Coming Soon to a Netflix Near You

The online DVD-rental store has big ideas about capitalizing on how people want to watch movies

Netflix, (NFLX), the online DVD-rental store, is one of the hottest stories in Hollywood. The company, which ranks No.30 on BW's Hot Growth Companies list, has already caused a lot of pain for video chains like Blockbuster (BBI). Now it's branching out into buying rights to movies. The goal: to build Netflix into the Home Box Office (TWX) of movie rentals by creating and distributing more diverse movies than you can get anywhere else (see BW, 5/25/06, "Netflix").

If you want to watch more movies like Hotel Rwanda and fewer like Basic Instinct II, you have a stake in Netflix's success. Netflix Chief Executive Officer Reed Hastings sat down with E-Business editor Tim Mullaney to discuss his company's strategy. Here are excerpts from their conversation.

You guys have set a very bold, very public goal: 20 million subscribers by 2010 to 2012, vs. 5 million now. Why is that plausible?

We have 13% of Bay Area households and our growth is accelerating. If it's still accelerating at 13% of households it's going to saturate north of 20%. The Bay Area has about 2% of Blockbuster's stores. We look back to three years ago, when we opened distribution centers in New York, LA, Atlanta, Dallas, Chicago, etc. with overnight delivery. Then we look at, "once we have overnight delivery, how does the growth go? What's the curve?" And in those markets the curve is slightly higher than in San Francisco after we got overnight delivery here.

How does having a really big audience help you do business with the studios?

If we get to 20 million, we've got a great platform [for owning movies], for advertising, and for downloading content. So we're beginning all those efforts. All of these efforts are nice now, not hugely important, but they'll be really important by the end of the decade.

Lots of people think downloadable movies will knock your head off. Are they wrong?

Any great investment has at its heart some contrarian thesis the rest of the world thinks is ridiculous. Ours is that DVD will dominate for a decade or more. If one believes DVD will evaporate in two or three years, they shouldn't invest in Netflix. Last year there were $24 billion in DVD sales and rentals. If you're a studio exec planning out the next five years, the growth is all about DVD revenue, with high-definition DVD, and TV shows on DVD. Studios won't do downloading of their brand-new stuff.

You've bought distribution rights to about 90 movies in the last year. Why?

There are two ways to look at our film acquisition. One is that we should compete with our suppliers and disintermediate them. The other is that that's a money burner and we should focus on underdeveloped niches like small films. We're strongly in the second camp. We'll have no better and probably worse results if we try to produce Hollywood films. So you want to do Bituminous Coal Queens of Pennsylvania or Cowboy del Amor -- these films are below studios' radar screens.

There's actually a surplus of films made, so we don't really need to produce films. And the cost of making films is dropping dramatically with digital editing and all those things. So more and more movies are made. It's like the book market: Thousands of books are completed every day, and the hard part is making a market for them. Movies are getting more like that.

Who should fear Netflix, besides Blockbuster?

If there's dislocation, it's really around movie advertising. Yahoo! (YHOO) and NBC (GE) sell studios lots of advertising to create demand. Our view is, if a segment of people is likely to love a film, it should get promoted to them. Hotel Rwanda was a small film that got great ratings from Netflix customers, so it got promoted widely and spread through our base. The dislocation is going to come in using technology for personalization and rating. I think that business is $4 billion a year.

How is the competition in downloading going to be different from competing with Blockbuster?

Well, for delivery, everyone will use Akamai (AKAM) or whatever -- all that will be commoditized. That's why we spend so much on our recommendation engine. We have five years to make ourselves the most incredible movie site, where you want to be a member, and then we'll offer movie downloading the same way everybody else does. We think the differentiator will be this incredible Web site.

What about all these new Web video services like YouTube? Do you need to play in short form or amateur video?

We're focused on long-form movie storytelling. I love the growth in that sector, but that's not us. The great thing about that for us is that's what's going to drive bandwidth to the home. We need to get something like 10 megabits to the home to download movies, and right now there's no reason for a consumer to upgrade to 10 megabits to the home. The more video is out there, the more bandwidth will grow and that's enabling for us.

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