Netflix – Managing a still-hot business as its time runs out.

Summary: Business is booming for Netflix as people stay at home more during the recession. But, online streaming video is certain to overtake mailed DVDs eventually.  Netflix is trying to stay ahead of the curve.  Good luck.

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Excerpted from WSJ, Netflix Boss Plots Life After the DVD, June 23, 2009 

Netflix is a standout in the recession. The DVD-rental company added more subscribers than ever during the first three months of the year.


But Netflix’s CEO Reed Hastings thinks his core business is doomed. As soon as four years from now, he predicts, the business that generates most of Netflix’s revenue today will begin to decline, as DVDs delivered by mail steadily lose ground to movies sent straight over the Internet. “As a capitalist, I’d rather have Blockbuster as my primary competitor than all those Internet companies,” Mr. Hastings says. So he is quickly trying to shift Netflix’s business — seeking to make more videos available online and cutting deals with electronics makers so consumers can play those movies on television sets.

Companies across the entertainment and technology landscape are struggling with how to profit from Internet video. There’s still significant risk that Netflix could falter or lose out to another company that figures out how to do it first. And having picked his battle, Netflix may risk missing other growth opportunities: – the company hasn’t yet expanded internationally or mounted a direct challenge to kiosks, such as Coinstar Inc.’s Redbox, that let customers pick up $1-a-night DVD rentals. It is considering expansion opportunities outside the U.S. and has no plans to open kiosks.

One of the biggest hurdles will be persuading Hollywood studios to give Netflix rights to show more and better movies through its Internet service at a time when many studios are protective of their DVD-sales revenues.

The company stumbled in an earlier effort to introduce a set-top box that would bring Internet video service into the living room. Netflix developed the hardware but then abandoned it after executives got cold feet.

Mr. Hastings, the CEO says he is a student of companies such as AOL that tripped up by failing to adapt to technology shifts.

Netflix’s big break came as a different industry leader failed to keep step. In the late ’90s, the home-video business was shifting to DVDs from VHS tapes, offered by rental giants such as Blockbuster Inc. Netflix emerged with warehouses that stocked larger selections of DVDs than Blockbuster’s rental outlets could, mailing them around the country in red envelopes. Netflix charged consumers a flat monthly rate to rent as many DVDs as they liked, eliminating the late fees charged by rental chains.

Blockbuster eventually started its own DVD rent-by-mail service, but scaled it back in late 2007 after consistently losing money on it.

Now, amid gathering signs of the DVD’s decline, the industry is poised to shift again.

Home-video sales, mostly from DVDs, last year dropped to $14.5 billion from $15.9 billion the previous year. Movie rentals remained flat over the period, at about $8.2 billion. The number of DVDs Netflix rents every year — about a half-billion in 2008 — is still growing, and Mr. Hastings predicts the company will still be shipping discs to consumers 20 years from now.

But he expects rental figures to begin to dwindle in four to nine years.

Anticipating the demise of DVDs almost from the beginning, the company’s name  didn’t reference discs or mailboxes and the company invested in software formulas to crunch data about its customers’ tastes so it could recommend DVDs to them, a technology that could carry over to an Internet movie service.

In January 2007, Netflix began letting subscribers stream video to their PCs from the company’s Web site, allowing users to watch video almost instantly without keeping permanent copies on their hard drives. The service featured only about 1,000 movies and television shows — about 1% of its DVD selection — but subscribers could use it for no extra charge.

Now more than 20% of Netflix members regularly use the service. The company says new users attracted by streamed movies have helped push its subscriber total up 25% to 10.3 million at the end of March from a year earlier.

The online model has another benefit for Netflix. The company currently pays about 80 cents to post a DVD to a customer’s home and back. Its bandwidth costs for streaming a typical two-hour movie: roughly a nickel.

Netflix’s biggest challenge in getting Hollywood to go along for the ride. Netflix’s selection of more than 100,000 DVD rental titles is made possible by the “first-sale doctrine” of U.S. copyright law, which permits buyers of DVDs to lend them out without studios’ consent.

In Netflix’s early days, its buying team would sometimes purchase DVDs at local Wal-Marts or Best Buys if it couldn’t get copies through studios.

In contrast, to deliver movies and television shows over the Internet, Netflix has to license them from studios. So far, it has gotten only about 12,000 titles, a hodgepodge of older films such as “Diehard,” episodes of popular TV shows including “30 Rock” and a smattering of new releases.

The main reason: Netflix must compete with television subscription services like Time Warner’s HBO, Viacom Showtime and others that gain exclusive rights to show studio movies on cable channels or through on-demand systems. These pay channels have bigger audiences than Netflix and a longer history of securing movie rights. Their lucrative deals can prevent Netflix from getting Internet rights for movies until years after they’re released on DVD.

If Netflix is to expand the titles on its Internet service, it will have to considerably boost its licensing spending, from roughly $100 million last year.

“Netflix has yet to show that it has the resources and profitability to be in the markets where licensing is the business policy.

Hollywood is “clearly conflicted” about the online service’s growth because it could help accelerate the decline of DVDs.

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