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Netflix changes entertainment game

By Michael Liedtke
The Associated Press

	MARCIO JOSE SANCHEZ / AP Reed Hastings came up with the idea for Netflix after being hit with a $39 late fee for keeping a rented video an extra week. Hastings' company charges $19.95 per month to customers, who can keep up to three movies at a time as long as they wish.
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LOS GATOS, Calif. — It would be easy to cast Netflix founder Reed Hastings as simply a dot-com rebel whose online DVD-subscription service empowers consumers by letting them keep video rentals indefinitely without facing late fees.

But Hastings, a former Peace Corps volunteer who once taught math in Swaziland, says he is pursuing a far nobler cause.

Hastings sees himself as a DVD evangelist, with Netflix a bully pulpit for his mission to deepen the world's passion for movies and find an audience for every film.

"I would like Netflix to transform the movie business," Hastings says without the slightest trace of bombast. "We want to become a Top 10 media company."

It sounds like a like a far-fetched ambition for an industry upstart that started this year with a 3 percent share of the $9.9 billion video-rental market, and stiffer competition from retail giants Blockbuster Entertainment and Wal-Mart Stores Inc. looming ahead.

Hastings, 43, isn't backing down, perhaps because he has already defied conventional thinking.

"He's the kind of guy you would back in a heartbeat because he is such a brilliant strategic thinker," said Jay Hoag, whose venture-capital firm, Technology Crossover Ventures, was among Netflix's early backers.

Skepticism has been shadowing Hastings since his 1999 launch of Netflix, which charges an all-you-can-watch monthly fee of $19.95 to receive up to three DVDs at a time through the mail.

Critics quickly panned Hastings' smorgasbord approach as another dot-com blunder. The service instead struck a chord with tech-savvy movie lovers fed up with late fees — a cash cow that industry leader Blockbuster Entertainment milked for about 15 percent of its revenue before Netflix came along.
 
Now Netflix is thriving, its audience rapidly approaching 2 million subscribers as the service attracts about 125,000 new customers each month, helped by software that personalizes movie recommendations based on customers' viewing histories and feedback on films they've seen.

The company's accelerating growth has helped its stock more than quadruple in less than two years despite persistent doubts about Netflix's ability to survive tougher competition and a long-anticipated shift to video-on-demand.

Meanwhile, consumers are renting fewer movies from Blockbuster, a trend that recently prompted majority owner Viacom Inc. to seek a buyer for its 81 percent stake in the 8,900-store video-rental chain.

Entrepreneurial approach

Even before Netflix, Hastings established himself as a shrewd entrepreneur.

In the early 1990s, he started a business-software maker, Pure Atria, that he wound up selling to Rational Software for $752 million in stock. Hastings then came up with the idea for Netflix when he returned a rented copy of the movie "Apollo 13" more than a week late and got slapped with a $39 penalty.

It may turn out to be the best money Hastings ever spent, considering his personal stake in Netflix is worth nearly $150 million.

Hastings isn't driven entirely by money. In 2000, former California Gov. Gray Davis appointed Hastings as president of the state's Board of Education — an unpaid position that he is lobbying to keep under California's new governor. "We have all of Arnold Schwarzenegger's movies at Netflix," Hastings says.

Netflix's library of 18,000 DVD titles also includes many little-noticed movies — the kinds of films for which Hastings hopes to build a larger audience. He aims to assemble the world's most diverse selection of DVDs and then draw upon Netflix's ability to analyze each customer's film tastes to "find the right movie for the right person."

It's a cause he hopes will help differentiate Netflix from mounting competition.

Competing with Wal-Mart

Wal-Mart, the world's largest retailer, launched a similar online rental service last year that undercuts Netflix by about a buck a month. Blockbuster already owns a Netflix copycat, FilmCaddy.com, and plans to introduce an online service that will deliver DVDs under its own brand name later this year.

"We should not only be able to compete in the online business but have a substantial edge over the existing competition," Blockbuster CEO John Antioco recently assured analysts.

But Netflix already is gaining a reputation as the place to go for independent films, foreign movies and documentaries that are tough to find in traditional rental stores.

Leyl Master Black is among the legion of subscribers who love to pluck eclectic movies from Netflix's recommendation list. Because she's paying a flat fee, Black, 33, feels more comfortable checking out an obscure DVD from Netflix than gambling on an offbeat rental during her increasingly infrequent trips to a Blockbuster store.

"I have seen so many movies from Netflix that I would never be able to find at a video store," said Black. "Using something like Netflix takes a little more advanced planning, but it's definitely worth it."

Churn rates

Netflix doesn't impress all its customers. About 5 percent drop the service each month. The defections, known as customer "churn," have been declining as Netflix has set up 23 distribution centers around the country to get DVDs to customers more quickly.

Controlling churn is vital to Netflix's success because the company loses money on new customers during the first four months. Based on its current churn rate, Netflix estimates the average subscriber keeps the rental service for 21 months, up from 16 months at the end of 2002.

The formula has paid off so far.

Netflix's revenue nearly doubled last year, producing a $6.5 million profit on subscriptions totaling $270 million, enough to encourage Hastings to expand into Canada and the United Kingdom.

Hastings believes Netflix could earn more than $20 million for all of 2004, with revenue reaching as high as $475 million.

"Reed has established a beachhead in something that looked like nothing more than a toehold just a couple years ago," said industry analyst Dennis McAlpine.

"It's not going to be easy to get rid of him now."

Copyright © 2004 The Seattle Times Company