I was looking through my files trying to locate a particular workforce scorecard example for a client when I ran across a saved issue of Fortune magazine. On the cover was Reed Hastings, the CEO of Netflix and the Fortune “Business Person of the Year.” Hastings was selected over iconic names such as Steve Jobs, Mark Zuckerberg, and Warren Buffet, among others. One of the primary reasons Hastings was chosen was Netflix’s sky-rocketing stock price, up 200% from January 2010 through December 2010.

The same day I found this magazine, Netflix subscribers (including me) received the following brief but direct e-mail from the Netflix Team:

"It is clear that for many of our members two websites would make things more difficult, so we are going to keep Netflix as one place to go for streaming and DVDs.

This means no change: one website, one account, one password, in other words, no Qwikster.

While the July price change was necessary, we are now done with price changes.

We value you as a member, and we are committed to making Netflix the best place to get your movies & TV shows.

Respectfully,

The Netflix Team"

This e-mail was a far cry from the personal message sent by the CEO in September including a mea culpa for both the sudden July price increase and not clearly communicating the company’s go-forwardstrategy. In the e-mail, Hastings introduced a sister company, Quikster, that would continue the direct DVD service. Silly name aside (Quikster sounds like a comic book villain, possibly resembling The Noid), I fully understood the need for a new strategy. The future of home entertainment is instantaneous on-demand services not 1990s technology delivered by the far older postal service. If proposals to reduce US postal delivery days are implemented, it would greatly change the direct DVD delivery model. The need for change is obvious.

In addition, if you read the eight-page Fortune article, you would have anticipated not only the change in business model but would have predicted Reed Hastings weathering any fallout from change. It is reported that Hastings has an obsession with failure that drives him to try new things and a willingness to “cannibalize” his own business by retooling Netflix into a streaming-video company, thereby disrupting his own business before others disrupt it. His greatest fear is falling in the footsteps of AOL, the once dominant dial-up service unable to maintain its edge in a broadband era. Regardless of the future vitality of the company – streaming makes more economical sense. Labor costs and fees for each DVD is about a $1 compare to 5 cents per stream.

So what happened at Netflix?

With such a strong-willed CEO and a high performance culture, why would Netflix back off the new strategy? Was the customer response so strong that Netflix feared losing its strong following? The customer reaction probably had some influence, but I believe the driving force was “loss aversion.” Loss aversion is the concept that human beings feel the pain of loss more intensely than they would feel a similar gain. As Brad Pitt said in the movie Moneyball, “I hate losing more than I love winning.”

How does “loss aversion” apply to Netflix? In January 2005, when the stock was valued at only $11 per share, a stock analyst called Netflix’s stock “a worthless piece of crap” and targeted the stock at $3 a share. This opinion was used as motivation, even being framed and hung in the Los Gatos, California headquarters. When Netflix announced pricing the DVD and streaming services separately, the stock price was near an all-time high of $299 per share. It is easier to make bold decisions when the potential losses are low. I believe as leaders at Netflix saw the stock price fall to $113 per share on September 30, 2011, the feeling of loss overrode the most logical and strategically sound long-term business plan.

While Netflix’s decision to back off their strategy benefits me as a customer, if I were a shareholder, the October submission message would make me less confident in the future of the organization. The ultimate insult to injury occurred on October 24, 2011 in after hour trading. While Netflix 3rd Quarter earnings beat analyst expectations and management’s own top-line and bottom-line estimates the stock price fell another 28% landing at $85.75.

The Netflix debacle will be the source material of business case studies for years to come. Ironically, the organization could have framed the new offer as “don’t lose the benefits of streaming – sign up now.” Utilizing the loss aversion phenomena may have helped Netflix avert this crisis of confidence.

What is the lesson for you and your organization?

Our emotions and human nature can overwhelm our logical and linear minds. When thinking about your 2012 strategic objectives, consider not only the financial implications of decisions, but the emotional implications as well. How can you guard against the emotional hazards? The first step is to acknowledge they exist.

So what happened at Netflix?

HR Metrics Coach