No pause in DVD rental wars
Netflix and Blockbuster one up each other to nab new subscribers
Seven years ago, Reed Hastings returned a copy of Apollo 13 to his local Blockbuster six weeks late and got slapped with a $40 fee. A former computer scientist, Hastings responded by launching Netflix, a DVD rental-by-mail service where "overdue" doesn't exist. Now Netflix dominates the market, and it's Blockbuster, Wal-Mart, and other competitors who are paying the price for being late.
For about $22 a month, a Netflix user can rent three DVD s at a time, choosing them from among the trove of titles listed on the company's website. There are no due dates, late fees, or shipping costs. As soon as one DVD is returned in its distinctive red envelope, the next title on the subscriber's online wish list is sent. "Hastings created a niche that didn't exist, and I think it's going to be hard to catch him," says Dennis McAlpine, an entertainment industry analyst with McAlpine Associates in New York.
Indeed, Netflix, with revenues of $272 million last year, has captured 95 percent of the online DVD rental market. But its share represents less than 5 percent of the $8 billion overall DVD rental business. And analysts predict the online rental business could be worth nearly $1.8 billion by 2008 as more consumers get DVD players and opt for the convenience of mail delivery.
Netflix got there first, but it is by no means alone. There are several smaller firms that rent DVD s by mail, and the giants are moving in. In August, Blockbuster rolled out a mail option, with slightly lower prices than Netflix. Over at Netflix, that news, in combination with lower-than-expected second-quarter earnings, sent its stock into a tailspin. Netflix's shares dropped to $17, half their 2004 high. The price has recovered somewhat, thanks to Netflix's new deal with TiVo, the personal videorecorder maker, to let consumers download movies over the Internet to their televisions. But that partnership is not expected to produce revenue for several years.
Meanwhile, analysts say that Blockbuster would need to convert only a small percentage of its 50 million store customers to its online rental service by year's end to deal Netflix another blow. "Although it got a late start, Blockbuster has the edge," says Aditya Kishore, an industry analyst with the Yankee Group in Boston. "It has hundreds of retail locations, a strong brand, money, and skill." Next year, Blockbuster plans to combine its services, allowing customers to rent or drop off movies by mail or in stores for a flat monthly fee--with no late charges. It also plans to use its stores as minidistribution centers to enable faster mail delivery. "This is clearly a marathon," says Shane Evangelist, general manager for Blockbuster online. "But once we're integrated, you won't be able to touch us on service." Evangelist predicts that the company will have 6.6 million online subscribers by 2008, whereas Netflix forecasts 5 million by 2006.
Missed it. But Blockbuster has been wrong before, as in assuming that its customers would rather deal with the hassles of driving to its stores than wait for the mail. That miscalculation lost the company thousands of customers to Netflix and the like. Retailers like Wal-Mart and Costco that sell discounted DVD s have also hurt Blockbuster, whose profits are expected to be down 71 percent this quarter. Now the firm is trying to operate online with little experience in the cyberworld. These missteps prompted Viacom chief executive Sumner Redstone to say recently that he "should have said goodbye" to the company years ago. Last week, after 10 years of majority control, Viacom finally spun off its interest in the movie-rental chain.
Nor has supermarketer Wal-Mart made much of a go of DVD-by-mail. Wal-Mart moved into the online rental market in 2002, undercutting Netflix with a $17 monthly fee and the expectation that its retail know-how would put the flimsy little start-up to shame. But Wal-Mart, which has a smaller DVD library and is slower to deliver than Blockbuster and Netflix, has had little impact. "For Wal-Mart, this is just another line of business," says Kishore. Indeed, Netflix subscriptions have grown from 700,000 to 2.3 million since Wal-Mart entered the market. "Customers come to us to watch DVD s, then they go to Wal-Mart to buy them," says Hastings, who believes Netflix can be to movie lovers what Starbucks is to coffee lovers. "Our role is to embody the love of movies."
To that end, Netflix, whose subscribers each rent an average of seven movies a month, has developed a ratings system to recommend movies to them. Roughly 70 percent of Netflix rentals are from its library, whereas the bulk of Blockbuster's business is in new releases. To build up its library and increase store traffic, Blockbuster will begin buying customers' DVD s and video games for store credit later this year.
Turnover. Still, Netflix is not without problems. The firm said last week that its churn rate--the percentage of customers who leave and are replaced by new subscribers each month--will probably be at the high end of expectations for the latest quarter. It costs Netflix about $38 to sign up each new subscriber, and marketing expenses have already driven down profits.
The day is also coming when neither the car nor the mail will be fast enough to deliver DVD s. Still, video-on-demand won't come soon or easily. "We're looking at years before downloading movies from the Internet to your TV really makes sense," says Kishore. For now, it still takes nearly as long to download a movie as it does to watch one. Plus, movie studios want to be protected when it comes to profits and piracy, and those issues are unresolved. There's also not much incentive to help the TiVos of the world. A DVD, for example, makes most of its profit during the first three weeks on the market. "With the money the studios are making from DVD s, they're going to be very careful," says McAlpine. "There has never been a better reason to keep the [release] window right where it is."
This story appears in the October 18, 2004 print edition of U.S. News & World Report.