Netflix

Public Company
Incorporated: 1997 as NetFlix.com, Inc.
Employees: 4,080
Sales: $1.67 billion (2009)
Stock Exchanges: NASDAQ
Ticker Symbol: NFLX
NAICS: 532230 Video Tape and Disc Rental

Netflix, Inc., is the world’s leading digital video disc (DVD) rent-by-mail company. The company serves more than 12 million subscribers and operates 50 processing facilities throughout the United States. Netflix offers many subscription plans, allowing customers to rent anywhere from one to eight DVDs at any given time and ranging in price from $4.99 to $47.99 per month. A portion of the extensive Netflix video library is also available for viewing on the Internet, through the company’s “Watch Now” feature. In addition, Netflix allows subscribers to watch content directly on their televisions through a variety of platforms, including the Roku video player and the TiVo digital video recorder; gaming consoles such as Sony Playstation 3, Wii, and Xbox; and various Blu-ray DVD players.

A NEW MODEL FOR DVD RENTALS: 1997

NetFlix.com, Inc., was founded in Scotts Valley, California, in 1997 by Marc Randolph and Reed Hastings to rent and sell DVDs over the Internet. Randolph had previously helped found a computer mail-order company called Micro Warehouse and then served as vice president of marketing for Borland International, while the one-time math teacher Hastings had founded Pure Software, which he had recently sold for $700 million. Hastings, who supplied the firm’s start-up cash of $2.5 million, had reportedly hit on the idea for rental-by-mail when he was forced to pay $40 in fines after returning an overdue videotape of the movie Apollo 13.

The DVD format, which can store a high-quality copy of an entire feature film on a single five-inch disc, had been introduced in the spring of 1997 and less than 1,000 titles were then available. Even though the hardware needed to play DVDs was fairly expensive and owned by relatively few Americans, Randolph and Hastings thought the disc had the clear potential to replace the bulkier, lower-resolution videotape as the consumer format of choice.

Key to the firm’s initial strategy was the fact that few video stores carried DVDs, making renting them in person a hit-or-miss affair. The company was also able to take advantage of the small size and light weight of the discs, which could be shipped to users inexpensively. The firm experimented with more than 200 mailing packages before finding one that could safely ship a disc (in a plain case without cover art and inserts) for the cost of a single first-class stamp. A stamped return mailer was also enclosed. NetFlix promised to virtually guarantee that titles would be in stock, with reasonably quick delivery offered through the U.S. Postal Service. The company pledged to buy more than 1,000 copies of new releases, which could be reserved in advance for shipment on the day they were made available in stores.

READY FOR BUSINESS: 1998

NetFlix opened for business in April 1998 with 30 employees and 925 titles for rent, which accounted for nearly the entire catalogue of DVDs in print. The firm offered some soft-core Playboy titles but shied away from hard-core pornography to avoid the potential for legal problems in certain states. NetFlix initially offered a seven-day DVD rental for $4, plus $2 shipping, with the cost going down when additional discs were rented. Discs could be kept longer for an additional fee. New DVDs were also offered for sale at a discount of up to 30 percent. Consumers could decide to purchase a rented disc once they got it home by having the balance of the retail price charged to their credit card. The firm’s Web site offered a number of informational features including movie reviews, and once a customer had rented several titles a profile would be generated that automatically suggested additional films of interest based on the characteristics of ones already chosen.

To promote its debut, NetFlix sponsored a sweepstakes to win an “L.A. Weekend” all-expense-paid trip to Los Angeles, California, as a cross-promotion with Warner Brothers for the newly available DVD of the film L.A. Confidential. The initial response to NetFlix’s service was strong, and its Internet site was briefly forced to shut down 48 hours after it went online. NetFlix was one of the first companies to rent DVDs by mail, with only a handful of other competitors in operation, including Magic Disc, DVD Express, and Reel.com.

A month after the company opened its virtual doors, it announced a promotional venture with Toshiba America to offer three free DVD rentals to purchasers of new Toshiba DVD players, and similar offers were soon made to buyers of Pioneer DVD players and select Hewlett-Packard and Apple computer models that included DVD drives. Later in the year Sony was also signed up, with additional companies following.

HONING THE NETFLIX BUSINESS MODEL: 1998-99

The company received a tremendous promotional boost in September 1998, when it made available 10,000 copies of a DVD of President Bill Clinton’s Grand Jury testimony in the Monica Lewinsky affair. They were sold for just two cents each, plus $2 shipping and handling. The offer was widely covered in the news media, although the success was marred slightly by a mix-up at the manufacturing plant, which shipped pornographic DVDs in place of a few copies of the disc.

