DVD rental market thickens
Big names could challenge Netflix with mail service

By Michael Liedtke
Associated Press
Published October 7, 2002

SAN JOSE, Calif. -- Netflix Inc. has been a feel-good story about an Internet start-up defying the dot-com downturn, proving there's an audience that wants to rent DVDs without going to a store or paying late fees.

The plot is about to get more complicated.

Blockbuster Entertainment, Wal-Mart and Columbia House are all exploring similar DVD subscription services, The Associated Press has learned.

Some of these services could be available nationwide this year or early next year--a development that could provoke price wars in the fast-growing market pioneered by Netflix.

Bentonville, Ark.-based Wal-Mart is poised to undercut Netflix's $19.95 monthly fee, which allows subscribers to check out up to three DVDs at a time.

Wal-Mart documents obtained by the AP indicate the retail giant plans to sell its service for $18.86 per month.

While the increased competition shapes up as good news for consumers, it could spell trouble for tiny Netflix.

Even with a customer base that has swelled to 742,000 subscribers in just three years, Netflix remains puny next to the likes of Dallas-based Blockbuster, the world's largest movie rental service, with 8,000 stores.

Netflix generated $67 million in revenue during the first half of 2002. Blockbuster collected $2.17 billion for its in-store rentals, including an estimated $325 million in late fees alone.

Inspired by late fees

It was Blockbuster's hefty late fees that inspired Netflix. Reed Hastings got the idea as he stewed over the $40 Blockbuster charged for a late return.

Hastings, Netflix's chief executive, views the challenge facing his company as a powerful endorsement of a service that analysts originally dismissed when it was launched in 1999.

Hastings is confident Netflix's head start will enable it to fend off competitive threats from much bigger brick-and-mortar companies, just as Amazon.com thwarted Barnes & Noble and Borders when they entered the online book business.

"Our ambition is to build a great company, and you can't do that without getting toughened by competition," Hastings said at Netflix's distribution hub in San Jose, where the company stockpiles 3.2 million DVDs encompassing 12,000 movie titles. "We think we have a great chance of winning this battle. So bring it on."

Netflix has won mostly positive reviews for a flat-fee service that allows subscribers to keep DVD rentals for as long as they want. Netflix mails the DVDs to subscribers, who return the movies in postage-paid return envelopes. Once Netflix gets a movie back, the company mails the next available DVD on each subscriber's online order list.

The concept has emerged as one of the Internet's biggest subscription services, with Netflix's customers doubling from a year ago. Analysts expect Netflix to collect about $150 million in revenue this year and $237 million next year.

There appears to be plenty of room for more growth.

With DVD players proliferating, annual spending on DVD rentals will soar from $3.2 billion to $8.4 billion during the next five years, predicts Adams Media Research.

Netflix's success previously inspired several smaller online imitators, but it's the threat posed by well-established retailers that worries analysts.

"I'm not sure Netflix is going to be the survivor in this space," said analyst Dennis McAlpine. "The concept is good, but there are no real barriers to entry that prevent others from doing the same thing."

Investors also appear antsy. Netflix's stock has dropped by more than 50 percent, to around $7, since Blockbuster's late July launch of an in-store subscription service in New York, Seattle, Houston and Phoenix.

Blockbuster won't reveal how many people have signed up for its "Freedom Pass" but says the experiment is a success.

Store trip still required

For now, Blockbuster's subscription service requires customers to visit its stores to get their DVDs. They can check out two at a time for $19.99 per month; three at a time costs $24.99. Customers keep the DVDs as long as they like, and there are no late fees.

But Blockbuster also appears poised to emulate the Netflix model, and mail DVDs to customers through an Arizona online service called DVDrentalcentral.com. Papers filed with the Arizona Secretary of State show that its headquarters and phone number are the same as Blockbuster's.

Online DVD rental "is something interesting to us," Antioco said. "What we don't know is if you can do it in a way where you can make money."

Despite its growth, Netflix still hasn't turned a profit, losing $98.9 million since its inception. But Netflix is taking in $3 million more than its recurring expenses each quarter, and with $93 million in the bank has more than enough to last until it turns a profit, Hastings said.

Netflix already looks like a success to Scott Flanders, chairman and CEO of Columbia House. Flanders wants to team up with a partner--possibly Netflix--to offer an online DVD rental service to Columbia House's 3 million members.

"What Netflix has established is impressive. It's an outstanding service that consumers want and need," Flanders said.

Copyright © 2002, Chicago Tribune