Why is everyone always writing off Netflix?

Commentary about business and finance.
Sept. 1 2010 1:59 PM

America's Most Underestimated Company

Why is everyone always writing off Netflix?

Illustration by Mark Alan Stamaty. Click image to expand.

People who think and write about technology companies for a living are prone to be wrong now and again. Try to find, for example, veteran analysts or journalists who haven't at some point made a claim about Apple that they didn't later regret. The technology sector is too dynamic, and the growth of certain technologies too explosive and unpredictable, for anyone to be right all the time. That's part of the fun.

But there is one company that has been more consistently underestimated than any other, whose innovations, growth, and, indeed, survival have been dismissed and denied for nearly all its corporate life. That's Netflix. Despite a long-term record of success, the company has repeatedly seen its stock, its technology, and its very business model publicly derided.

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How nasty and wrong have the critics been? In 2005, Michael Pachter, an analyst for Wedbush Morgan Securities, called Netflix "a worthless piece of crap with really nice people running it." Today, that worthless piece of crap has a market capitalization of $6.4 billion. In early 2007, when Netflix first announced its plans to allow subscribers to stream videos instantly—rather than wait for DVDs to arrive in the mail—esteemed tech journalist Om Malik predicted that this move would "soon be relegated to the dustbin of failed ideas." Netflix has more than doubled its subscriber base since then, and today nearly two-thirds of them use Netflix's streaming video service.

Some Netflix skeptics have been honest enough to admit their errors. In October 2006, Jim Cramer memorably donned sackcloth and ate a piece of a hat with the stock symbol NFLX on it. His sin: He told his viewers to sell Netflix at $19 a share. Today, it's trading at more than $130.

While its critics were flailing away, the company has continued to grow steadily and spread its influence well beyond the red envelope. One of Netflix's direct competitors, Blockbuster—which for years was supposed to put Netflix out of business—is teetering on the edge of bankruptcy. Netflix's iPad app was widely deemed one of the best available when the device launched in April. And when Apple announced today that its new Apple TV service would stream movies and TV shows, Netflix content was front and center.

What is it about Netflix that causes critics to misread it so badly? Call it the innovator's paradox: Netflix forged an identity by building a simple business—DVD delivery by mail—that had never been done before. The very fact that this DVD-by-mail idea connected so deeply with consumers led many observers to think that was all that Netflix could or would ever do. Instead, the DVD delivery service—while still vital to Netflix's revenue—looks more like the Trojan horse of a much wider strategy designed to change how Americans watch filmed entertainment.

The company's critics have also tended to focus on technological platforms, rather than what consumers actually want. Netflix, like Amazon, has built its relationship with customers extremely carefully and successfully—some 15 million people now send Netflix money every month. (How many nonutility companies can boast that?) As long as it continues to keep its customers happy, it should be able to transfer them to whatever platform—DVDs by mail, streaming over the Xbox or Wii or set-top boxes, the iPad, the iPhone—those customers want.

This isn't to say that Netflix is bulletproof or that it's possible to justify the more than doubling of its stock price in the last year. There are all sorts of threats to its business. These threats come from competing technologies like BitTorrent and from stakeholders in Hollywood. But perhaps the biggest threat is from Amazon. For years, it's been rumored that Amazon would take over Netflix, even though Netflix's real-world distribution centers would create huge tax headaches for Amazon. Even if Amazon did once have designs on Netflix, it appears to have decided that if it can't join 'em, it'll beat 'em with the apparently imminent launch of a subscription TV service.

It would be silly to deny that competitors may eat away at Netflix's lunch, and it's not as if Netflix has a fallback. But as Daniel Roth elegantly put it in a Wired story a year ago: "There are a million different ways for Netflix to fail. But that has always been the case. Netflix should have failed already, taken down by Blockbuster or Wal-Mart, kneecapped by Hollywood, made irrelevant by BitTorrent or iTunes." If you want to predict the demise of Netflix, go ahead—but somewhere there's a hat for you, ready to be eaten.

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