In December NetFlix announced that it would stop selling DVDs. It began directing customers interested in purchases to Amazon.com, Inc., which had recently begun offering DVDs as well. In exchange for bowing out of this business area, NetFlix would be promoted on Amazon’s highly trafficked site. The firm cited the relatively modest sales figures, the sizable competition, and the huge effort that would be required to remain competitive. By this time NetFlix’s library had grown to 2,300 titles, and home DVD player sales were taking off, although prices remained high and only 1 percent of U.S. households owned the device.

In January 1999 NetFlix began partnering with the online movie information provider All-Movie Guide, which would direct people looking up a title NetFlix carried to the firm’s Web site. In March the film critic Leonard Maltin signed on to write an exclusive monthly film column for the site, with five “must-rent” DVD titles listed each time. The company was now buying 10,000 or more copies of some popular titles and had a total inventory of more than 250,000 discs. Its staff had grown to 110.

In July Hastings, the chief executive officer (CEO) of NetFlix, announced that the company had secured $30 million in new financing from Group Arnault, a French luxury goods investment firm that was starting to back e-commerce ventures. The money would be used to fund new brand-building and marketing endeavors. A number of new competitors were beginning to emerge, and the Group Arnault backing was seen as crucial to establishing NetFlix’s dominance of the DVD rental category. Shortly afterward, the firm announced a new cross-promotional initiative with Musicland Stores Corp. and plans to offer free rental coupons in the box of most new DVD players sold.

INTRODUCING THE SUBSCRIPTION PLAN: 1999-2000

In September 1999 NetFlix introduced the Marquee Program, which allowed members who paid $15.95 per month to preselect four DVDs, with no late fees or due dates. Customers could also rent new discs each time they returned one and could put themselves in a queue for checked out titles in which they were interested. CEO Hastings commented that the new service was possible because the company had achieved the economies of scale, with 10,000 orders processed each day by its own proprietary software system. Despite NetFlix’s growing popularity, for fiscal year 1999 it reported losses of $29.8 million on revenues of only $5 million. Like many Internet start-ups, NetFlix was still spending heavily to entice customers to its Web site, betting that it would become profitable after the brand was better established.

In February 2000 NetFlix introduced the new service CineMatch, which compared rental patterns among its customers and looked for similarities in taste. Using this information, the company recommend titles to people whose profiles were similar. It could also be programmed to combine the attributes of two users, such as a married couple, and recommend titles that both might like. The information gleaned from the CineMatch system, which required customers to rate 20 films using a five-star scale, was also shared with movie studios to help them plan marketing campaigns. Early the next year NetFlix changed the Marquee Program to offer unlimited rentals for $19.95 per month, with a maximum of four titles out at a given time, although this was later dropped to three. Shipping and handling were included in the price. At the same time, the firm phased out single-title rentals, as 97 percent of its business was now derived from the Marquee Program. The company was currently distributing more than 100,000 DVDs per week.

In May 2000 NetFlix announced plans for an initial public offering of $86.3 million worth of common stock but withdrew it in July. Investors had become increasingly skeptical of the e-commerce business model, and NetFlix’s lack of profits was a red flag to many. Despite this setback, the company continued to expand. By year’s end it had over 7,000 titles available to a customer base of 250,000.

FORGING STRATEGIC REVENUE SHARING AGREEMENTS: 2000-01

In December 2000 a major goal was achieved when revenue sharing agreements were reached with Warner Home Video and Columbia Tri-Star. In exchange for a percentage of rental receipts, the movie studios gaveNetFlix better prices on large quantities of DVDs, which the firm needed to have on hand to fulfill requests for new releases. A number of other studios, including DreamWorks SKG and Artisan Entertainment Inc., were soon signed up as well. The company also unveiled its first television ads at this time, running them in a limited number of markets that had high per capita numbers of DVD players.

In January 2001 NetFlix signed a deal that gave it exclusive distribution of the DVD version of the recent art house hit Croupier, which it would have for three months before the title was available elsewhere. Other such deals were reportedly in the works. An important aspect of NetFlix’s business was the availability of titles that were not found in mainstream video stores such as Blockbuster Inc. The company also had great success tapping into the underserved markets for independent and foreign films. One particular area of success was in renting so-called Bollywood films from India. The firm offered about 1,000 titles in this category, and Page 353  |  Top of Articlethese circulated frequently. NetFlix also found that subscribers were renting many lesser-known films after they had been suggested by the company’s recommendation system. Because they were not paying for each movie individually, NetFlix customers could take a chance on an interesting-sounding title with which they were not familiar.

