For the past 20 years, the standard process for renting a movieinvolved getting in a car, driving to a store, picking up a hunk ofplastic or videotape and driving home to stick it in a machine. Intime, home viewers will be able to push a button on a remote controlor their computer and watch just about any movie or television showthey want, making the whole Blockbuster experience as antiquated aswalking 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 arethen mailed to their homes.
Consumers have embraced Netflix, which has nearly 2 millionsubscribers. The company predicts revenue of $500 million in 2004, a10-fold increase from five years ago. But Netflix is still a smallpiece of the rental business: Last year, consumers spent $8.2 billionto rent movies from stores. And the company faces new challenges inits quest to show it will continue to grow as a mail-only service atits fast-forward pace.
On Thursday, Netflix, based in Los Gatos, Calif., reported a lossof $5.8 million for the first quarter, more than twice the $2.4million loss the company reported in the first quarter of 2003. Toreverse that trend, the company said it would raise its monthlysubscription rate in June from $19.95 to $21.99 per month -- a moveit conceded might make some customers unhappy.
Cancellations could grow from 4.7 percent of all subscribers inthe first quarter to 5.9 percent over the next three months, thecompany said. In response, Wall Street punished the stock, which hasclimbed steadily in recent years. Shares of Netflix closed yesterdayat $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 its1999 launch -- now feels the heat of competition. Wal-Martestablished a similar DVD-by-mail system last June and Blockbuster isabout to start one.
In an interview with Bloomberg television yesterday, Netflix chiefexecutive Reed Hastings said his company's first-quarter loss isattributable largely to increased advertising and marketing costsdesigned to grab new subscribers.
"We're focused on building the world's best movie service,"Hastings said, predicting the company could continue to build itssubscriber base despite any defections through 2004. "And if you talkto our subscribers, that's what we have."
Subscribers log onto the Netflix Web site and rank the movies theywant to rent, forming a "queue." For $19.95 per month (soon to be$21.99), subscribers are mailed the first three movies in the queuefrom one of the company's 24 distribution centers. They are allowedto keep three movies at a time for as long as they want. When theyreturn one, the next choice in their queue is mailed to them, and soon. Netflix has about 18,000 titles.
In June, Blockbuster plans to expand what it calls its "in-storesubscription" plan, which still requires consumers to come to thechain's 5,000 U.S. stores, but allows them to keep a certain numberof movies for an unlimited time with no late fees, like Netflix.Further, in the fourth quarter of this year, Blockbuster hopes toroll out a Netflix-like mail-rental service, said company spokesmanRandy Hargrove.
Aside from competition, the first-quarter numbers suggested thatNetflix may be becoming a victim of its own success.
The company said it was forced to raise its subscription fee tooffset the labor cost of filling customer orders. Netflix is a labor-intensive business, requiring human hands to stuff DVDs intoenvelopes that are mailed to customers, then empty the returnenvelopes and return the DVDs to inventory.
If subscribers only cycle through three movies per month, theywind up paying about $7 per rental, about twice what they would payat a rental store. Which means Netflix's watch-all-you-want priceencourages customers to rotate through several movies per month,increasing labor and postal costs.
Subscribers rented an average of seven movies a month in the firstquarter of this year, up from five a month during the same periodlast year, Netflix said, cutting into the company's gross margin.
Though generally bullish on Netflix -- his company has rated thestock "overweight" -- Pacific Growth Equities analyst Derek L. Brownsaid he understands how increasing usage can be a problem. "Thecounter to that is increasing usage presumably means happiercustomers, which presumably would suggest longer [subscription]lifetimes," he said.
Then there is the long-term foe. Netflix's through-the-maillifespan 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-demandlibrary has about 1,000 titles. But, as choices increase, customersmay prefer pushing a button to watch a movie instead of waiting forit to arrive in the mail.
That's the main reason, Hastings said, that Netflix will start amovie-download rental system next year.
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