Netflix needs to get in touch with customers’ rage

October 25, 2011, 5:57 PM UTC

By Dan Mitchell, contributor

FORTUNE — There’s no denying that Netflix and its chief, Reed Hastings, have made serious missteps. In trying to move the company away from DVD rentals as it expands its streaming-video business and in raising prices for some customers, Netflix has suffered major setbacks one after the other. That doesn’t mean, though, that the overall strategy isn’t sound — only that Hastings has bungled the presentation and wildly misinterpreted the source of his customers’ anger. Most astonishingly, he is still refusing to do anything to do anything for his customers to make them feel better about the company.

And he’s been punished for it — severely — by both customers and investors. The future of movie rentals is clearly in streaming, and Netflix (NFLX) eventually will drop DVDs one way or another. In a since-dropped plan to split the company in two, with Netflix offering streaming and a new company, to have been called Qwikster, offering DVDs by mail, the company moved too abruptly. It alienated a lot of customers. And, it was all the worse having come just after the company changed its pricing, meaning that people who wanted both streamed movies and DVDs pay more. (That pricing is staying in place.)

Many of those customers had a righteous beef — those who wanted access to both DVDs and streams (because many movies aren’t available via streaming) would have been faced with an unnecessarily cumbersome process, having to order from two different Web sites with two separate billing systems. Others, though, had simply gotten used to having access to an extraordinary catalogue of films for an extraordinarily low price. When those prices went up, they reacted. On Monday during its third-quarter earnings conference call, the company revealed that over the past three months, it lost about 805,000 customers.

And yet, the bottom-line message from Netflix seemed to be: We’re moving to streaming, even though there are a lot of movies not yet available there, and you’re moving with us or else you’re paying a lot more. Oh, and you’re not getting more for your money; in fact, and many of you are getting less. Customers who want to continue having access to both DVDs and streamed movies are paying 60% more than they had been. They may still be better off than they would be in a world without Netflix, but they are worse off than they were before the price hike.

Some of Netflix’s problems could have been averted if the company had simply offered something for the extra money it was demanding. Perhaps even the split into two companies would have gone over. But Hastings still doesn’t seem to quite understand the nature of his customers’ rage. On Monday, he told analysts there would be no special attempt to bring back some of the customers Netflix has lost. “The focus is on bringing back our reputation and brand strength, but it won’t happen through grand gestures,” he said.

Hastings might understandably be nervous about grand gestures, since he hasn’t had much luck with them recently. But things are different when a grand gesture is actually a benefit to customers, as opposed to being simply a way to extract more money from them. And now that Netflix is entering a period of greatly increased costs and increased competition from the likes of Amazon (AMZN), the company can’t afford to rely on its brand alone.

In announcing earnings on Monday, the company forecast that profits will fall to between $19 million and $37 million in the coming fourth quarter. That’s quite a range, but at either end if it, it would be considerably down from the $62.5 million in profits Netflix reported for the third quarter, which were up 63% from the year-ago period. Investors are punishing the company severely, with shares trading more than a third lower in late-morning trading on Tuesday.

Netflix has its eye on the long-term future — a future of movies streamed over the Internet — and a future that lies largely overseas. That’s a good thing. “But the plans to sacrifice short-term profits concerned some people on Wall Street,” the Wall Street Journal reported on Monday.

If Hastings had handled its recent moves more deftly, it might not have lost so many subscribers. As it is, Hastings has put himself in the position where any criticism of him and his company is considered valid. It will take more than brand management to turn that around; he’s going to have understand what’s behind customer rage.