During the spring of 2001 the company began offering a free six-week trial membership via the Internet Movie Database, a popular movie information Web site, and selling off overstocked titles through the e-tailers Wherehouse.com and Half.com. In September NetFlix partnered with Best Buy Co., Inc., to create a cobranded DVD rental service in the company’s 1,800 stores and on its Web site. Best Buy also owned several other retail chains, including Sam Goody, Media Play, and Suncoast. By late 2001 NetFlix secured additional venture capital funds, and the company began predicting profitability by the fourth quarter of the fiscal year.

Following the September 11, 2001, terrorist attacks against the United States, the company’s monthly subscription rate doubled, due as much to fearful Americans seeking refuge at home as to the dropping price of DVD players, which now could be purchased for less than $100. Despite its rapidly growing customer base, the company lost $21.1 million for the year on revenues of $74.3 million.

GOING PUBLIC

In February 2002 NetFlix announced that it had attained the long-anticipated subscription figure of 500,000. This included some who chose the recently added NetFlix Lite, which cost $13.95 per month and limited users to two rentals at a time. In March the company revived its plans for an initial public offering (IPO), and when it sold 5.5 million shares in late May it raised $82.5 million, more than some had expected. The money was targeted to pay down $14.1 million in debt and cover promotional expenses. In conjunction with the IPO, the firm also quietly amended its name to Netflix, Inc.

Earlier in the year the company had opened new regional distribution facilities near Los Angeles and Boston, Massachusetts, to speed delivery to those areas. These facilities had quickly proven their worth, and by June other facilities were open in Atlanta, Georgia; Denver, Colorado; Detroit, Michigan; Houston, Texas; Minneapolis, Minnesota; New York City, New York; Seattle, Washington; and Washington, D.C. Netflix spent approximately $60,000 on each site for computers, bar-code scanners, and printers, and the facilities were set up to handle 50,000 orders per day. The locations were situated so that the company could achieve overnight first-class mail delivery to as many customers as possible. Netflix’s per capita subscription rate was much higher in San Francisco, California, by almost 5 percent, and this was largely attributed to the overnight response to customer orders. In contrast, subscribers on the East Coast had to wait approximately four days for an order to reach them, reducing the number of DVDs they could receive each month. Each distribution site did not maintain a full inventory, so when an order for an out-of-stock disc was received, the company’s computers found the closest location of a copy and automatically generated a shipping order to forward it.

During the summer of 2002 the company also experimented briefly with a brick-and-mortar DVD rental store in Las Vegas, Nevada. Called Netflix Express, the 600-square-foot operation was located in a supermarket and was open for less than a month. Netflix now had 670,000 subscribers and offered 11,500 different titles. It had also signed revenue-sharing agreements with more than 50 film distributors, who received approximately 20 percent of the company’s subscription fees.

COMPETING WITH COMPETITORS

As Netflix garnered more media attention and its subscriber numbers soared, the competition began to heat up. During the summer of 2003 Blockbuster began offering an unlimited, no-late-fee subscription service for DVD rentals in some stores. It also bought an online DVD rental company and renamed it FilmCaddy.com.Netflix was also being targeted by Wal-Mart Stores, Inc., which had started its own unlimited online DVD rental service. Priced at $18.86 per month, the service undercut Netflix by just over a dollar. Wal-Mart claimed it had 12,000 titles available, comparable to what Netflix offered. Another major player, Columbia House, was reportedly eyeing a similar plan as well. With these threats, and with Netflix’s subscriber cancellation rate inching upward, the company’s stock price dropped by more than half.

Responding to these challenges, Netflix announced that it would open a dozen more distribution facilities by the end of 2003 to serve major metropolitan areas such as Chicago, Illinois; Dallas, Texas; and Portland, Oregon. The firm was targeting 5 million subscribers by 2009 and had plans to begin distribution in Canada. Annual figures for 2002 showed double the previous year’s revenues, $152.8 million, and losses of just $1.6 million, which was a dramatic improvement over 2001. The subscriber cancellation rate was also dropping, to 6.3 percent for the final quarter of the year.

ONE MILLION SUBSCRIBERS: 2003

Netflix hit the 1 million subscriber mark in February 2003, by which time it had also opened five additional shipping facilities. Its stock price was on the rebound and in the spring it was $22 a share, almost 50 percent more than it had commanded at the IPO. June saw the firm report its first profitable quarter to date, and it also became one of the first Silicon Valley companies to count stock options as expenses, a move that came in the wake of the public outcry over a number of corporate accounting scandals. The company gave stock options to all of its salaried employees, and this was expected to add $2 million in costs in the latter half of the fiscal year. Also in June Netflix was awarded U.S. patents for its software systems that tracked DVD rentals and compiled customer requests. By midsummer the company had more than 1.1 million subscribers and a library of 15,000 titles from which to choose.

