The biggest challenge facing Netflix, says company spokesperson Rick Sneed, is educating customers about how its online DVD rental service works. "When you mention it to someone who's not familiar with it, they look at you weird," he says. "In focus groups, we'll go through the entire process and they'll say, 'when do I have to return them?' and 'what are your late fees?' It's a very alien concept." As a result, Sneed says, Netflix spends three out of four of its marketing dollars on informing consumers about how to use its service.
But as Netflix's 670,000 subscribers know, the company's service is not complicated.
For a flat $19.95 per month, subscribers can visit the Netflix site and choose what movies they'd like to rent - up to three at a time. The movies are then mailed directly to the subscribers, who can keep the rentals as long as they like; they can get new movies as soon as they mail back previous rentals (a postage-paid envelope is provided). There are no late fees.
Perhaps the reason that Netflix seems foreign to some is that the company is virtually alone in the field. Founded in 1998, the company began with a traditional video rental approach. Customers paid for each rental and the company charged late fees. The only new wrinkle was allowing members to pick movies online and delivering by mail.
When Netflix switched to its current subscription approach the business grew exponentially - also helped no doubt by the greater number of DVD players, not to mention greater comfort with online transactions. By January 2000, the company had 85,000 subscribers. A year later, it had 300,000. By the end of 2002 it's expected to have 800,000.
Netflix's first distribution center was in San Jose, so the company has its highest market penetration in the Bay Area, at 3.2 percent of all households, Sneed says. Now with 12 distribution centers across the country, Sneed claims Netflix can mail movies to 90 percent of the US population within one to two days.
Big Promotion Equals Big Results
Netflix markets heavily. All the major manufacturers of DVD players include a Netflix offer in the box of each new unit, Sneed says. The company also markets through Best Buy and its various subsidiaries, with prominent ads for its service in the stores' DVD areas. "In many of the stores the cashier is flagged to tell you about Netflix if you buy a DVD player," he says.
Netflix uses banner ads at many major portals, including AOL, MSN and Yahoo, as well as an affiliate program that Sneed says creates links from thousands of Web sites.
The company's promotional push paid off. In May of this year, Netflix performed a rare feat for an Internet company in 2002: it raised $82.5 million in a successful IPO. Netflix forecasts that it will begin to be profitable in the second quarter of 2003.
A New Competitor
As Netflix grew, home video rental giant Blockbuster seemed to take little notice. But in July the Dallas-based company, which boasts 48 million members and 8,100 stores worldwide, began experimenting with its own monthly subscription plan.
Blockbuster is running its subscription test in four markets: Phoenix, Seattle, Houston and New York. Called "DVD Freedom Pass," it allows customers to rent two movies at a time and keep them as long as they want for $19.99 a month (or three movies for $24.99 a month). There are no late fees.
Blockbuster's subscription plan uses an in-store approach. But, company spokesman Randy Hargrove says, "We're actively studying the potential of mail order subscription, and if we saw the market as financially viable we could enter it easily."
Netflix welcomes Blockbuster's competition, Sneed says. "Once they get into it, and Walmart gets into it, they're going to bring big bucks, because the only way they can go against us is to very heavily spend in marketing," he says. "All that's going to do is convince consumers this is a good way to rent movies." Furthermore, he says, Netflix's home delivery is a key difference. "Once people experience it, they learn to love it."
A Third Factor
Both Netflix's and Blockbuster's model will need to change in the years ahead, say some analysts. According to Forrester research, close to six million homes will have access to video on demand (VOD) by the end of 2002, and within five years this number will increase to more than 30 million homes.
Netflix will adjust easily to the shift in delivery method, Sneed says, explaining that Netflix is agnostic about delivery channel.
"What we're doing at the moment is using DVD to build a very savvy Internet store customer who is used to selecting movies online," he says. "When it makes sense for us to deliver through downloading, we'll do that."
Blockbuster's Hargrove says that Blockbuster does not feel threatened by VOD. He points out that movie studios make an enormous amount from the $23 billion a year video retail and rental market, and says the studios want to maintain the current structure.
He explains that Hollywood films are released in four stages, in order: theatrical release, video rental, premium cable, and finally free TV. Hollywood studios would not release movies for video on demand until the "premium cable" stage of this cycle, he says. In other words, after in-store rental, so VOD would have little impact on Blockbuster.
"If you look at studio profits, on a retail sale, studios make an average profit of $14 per sale," Hargrove says. "For a video on demand transaction, the studio's profit on average is $2.50 - so it would take five VOD transactions to maintain profitability. For that reason they cannot afford to cannibalize the $23 billion dollar a year video retail and rental market."
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