Netflix

DVD rentals' mail model: from its roots in a dark closet, Netflix has grown by putting a premium on customer satisfaction. (Netflix 5th Anniversary). Laura Dunphy.

Full Text: COPYRIGHT 2003 Reed Business Information

For anyone who has returned to the video store 10 times looking for a film that's never in stock or discovered in his DVD player a rental that should have been brought back days before, Netflix is a wish come true.

CEO Reed Hastings first envisaged subscription rentals years ago after finding a long-overdue copy of Apollo 13 in his closet. About $40 in late fees later, he was mulling plans to turn the traditional rental model--pay per title, for a set time, with late fees--into a system in which customers pay a flat fee to use the service as much as they want each month. DVD made the idea a reality, because the weight and durability of discs made it feasible to send titles via the mail.

After its 1998 founding and launching its subscription service in 1999, Netflix now boasts more than 1.05 million subscribers. Those customers pay $19.95 monthly for unlimited DVD rentals from more than 14,500 titles, up to three at a time with no late fees, sent via one- to three-day mail delivery.

"When people think about renting through the mail, they think it might take too long, and we dispel that in the first try," says Ted Sarandos, VP of content acquisition.

About 60% of customers now receive one-day shipping, and the service will open about one new metropolitan shipping center each month, with the goal of 70% to 75% of customers receiving DVDs overnight by year end. Overnight delivery is crucial because it's a key way Netflix satisfies customers, a necessity considering how the company gets most of its new business.

"For the most part, word-of-mouth is how we have grown, and it is, quote, our largest marketing partner," says Leslie Kilgore, VP of marketing. "Over 90% of customers tell us they promote the service to their friends, family members and colleagues."

The reliance on positive referrals is why Sarandos and Kilgore say that maintaining top-level customer service will remain Netflix's No. 1 priority.

Netflix has supplemented word-of-mouth with online marketing, signing up smaller sites as affiliates and entering into larger partnerships with well-known portals AOL, Microsoft Corp. and Yahoo! Yet perhaps its most successful, and unlikely, relationship is with consumer electronics giant Best Buy (see. story, page 14).

Netflix boasts the same big blockbusters as traditional retail outlets, but other genres are seeing greater growth. Documentaries, foreign-language movies and extreme sports are hot, because they're underserved in traditional rental outlets, Sarandos says.

For example, French charmer Amelie became one of Netflix's top all-time rentals, and the service accounted for 15% to 13% of the title's total rental business. That's why Netflix executives are eagerly awaiting upcoming niche titles that might have only one or two copies on traditional rental outfits' shelves, such as Michael Moore's documentary Bowling for Columbine, Roman Polanski's The Pianist and the Salma Hayek vehicle Frida.

Not every genre can take priority, however, so the company does not prioritize the special-interest, how-to and instructional market. Executives feel that genre is more suitable for ownership.

With I million subscribers clamoring for so many selections, how does Netflix decide how many of any given title to buy?

"Were a software company, so we have great technology to build models for comp performance and past performance of similar titles and similar genres," Sarandos says. "We're also in extensive touch with the consumer. We get intent-to-rent data from them and benefit from early queue adds. They can say they want to see it months before the DVD release, which is great insight."

It also helps that Netflix has built better studio relationships. Three years ago, no studios had direct deals with Netflix, but now every major studio, plus 80 individual providers, give content to the service.

Although it fostered relationships to increase content, Netflix also wanted to increase cash flow. Netflix originally planned to go public in 2000 but postponed because of the tech slump. The proposal was refiled in March 2002. On its first trading day, the stock price leapt 12% to $16.95. Netflix sold 5.5 million shares and raised $82.5 million as a result of the PO. Shares have recently traded above $20. Revenue for 2002 was $152.8 million, and the company expects revenue for 2003 to be $255 million to $275 million.

There's a reason why growth is strong but not explosive. "It's introducing people to a behavior change," Kilgore says.

The implementation of a 10-day free trial (14 days with special promotional codes) has been and will continue to be a successful introduction to the service. "About 90% go on to become paying customers," she says.

Looking forward, Netflix's challenge may be electronic, if the vision for a home network that brings entertainment content via the Internet straight to consumers' TV sets becomes reality. "New technology is very sexy to talk about, but it's also a long way off," Sarandos notes.

That said, Netflix believes it is laying groundwork by altering behavior so customers become comfortable navigating the Web for their rental selections.

"How it gets to you is not as important," Sarandos says. "I could see that the business could very easily morph into electronic delivery complemented with DVDs through the mail."

RELATED ARTICLE: Anything to avoid a late fee

CEO Reed Hastings came up with the idea for Netflix based on his own experience

Reed Hastings still goes to the video store. Although he's the CEO of one of the industry's most successful online ventures, he and his 5- and 8-yearold children still hit the local Blockbuster Video on occasion when the need for more immediate video gratification arises. However, he'd rather talk about his online venture, and did so with VB's John Gaffney.

VB: You started out as a software developer. How did you get from there to here?

Hastings: It came from being a frustrated customer. I loved movies but I hated the late fees. I wanted