economic distress. And in any case, with a poor library of video-streaming movies, why would consumers be willing to pay a jarring 60 percent more?

•Hard negotiations with complementors (companies with complementary products/services and mutual customers) and suppliers can come back to bite you. Netflix's aggressive bargaining around prices in the DVD-by-mail business had antagonized studios and content providers. The format change to video streaming allowed studios to gain back bargaining power, and they were less willing to provide preferential access to Netflix. For example, Walt Disney and Sony pulled back their video streaming offerings through Netflix. Further, the new technology permitted studios to get a lot more money for their offerings (in a pay-per-view as opposed to pay-per-DVD system), which greatly impacted Netflix's cost structure in video streaming. The not-so-great value proposition offered through video streaming was exacerbated due to poor complementor/supplier relationships.

•Once lost, credibility is hard to gain back. Splitting into two companies and then reversing that decision weeks later implies a lack of foresight and thought. Regardless of how much thought they may have actually poured into the original decision, Netflix came across as lacking a clear plan and looking rudderless. Subsequent attempts to regain credibility have been marred by the lack of coherence; as a result, critical stakeholders (consumer and stockholders) are questioning the future viability of a once very successful company.

Rajshree Agarwal is dean's chair in strategy and entrepreneurship at the University of Maryland's Robert H. Smith School of Business. Her email is Raj Echambadi is an associate professor of business administration at the College of Business as the University of Illinois. His email is