Qwikster: Beginning of the End for DVDs?

NEW YORK (MainStreet) – If there was any doubt before, Netflix has made it clear that it sees digital distribution as the future of movie rentals.

Just a few months after alienating customers with a big price hike, Netflix announced last night that it would officially separate its DVDs-by-mail service from its instant streaming service. While the streaming service will retain the Netflix name, the company’s original business model – physical discs in those ubiquitous red envelopes – will now be a new subsidiary company called Qwikster.

Netflix insists that the move is meant to strengthen both services, and CEO Reed Hastings said in a blog post that “we will be better at streaming, and we will be better at DVD by mail.” But the fact that DVDs by mail are being spun off into a separate service with a new name while the streaming service retains the established Netflix brand makes one thing clear: Despite the popularity of DVDs by mail, clearly Netflix sees streaming as its core business and the way of the future. Indeed, Hastings acknowledged in his blog post that “DVD by mail may not last forever.”

So does that mean physical discs are destined to go the way of VHS?

“DVDs will not go away completely, but they’ll become a much smaller market segment,” says Shahid Khan, a former media industry consultant and now chairman of Mediamorph, a cloud computing software firm. “It’s going to be a shrinking market over time, but it’s not going to go away, at least in the next five years.”

In this sense, then, Netflix’s separation of the two businesses seems like a good move: It retains a service that remains popular with many users, but rightly focuses on a digital distribution business model that is rapidly eclipsing physical discs. If this were simply a question of which model will ultimately prevail with consumers, Netflix certainly seems to have bet on the right horse.

“Netflix clearly wants to be a streaming company,” says Achal Bassamboo, a professor at Northwestern University’s Kellogg School of Management who recently penned a study on Netflix’s DVD-by-mail service. “They’re not just looking at the short-term future, this is a more strategic move.”

But the business realities make it a more questionable move for Netflix. By becoming a streaming-only company, Netflix is entering an increasingly crowded marketplace where everyone from Blockbuster to the major cable companies are beefing up their video-on-demand offerings. And while Bassamboo correctly points out that it’s a lot cheaper for Netflix to stream a movie than to mail it back and forth, the breakdown of Netflix’s deal with Starz makes it clear that drawing up digital distribution agreements with the big movie studios can get very tricky.

“The upside of DVDs is that the agreements it can have with the studios are pretty standard, so the cost model is predictable,” says Khan. “Digital distribution is more uncertain in a way that I’m not sure Hastings appreciates, as they’re very dependent on the studios for how much content they get.”

While DVDs remain popular among Netflix subscribers for now, Netflix is right that streaming will win out in the long run, as Bassamboo predicts that physical discs will eventually meet an end similar to VHS tapes. Whether that makes this a good business decision for Netflix in the here-and-now is a more difficult question to answer.

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