Company Profile: How Netflix Rents 3 Million DVDs a Week to 2.2 Million Paid Subscribers

Six years ago, after having taken his first company public and leading it through a juicy pre-dot.com bust acquisition, Reed Hastings decided it was time for a well-deserved break. He walked into his local video shop and rented the movie “Apollo 13.”

And promptly forgot about it.

That is, until he received a nasty shock: a $40 late fee.

Rather than vow to shape up and stay on top of his video rentals from that point forward, Hastings decided to start a company that would do away with his problem entirely. And so was born Netflix in 1999, the first company to market subscriptions online for DVD mail rentals, and to charge no late fees.

Quick data points:

Subscribers: 2.2 million currently active subscribers have signed up and paid online. Netflix's stated goal is to have 4 million paids by the end of 2005.

Subscribers pay on average roughly $20.00 a month.

Acquisition Costs: During the first nine months of this year, the company spent an average of $36.06 to sign up each new subscription.

DVD Stock: Netflix owns a total of more than 16 million DVDs. (By comparison, a typical neighborhood video store has less than 3,000 titles.) An estimated 3 million DVDs are rented out per week.

Revenues: The company just announced its first-ever profit, a tidy $142 million in the last quarter representing a 93% increase over the previous year.

Cash: Netflix went public in May 2002 on negative earnings and has $175 million cash in the bank.

Business basics: How Netflix works

Netflix has prospered by keeping it simple and staying focused on eliminating the inconvenience associated with the traditional trip down to the Blockbuster (not to mention the aforementioned late fees which, by the way, net the average Blockbuster store up to $10,000 a month).

Instead, Netflix customers sign up online for a monthly subscription package which allows them to rent up to 3, 5 or 8 DVDs at any one time (more on pricing in a moment). Netflix even supplies the postage-paid envelopes, which means no more sloshing out on a rainy night.

But where the beauty of the Internet really comes into play is this: How many times have you been at the video shop and been forced to make a phone call something along the lines of: “Honey, there are no more copies of Moulin Rouge…would you be interested in, maybe, Steve Martin’s The Jerk?”

When you first sign up for Netflix, you’re prompted to make a wish list of all the movies you’ve ever wanted to see. These then go into your personal queue.

As soon as you return one DVD, the next title in your queue is automatically shipped from one of the company's 29 warehouses around the U.S. If it’s not available, the system just goes on to the next. You can rearrange the order of your queue at any time, or just sit back and be surprised when the next video arrives. No more late night video store phone calls. It’s even more couch potato friendly than TiVo.

Biggest challenges:

Despite finally moving into the black this month, the company reported a $5.8 million loss for the first quarter of 2004, more than double their loss of $2.4 million for the previous year. And 2005 is shaping up to be the pivotal year, says Shernaz Daver, Netflix VP of Corporate Communications, “a year of market share and land grab.”

What’s keeping Netflix execs up at night is not competition with brick and mortar stores like Blockbuster which Daver chides as still only dabbling with taking orders from video customers online. Not even relative newcomer Walmart can scare them – the retail giant has been in the space a year now but has barely made a dent.

Rather it’s the fear that Amazon.com will enter the space. Indeed, when rumors spread earlier this month that Amazon.com planned to do just that, Netflix’s stock was pounded, taking a 41% hit from which it has yet to recover (the company has seen its stock swoop a whopping 75% in the last nine months).

Amazon’s entry into the DVD rental business would make a lot of sense: the company already has the warehouse and postal fulfillment infrastructure in place.

Daver prefers to view the possibility as a challenge, saying that if Amazon did indeed enter the business, “winning against them would be like winning against Brazil in the World Cup.”

Still, the company isn’t taking any chances. After hiking its 3 DVD-at-a-time rate from $19.95 to $21.95 as recently as April, Netflix has announced it is dropping the monthly fee for its most popular subscription category by 18% to $17.99 come November 1.

For die-hard movie mavens, there’s also a 5-at-a-time rate at a reduced price of $29.99, and for up to 8 DVDs out at once, you’ll be paying $47.99 a month. (There’s also an option for movie wimps – 2 DVDs at-a-time for $11.99 but with a maximum cap of 4 rentals a month.)

Marketing Tactics:

You’d think that Netflix would try to upsell these higher priced subscriptions at check out, but they’re barely mentioned on the site with only a small link off the Account Details page.

The company is similarly low-key about touting its in-house movie reviewer James Rocchi: while he is featured prominently on the site, you can’t receive the latest reviews by email. Would seem like a no-brainer, but Netflix stays on message:

The marketing take-away: keep it simple and stay focused.

In terms of acquisition marketing, the company focuses its ad buys online, keeping a fairly even mix of banners, pop-ups, pop-unders and pay-per-click (“it’s pretty hard to go a day on the Web and not see a Netflix ad,” jokes Daver).

More recently, limited offline TV spots have begun airing. We've noticed several other major subscription sites such as eDiets also testing TV this year, mainly because online media is no longer the ultra-cheap buy it was during the bust.

Netflix also has an active affiliate program, offers gift certificates, and makes its Top 25 lists available as an RSS feed.

The site's viral Tell-a-Friend program is a significant success. Nine out of ten Netflix members have used it at least once to invite a friend to join the service.

One key sticky site feature that helps convert acquisitions and reduces paid subscriber churn is the site's recommendations and rating feature.

Inspired by Amazon's ratings and recommendations functions, the site looks at both what you’ve already chosen to rent and on how you rate other films (every time you return a film, you’re automatically queried by email to rate it).

Netflix says that approximately 60% of movies are selected based on recommendations and there are some 315 million customer-submitted movie ratings on the site.

Even more impressive, the average subscriber has rated about 150 movies. (Note: this doesn't mean they rented all 150 from Netflix, but it does imply an unusually high degree of ongoing engagement with the site.)

The future belongs to broadband...

Earlier this month Netflix announced a deal with TiVo to launch a video-on-demand service that will deliver movies to consumers through the Internet. Does that mean Netflix has its eyes on a future of entirely digital distribution?

“That’s certainly the prize,” says Daver. “But we don’t see DVDs becoming obsolete as a medium in the near future… at least not for five years.”

Hmmm… last time we checked, five years was pretty near-future to us!