Netflix pushes envelope but can it still deliver?
The mail-order rental company hits a slump
That's the question confronting the online DVD rental pioneer as it faces rising costs, higher churn and its first serious competitor -- Blockbuster's launch of a similar service Aug. 11.
Netflix has seen few challenges in the four years since it transformed the DVD biz by eliminating late fees and rental limits with its mail-order service.
Since then, it has rapidly grown to more than 2 million subscribers and become a Wall Street darling, with its stock booming 150% in the year leading up to mid-July.
But things have changed.
Releasing its second-quarter earnings, Netflix said that due to the rising cost of Internet advertising, its subscriber acquisition costs would grow more than expected and a spring price increase would keep its churn rate at more than 5%.
The company's stock plummeted 28% on July 16 to $23.02 and has since dipped below $15, a nearly 52-week low.
To pessimists, Netflix may look eerily like a certain other technology company that transformed the way affluent young professionals consumed media, but then withered in the face of competition: TiVo.
Despite becoming a household name, TiVo's fortunes declined as cable companies gained ground with generic versions of its digital recording capabilities and DirecTV, its biggest partner, indicated it will soon do the same.
Like TiVo, Netflix is facing a cheaper competitor, Blockbuster, which launched its service for $2 less per month and is integrating it with stores.
The dominant rental company, which has had problems of its own in the face of cheap DVD sales at big box stores like Wal-Mart, is spending $90 million on new initiatives, including its online venture. (Wal-Mart also has an online rental store, but hasn't promoted it much and has had little impact.)
"This business isn't as simple as it looks," observes analyst Dennis McAlpine of McAlpine Associates. "It's worth it for Netflix to take as much of this market as it can before someone else starts doing it well."
Netflix founder and CEO Reed Hastings says a more apt comparison than TiVo is America Online, which pioneered the dial-up Internet access market and then, thanks to having a better product, fended off an invasion of its territory by Microsoft in the mid-'90s.
"Blockbuster's entry shows that online rental will be a large and maybe dominant part of rentals in the next five years," Hastings says of his business, which generated $280 million out of the $8.2 billion rental market in 2003. "We think our service quality is so superior that we're comfortable with that as our positioning."
Ultimately, whether Netflix becomes AOL or TiVo may depend on whether consumers will pay more for its advantages in turnaround time and indie pic selection or whether they simply want a cheap way to get DVDs to their door.
