Don't bet against Netflix's Reed Hastings

Don't bet against Netflix's Reed Hastings
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Not only is he a terrific CEO, but also he's a great technologist. Even when faced with marked volatility in Netflix's stock prices, he's likely to stay the course and continue to build company value. Therein lies a lesson for both tech stock investors and tech entrepreneurs.

After a phenomenal 2015, Netflix share prices have declined about 14 percent this year. Hastings has responded by reiterating the company's goals of increasing its base of 46 million U.S. subscribers to 60 to 90 million, telling the New York Times: "I don't see why 10, 20 years from now, why every American household isn't subscribing to Netflix, except for maybe competition." Still, he did apologize to investors in a July earnings call for the stock "volatility."

The reality is that tech company stocks are volatile. That's the risk you face when running or investing in a fast-growth, high-potential company. Even private companies undergo frequent ups and downs, a reason many do not go public and be at the whim of unsophisticated investors unprepared for fluctuations. The investing public loves a tech stock on the way up but often don't know what to do when it takes a dip.

Investors would do well to focus on how 19-year-old Netflix has proven to be nimble and adaptive in the oh-so-fickle world of America's entertainment habits. Its timing in moving from mailed DVDs to streaming was excellent and it has begun producing its own content, such as the hit "House of Cards." Netflix has changed the way America watches TV - we "binge" instead of watch. And let's not forget Netflix's devastating impact on the video store business.

Hastings has built Netflix with fantastic, low-cost software, based mostly on open source. You've likely heard this phrase before: "Software is eating the world." Netflix is video as software, just as Amazon is books as software, Tesla is cars as software and Uber is transportation as software. Everyone is trying to get into software now because it can so dramatically change paradigms.

As a pioneer in open source, Netflix has a cost structure second to none. About 80 percent of Netflix's software is free-to-use open source and about 20 percent is proprietary. Moreover, the company has created much of its own unique software, which has been published and "given back" to the open source community. But sometimes investors have trouble understanding how to value companies that are built on open source.

Not surprisingly, Netflix's success has bred competition. Hulu, YouTube and Amazon have jumped into the streaming entertainment market and are challenging the incumbent. And there's still a lot of disruption in the complex video space. Upstart Zype, for example, is changing the need for intermediaries such as broadcasters and cable companies by letting users publish and monetize video content using a single interface.

Hastings is going to face increasing competition, but that's normal whenever you're the first to shine a light in an area that no one really thought of before.

Netflix's plan to increase its monthly prices, including "un-grandfathering" existing users, bears watching; this may have been a reason for a 16 percent stock-price plunge in July. Whenever you raise prices, you have to figure out the elasticity of demand and how much pricing power you really have. Consumers are loyal to a product they perceive as good and will pay a little more. However, if your price is too high, you will attract even more competitors who will undercut your prices.

Hastings shows that as a leader of a company you have to have the courage of your convictions and not to be swayed with near-term volatility. As he has done, start-up CEOs need to communicate with constituents and manage Wall Street's expectations. Consider Amazon, which has managed Wall Street beautifully - mainly by not showing profits. Instead, CEO Jeff Bezos has plowed profit back into growing the business, now considered the world's largest retailer.

The minute you show profits, they're like an additive drug - Wall Street wants more. Managing investor expectations is a hard, but essential job. If you show too much profit too early, you can never go back. Investors will hammer you on your stock prices.

According to the New York Times, Hastings has said he will deliver profits in 2017 while maintaining break-even profitability this year. His focus has been on growth; that likely will pay off in the long run.

Lou Shipley is a Lecturer at the Martin Trust Center for MIT Entrepreneurship at the MIT Sloan School of Management and president and CEO of Black Duck Software in Burlington, Mass.

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