Saturday, November 26, 2011

Netflix Learns from Its Mistakes - Taxes Shareholders, Not Subscribers

Eduardo Saverin's shares of
Facebook were diluted 

More bad news for Netflix shareholders may mean good news for subscribers. 

Last week, Netflix issued more shares of its stock in order to raise $400 million in cash.  Netflix needs the money to license more content for its “Watch Now” instant stream library – the future of the company.

On news of this announcement, Wall Street sent the price of Netflix shares down 6.5%. This was no surprise.  Whenever a company issues more shares of stock, the reaction on Wall Street is uniformly negative because it dilutes the value of the existing shares. That’s exactly what happened to Eduardo Saverin, the Facebook founder, as depicted in the memorable scene in the “Social Network”.   

You would think that giving Wall Street more bad news was the last thing Netflix wanted to do. The battered stock has fallen from a high of $300 in July to around $63 today (translation: if you bought $1,000 worth of shares in July, you’d have lost $800 of that investment).

Given the enormous pressure to turn the stock around, the fact that Netflix chose to “tax” shareholders and not subscribers, is an encouraging sign that it learned from this summer’s missteps.  A much more Wall Street friendly way to finance the rights to more content would have been to realize Netflix’s enormous advertising potential, estimated at $60 million per quarter.  

While subscribers would never have tolerated a barrage of Hulu style ads, Netflix could have tactfully integrated advertisers within the service.  For instance, Wal-Mart could sponsor a Christmas themed playlist, which is relevant and useful heading into the holiday season.

In choosing to raise the $400 million by pissing off shareholders instead of subscribers, Netflix is showing that it learned from its mistakes. That golden rule, oft repeated by CEO Reed Hastings, is even more important in the digital age, where a mistake can turn your loyal subscribers into an angry mob quicker than you can say Qwikster.   

Regardless of how subtle the ads would be, Netflix cannot risk angering its user base again. While that may not assuage the day traders on Wall Street, prioritizing subscriber sentiment shows a company that is committed to a long term vision.  

Image courtesy of Business Insider

See More: How Netflix's Lack of Advertising is Quietly Shaping the Online Ad Business 

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Wednesday, November 23, 2011

Famine on the Content Farm – eHow’s Troubled Year


“Just Google it.” Over the last ten years, consumers have come to rely on Google for the answer to just about any question. The folks at Demand Media created a business around that expectation, building a content empire designed to answer the millions of mundane queries that people type into Google every day. The cornerstone of that empire is eHow.com which features a vast library of humdrum articles like“How to Prepare a PopTart” or “How to Throw a Baseball." eHow isn’t out to win a Pulitzer prize, but in aggregate, these types of everyday “long-tail” search queries constitute an enormous amount of online traffic, dwarfing individual sites like CNN.com. In its quest to conquer the ad revenue of the long tail, eHow has encountered a series of challenges, sending shares of its publicly traded parent company Demand Media, on a downward spiral. 

Birth of a Content Farm
The first problem was a predictable one: scale. The task of pairing millions of Google searches with a perfectly matching article required eHow to enlist an army of freelance journalists. To handle this herculean task, eHow set up a revolutionary content management system which fueled the over the 3 million articles that can be found on the site today. This system, known as Demand Media Studios, has a reputation among journalists for reliable payment and steady work. Its nimble production capabilities also attracted advertisers, like L'Oreal, who commissioned an extensive "How To" series on make-up application.

Despite the ad revenue and efficient back-end technology, content production costs were getting out of control. To make matters worse, eHow’s quality control began to falter against the relentless need to publish, publish, publish.  Sub par articles flooded the site and eHow’s reputation began to suffer. Critics labeled the site a “content farm” and an entire blog dedicated to the “worst of eHow” called out the laughable quality of articles.   

Google Takes Aim
eHow’s lack of quality control was no laughing matter to Google. In February, the “Panda Update”, a highly publicized tweak to Google’s algorithm was rumored to target eHow and other so-called content farms like Yahoo’s Associated Content. When the dust settled, eHow had dodged Panda’s bullet and traffic to the site remained steady.  Yahoo wasn't as lucky. Associated Content’s visibility in search results plummeted, raising eyebrows from critics who questioned if Google had intentionally targeted its search rival. Regardless, eHow’s singular dependence on Google was plain to see. Sure enough, a subsequent update to Google’s algorithm struck a blow to eHow’s search results.  There could be no doubt, eHow was at the mercy of Google and shareholders didn’t like it.  

So Long, Long-Tail
The mounting adversity took its toll on Demand’s stock. The January 26th IPO priced Demand Media shares at $23.50, today it trades at $7.00. Translation:  If you bought $1,000 worth of stock during the IPO, it would be worth around $300 now.

The pressure to drive the stock up forced CEO Richard Rosenblatt to explore a new direction. eHow cleaned up its sprawling site, focusing on core categories like Food, Home, Style and Money. They inked a deal with YouTube and went into partnership with Rachel Ray. These changes made for great PR but represented a complete departure from the original business model. Hereto, eHow’s business was to provide text based articles to match millions of long-tail Google searches – it was a volume play.  The new focus on a few core content categories, the foray into video production and partnerships with A-list talent showed that eHow had abandoned quantity in favor of quality. Sounds great, until you consider that eHow is now competing for eyeballs with traditional media companies who know a thing or two about quality.

A Red Flag for Investors
For eHow, the business model required to conquer the unwieldy size of the long tail proved to be unsustainable. But, the prospect of a turnaround is dim when you consider the ferocity and deep pockets of the competition it will find in the world of premium content. 

See More:  Netflix Learns From Mistakes:  Taxes Shareholder, Not Subscribers


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