By the end of 2003 Netflix had expanded its subscriber base to 1.5 million customers. Furthermore, its fourth-quarter revenues increased to $81.2 million, which was a substantial increase over the same period in 2002, when the company’s sales were $45.2 million. More significantly, the company posted a profit of $2.3 million for the quarter, after suffering a fourth-quarter loss of $2.2 million a year earlier. These brisk earnings were not lost on investors. By December 2003 Netflix saw its stock value skyrocket to roughly $50 a share, an increase of 400 percent over the course of the year.

EMERGING TECHNOLOGIES, NEW COMPETITION: 2004-10

Regardless, Netflix faced many challenges heading into the second half of the decade. In early 2004, as it contended with rising marketing costs, the company was forced to increase its monthly subscriber fee from $19.95 to $21.99 per month. This price hike came at an inopportune time, as Blockbuster was able to offer its DVD-by-mail service for only $19.99 per month. Furthermore, by October 2004 rumors had begun to circulate that Amazon was on the verge of entering the online DVD rental business. Amazon had already established an online rental service in the United Kingdom, and an eventual entry into the U.S. market seemed inevitable to many observers. To confront this potential threat, Netflix announced that it would reduce its subscriber fee to $17.99 per month. Blockbuster promptly followed suit, lowering its monthly rate to $17.49. As increased competition exerted greater pressure on Netflix, many analysts downgraded its stock value, with some suggesting the company was ripe for a takeover.

Arguably more daunting for Netflix during this period was the rapid emergence of streaming-video technology. By mid-decade an increasing number of regional cable television providers were beginning to offer video-on-demand to their subscribers. Even though the volume of programming available in this format still remained relatively small, the ease and convenience of the streaming technology was hard for Netflix to ignore. As the popularity of streaming video increased, the company began to consider ways that it could exploit on-demand technology to reach a wider customer base. In September 2004 Netflix formed a strategic partnership with TiVo Inc., the company that had revolutionized the digital video recorder (DVR) for cable television, to develop a means of streaming secure video content to personal computers via the Internet.

As the decade drew to a close, streaming video became an increasingly important component of the company’s long-term growth strategy. In January 2007 Netflix finally launched its “Watch Now” online service, making select videos available to subscribers instantly over the Internet. The new feature remained relatively modest in scale compared with the company’s established DVD-by-mail service. Even though the Netflix library had grown to 85,000 titles, only 5,000 were available for online viewing. By October the company was processing roughly 1.6 million DVDs per day. By contrast, only 40,000 titles per day were being viewed over the Internet.

Even so, the “Watch Now” option grew steadily in popularity, and Netflix began to explore new platforms for broadcasting online content. In January 2008 Netflix joined the South Korean firm LG Electronics Inc. to develop a device capable of streaming videos from its instant library directly onto a television. In May Netflixand the California-based technology firm Roku, Inc., began marketing a similar video player. Priced at $99, the Roku box was widely hailed for its simplicity, affordability, and quality. Two months later Netflix partnered with Microsoft Corporation to develop streaming video capability for the Xbox game console. The company reached a similar agreement with Sony Corporation in late 2009, when it began offering programming through the Sony PlayStation 3. Beginning in April 2010 Netflix also made content available via the Nintendo Wii console. By this point the company had over 12 million subscribers. With more than 42 percent of them regularly viewing Internet-based content, it seemed clear that streaming video had the potential to become the core of the company’s business plan heading into the next decade.

Company Perspectives

Netflix has revolutionized the way people rent movies—by bringing the movies directly to them. With today’s busy lifestyles and consumers demanding more value and control, it’s no wonder that Netflix has become the preferred online provider of the home entertainment experience.

Key Dates

1997:

NetFlix.com, Inc., is formed in California by Marc Randolph and Reed Hastings.

1998:

The company begins offering DVD rentals and sales.

1999:

Group Arnault invests $30 million in the firm and a subscription plan debuts.

2000:

Revenue sharing deals are signed with Warner Home Video and Columbia Tri-Star; CineMatch is introduced.

2001:

A partnership with Best Buy Co., Inc., gives NetFlix exposure in the chain’s 1,800 stores.

2002:

The company goes public and changes its name to Netflix, Inc.

2003:

Subscribers top 1 million, and Netflix has its first profitable quarter.

2007:

Netflix begins streaming instant video via the Internet.

2008:

Netflix begins marketing the Roku viewing box, enabling subscribers to watch online content on their televisions.