Judge's Ruling Clears Way For Class Action Litigation
OAKLAND, CA. -- It must have seemed like a great plot line at the time.
On May 19, 2005, Wal-Mart and Netflix put out a press release announcing that the companies' two online retail sites would "promote each other's core business." The deal was described as a "joint promotional agreement" which would allow each company to benefit from each other's "complimentary expertise."
The agreement was a non-compete deal which divided up the DVD market by drawing a bright line separating DVD rentals from sales, based on the companies' strengths. Netflix would promote Wal-Mart's sale of DVD movies, and Wal-Mart would promote Netflix's DVD rental business. Neither company would intrude onto the other's territory. According to their joint press release, the two companies agreed "to market one another's key movie business at their respective websites."
Wal-Mart agreed to stop its DVD rental service -- which it did in June of 2005 -- and its rental customers would "be offered the option to become Netflix subscribers at their current Wal-Mart rate for one year from the date they sign up." Wal-Mart also agreed to use its website, walmart.com, to promote and refer customers who wanted to rent DVDs to Netflix. To this day, walmart.com/movies does not rent DVDs.
In return, Netflix, which claims to have more than 16 million members, agreed to promote Wal-Mart's online movie sales, including a pre-order price guarantee, which Netflix allowed to be accessed from its website, and promoted through mailers sent to Netflix subscribers. The pre-order price guarantee ensured customers the "lowest available price on pre-order movies," according to the companies' joint statement.
In response to this "agreement" between two of its rivals, Blockbuster advertised a special offer to Wal-Mart and Netflix DVD subscribers: if a Wal-Mart or a Netflix subscriber switched to Blockbuster's online DVD rental service, the subscriber got two months of free service, a free DVD of their choice, and a freeze of their subscription rate for a year.
"We've experienced tremendous growth in our online movie sales," said Wal-Mart's chief marketing officer for the retailer's website, "and are committed to enhancing our focus in this business at Walmart.com. We're equally excited to team with Netflix, the pioneer of online movie rentals, which not only distinguishes both of our core online competencies, but offers a complementary solution of value, service, and convenience to customers."
Netflix's CEO, Reed Hastings, added: "This agreement bolsters both Netflix's leadership in DVD movie rentals and Wal-Mart's strong movie sales business, while providing customers even more choices and convenience. Both companies will continue to expand their respective leads in providing the best in movie entertainment to millions of online customers."
But for DVD rental subscribers, it was not apparent how this deal translated into "more choices and convenience." Instead, it looked like a choice made for the convenience and profit of the retailers -- not for consumers. The deal ended major competition in DVD sales and rentals. Netflix told its investors that it believed the agreement "would not materially impact the company's current subscriber growth or financial performance."
Netflix boasted that teaming up with Walmart.com would bolster the company's competitive position, because the popularity of Walmart.com and the Web site's traffic "offer an opportunity for increased awareness and referrals to the Netflix service."
This week, the Netflix/Wal-Mart DVD deal was back in the headlines -- but with a negative spin. A U.S. District Court Judge in Oakland, California ruled that a Netflix subscribers' lawsuit brought in 2009 challenging the DVD agreement as monopolizing the market could proceed as a class action lawsuit. In an order dated Dec. 23rd, Judge Phyllis Hamilton ruled that the plaintiffs were "united by common and overlapping issues of fact and law."
According to the lawsuit, the alleged conspiracy began when the chief executive of Netflix, met the CEO of Walmart.com for dinner in January 2005 to discuss how to push back competition in the DVD market in the U.S. At that time the Netflix and Wal-Mart website were competitors in online DVD rentals.
The lawsuit charges that Netflix and Wal-Mart colluded to divide the DVD market and reduce competition when they announced their "joint promotional agreement." The lawsuit claims that this agreement was reached after main rival Blockbuster began challenging Netflix by renting DVDs online. Netflix's agreement with the Arkansas-based retailer removed Wal-Mart as a rental competitor, and gave Netflix an advantage over Blockbuster by having Wal-Mart directing subscribers to Netflix.
Despite their market agreement with Netflix, Wal-Mart dropped hands with its partner when the lawsuit was filed. The giant retailer -- no stranger to class action litigation -- decided to settle with the plaintiffs, and reportedly will end up paying out $40 million to erase the claim. A hearing on the Wal-Mart motion will be held in early February. Netflix is not part of that settlement -- it was a deal that Wal-Mart cut on its own
The Judge agreed that the Wal-Mart/Netflix alliance kept DVD rental prices higher than they would have been in a fully competitive marketplace. "As a result, millions of Netflix subscribers allegedly paid supracompetitive prices," the Judge wrote.
At the time of the Wal-Mart/Netflix deal, Blockbuster had approximately 9,100 stores worldwide. That number today has fallen to 7,000 stores. In 5 years, Blockbuster has been forced to shut down 23% of its stores. Blockbuster now tells its shareholders "the Company is no longer just a chain of video stores... Blockbuster now offers convenient access to media entertainment any where and any way consumers want it -- whether in stores, by mail, through vending / kiosks or digital download."
Now that a judge has ruled the plaintiffs can form a class, Netflix may be forced either to appeal the decision, or face years of litigation. A company spokesman told the Associated Press, "The case has no merit and we're going to continue to defend it." At least Wal-Mart understands how this movie ends: it has learned to treat class action lawsuits as a loss-leader, settling dozens of them.
Netflix should download Wal-Mart's script: settle the case, admit no wrong-doing, pay millions to the plaintiffs, and get back to its "core competency."
Al Norman is the founder of Sprawl-Busters, and the author of the book "The Case Against Wal-Mart." He can be reached at info@sprawl-busters.com