Netflix

6/23/09 – Netflix's CEO, Reed Hastings, thinks his core business is doomed. As soon as four years from now, he predicts, the business that generates most of Netflix's revenue today will begin to decline, as DVDs delivered by mail steadily lose ground to movies sent straight over the Internet. So Mr. Hastings, who co-founded the company, is quickly trying to shift Netflix's business -- seeking to make more videos available online and cutting deals with electronics makers so consumers can play those movies on television sets.

Companies across the entertainment and technology landscape are struggling with how to profit from Internet video. There's still significant risk that Netflix could falter or lose out to another company that figures out how to do it first. And having picked his battle, the intense former engineer may risk missing other growth opportunities: Mr. Hastings hasn't yet expanded internationally or mounted a direct challenge to kiosks, such as Coinstar Inc.'s Redbox, that let customers pick up $1-a-night DVD rentals.

Mr. Hastings says he is still considering expansion opportunities outside the U.S. and has no plans to open kiosks.

One of Mr. Hastings's biggest hurdles will be persuading Hollywood studios to give Netflix rights to show more and better movies through its Internet service at a time when many studios are protective of their DVD-sales revenues. Late last year, Sony Corp.'s Sony Pictures threw a hitch into Mr. Hastings's plans when it temporarily blocked access to some of its movies from Netflix's Internet video service in a dispute over whether Netflix had rights to them.

Moreover, Mr. Hastings stumbled in an earlier effort to introduce a set-top box that would bring Internet video service into the living room. Netflix developed the hardware but then abandoned it after Mr. Hastings and other executives got cold feet.

Home-video sales, mostly from DVDs, last year dropped to $14.5 billion from $15.9 billion the previous year, according to Adams Media Research. Movie rentals remained flat over the period, at about $8.2 billion. The number of DVDs Netflix rents every year -- about a half-billion in 2008 -- is still growing, and Mr. Hastings predicts the company will still be shipping discs to consumers 20 years from now.

In January 2007, Netflix began letting subscribers stream video to their PCs from the company's Web site, allowing users to watch video almost instantly without keeping permanent copies on their hard drives. The service featured only about 1,000 movies and television shows -- about 1% of its DVD selection -- but subscribers could use it for no extra charge.

Now more than 20% of Netflix members regularly use the service. The company says new users attracted by streamed movies have helped push its subscriber total up 25% to 10.3 million at the end of March from a year earlier.

The online model has another benefit for Netflix. The company currently pays about 80 cents to post a DVD to a customer's home and back. Its bandwidth costs for streaming a typical two-hour movie: roughly a nickel.

Mr. Hastings's biggest challenge in reorienting Netflix is getting Hollywood to go along for the ride. Netflix's selection of more than 100,000 DVD rental titles is made possible by the "first-sale doctrine" of U.S. copyright law, which permits buyers of DVDs to lend them out without studios' consent.

Netflix must also compete with television subscription services like Time Warner's HBO, Viacom Inc.'s Showtime and others that gain exclusive rights to show studio movies on cable channels or through on-demand systems. These pay channels have bigger audiences than Netflix and a longer history of hashing out complicated licensing agreements to secure movie rights. Their lucrative deals can prevent Netflix from getting Internet rights for movies until years after they're released on DVD.

If Netflix is to expand the titles on its Internet service, it will have to considerably boost its licensing spending, from roughly $100 million last year.

Mr. Hastings says he expects to spend more for Internet movie rights as the popularity of the Internet service grows, while continuing to mail DVDs to customers when they can't stream the same titles over the Internet. Last year he added several thousand titles to Netflix's online library by cutting a deal with Starz Entertainment, the Liberty Media Corp. premium channel that has rights to movies like Walt Disney Co.'s "Wall-E."

Mr. Sarandos, Netflix's point man with the studios, says Hollywood is "clearly conflicted" about the online service's growth because it could help accelerate the decline of DVDs. "They're supportive of our growth since we license content from every single studio in Hollywood," he says. "At the same time, they would like to preserve these business models as long as they can."

Mr. Hastings says he plans to stick to what he knows, software and online services. On the Internet, he is certain to face more powerful competitors than he has in the DVD-rental business, as Netflix competes for consumers with video services from the likes of Apple, Amazon, Google and Hulu.