NetFlix Faces Rivals, Cable Competition
Company's Niche Is Uncertain
washingtonpost.com
By Frank Ahrens
Washington Post Staff Writer
Saturday, April 17, 2004; Page E01
For the past 20 years, the standard process for renting a movie involved getting in a car, driving to a store, picking up a hunk of plastic or videotape and driving home to stick it in a machine. In time, home viewers will be able to push a button on a remote control or their computer and watch just about any movie or television show they want, making the whole Blockbuster experience as antiquated as walking to a well to retrieve fresh water.
Until then, however, there are Netflix and its imitators, companies that allow consumers to order DVDs on the Internet that are then mailed to their homes.
Consumers have embraced Netflix, which has nearly 2 million subscribers. The company predicts revenue of $500 million in 2004, a 10-fold increase from five years ago. But Netflix is still a small piece of the rental business: Last year, consumers spent $8.2 billion to rent movies from stores. And the company faces new challenges in its quest to show it will continue to grow as a mail-only service at its fast-forward pace.
On Thursday, Netflix, based in Los Gatos, Calif., reported a loss of $5.8 million for the first quarter, more than twice the $2.4 million loss the company reported in the first quarter of 2003. To reverse that trend, the company said it would raise its monthly subscription rate in June from $19.95 to $21.99 per month -- a move it conceded might make some customers unhappy.
Cancellations could grow from 4.7 percent of all subscribers in the first quarter to 5.9 percent over the next three months, the company said. In response, Wall Street punished the stock, which has climbed steadily in recent years. Shares of Netflix closed yesterday at $30.75 per share, down nearly $6.27, or 17 percent.
There are other storm clouds forming, too, analysts say. Netflix -- essentially alone in the movie-through-the-mail business since its 1999 launch -- now feels the heat of competition. Wal-Mart established a similar DVD-by-mail system last June and Blockbuster is about to start one.
In an interview with Bloomberg television yesterday, Netflix chief executive Reed Hastings said his company's first-quarter loss is attributable largely to increased advertising and marketing costs designed to grab new subscribers.
"We're focused on building the world's best movie service," Hastings said, predicting the company could continue to build its subscriber base despite any defections through 2004. "And if you talk to our subscribers, that's what we have."
Subscribers log onto the Netflix Web site and rank the movies they want to rent, forming a "queue." For $19.95 per month (soon to be $21.99), subscribers are mailed the first three movies in the queue from one of the company's 24 distribution centers. They are allowed to keep three movies at a time for as long as they want. When they return one, the next choice in their queue is mailed to them, and so on. Netflix has about 18,000 titles.
In June, Blockbuster plans to expand what it calls its "in-store subscription" plan, which still requires consumers to come to the chain's 5,000 U.S. stores, but allows them to keep a certain number of movies for an unlimited time with no late fees, like Netflix. Further, in the fourth quarter of this year, Blockbuster hopes to roll out a Netflix-like mail-rental service, said company spokesman Randy Hargrove.
Aside from competition, the first-quarter numbers suggested that Netflix may be becoming a victim of its own success.
The company said it was forced to raise its subscription fee to offset the labor cost of filling customer orders. Netflix is a labor-intensive business, requiring human hands to stuff DVDs into envelopes that are mailed to customers, then empty the return envelopes and return the DVDs to inventory.
If subscribers only cycle through three movies per month, they wind up paying about $7 per rental, about twice what they would pay at a rental store. Which means Netflix's watch-all-you-want price encourages customers to rotate through several movies per month, increasing labor and postal costs.
Subscribers rented an average of seven movies a month in the first quarter of this year, up from five a month during the same period last year, Netflix said, cutting into the company's gross margin.
Though generally bullish on Netflix -- his company has rated the stock "overweight" -- Pacific Growth Equities analyst Derek L. Brown said he understands how increasing usage can be a problem. "The counter to that is increasing usage presumably means happier customers, which presumably would suggest longer [subscription] lifetimes," he said.
Then there is the long-term foe. Netflix's through-the-mail lifespan may be shortened by the continued rollout of "video-on-demand" services offered by cable and satellite companies. Currently, such services have limited inventories -- Comcast Corp.'s on-demand library has about 1,000 titles. But, as choices increase, customers may prefer pushing a button to watch a movie instead of waiting for it to arrive in the mail.
That's the main reason, Hastings said, that Netflix will start a movie-download rental system next year.
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