Netflix, Inc.

views updated

Netflix, Inc.

970 University Avenue
Los Gatos, California 95032
U.S.A.
Telephone: (408) 399-3700
Fax: (408) 399-3737
Web site: http://www.netflix.com

Public Company
Incorporated: 1997 as NetFlix.com, Inc.
Employees: 495
Sales: $152.8 million (2002)
Stock Exchanges: NASDAQ
Ticker Symbol: NFLX
NAIC: 532230 Video Tape and Disc Rental

Netflix, Inc. is the world’s leading DVD (Digital Video Disc) rent-by-mail company. The firm has more than 1.1 million subscribers who typically pay a monthly fee of $19.95 for unlimited rentals, provided they have no more than 3 discs out at one time. The company offers more than 15,000 titles and maintains an inventory of more than 5 million discs. To speed delivery, Netflix has opened more than 20 regional shipping centers around the United States, and most DVDs are received by customers a day or two after ordering them on the company’s Web site. More than a third of the publicly traded company is owned by Jay Hoag’s Technology Crossover Ventures.

Beginnings

Netflix was founded in Scotts Valley, California, in August of 1997 by Reed Hastings and Marc Randolph, both veteran “new technology” entrepreneurs, 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 one-time math teacher Hastings had founded Pure Software, which he had recently sold for $700 million. Hastings, who supplied the firm’s startup cash of $2.5 million, had reportedly hit upon the idea for rental-by-mail when he was forced to pay $40 in fines after returning an overdue videotape of the film 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 the year and less than a thousand titles were then available. Although the hardware needed to play DVDs was fairly expensive and owned by relatively few Americans, Hastings and Randolph thought the disc had the clear potential to replace 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 very cheaply. 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.com (with a capital “F,” as the name was originally rendered) promised to virtually guarantee 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.

The company opened for business on April 14, 1998, with 30 employees and 925 titles for rent, which comprised nearly the entire catalogue of DVDs in print. The firm offered some “soft-core” Playboy titles but shied away from hardcore 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, the company sponsored a sweepstakes to win an “L.A. Weekend” all-expense-paid trip to Los Angeles 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 up. 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 later.

Two-Cent Clinton DVD Sells 10,000 Copies in 1998

The company got 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, though 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 it would stop selling DVDs, directing customers interested in purchases to the Web site of e-commerce heavyweight Amazon.com, 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 which 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, though prices remained high and only 1 percent of U.S. households owned the devices.

In January 1999, NetFlix began partnering with online movie information provider All-Movie Guide, which would direct people looking up a title NetFlix carried to the firm’s Web site. March saw well-known film critic Leonard Maltin sign 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, NetFlix CEO Reed Hastings announced the company had secured $30 million in new financing from Group Arnault, a French luxury goods investment firm that was also 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 now emerging, and the Group Arnault backing was seen as crucial to establishing NetFlix’s dominance of the DVD rental category. Shortly afterwards, the firm announced a new cross-promotional initiative with Musicland Stores Corp., as well as plans to offer free rental coupons in the box of most new DVD players sold. The summer brought good news when electronics chain Circuit City announced the abandonment of DIVX, a limited-use DVD rental program that it had backed but which had found little support among consumers.

Subscription Plan Introduced in September 1999

In late September, NetFlix introduced a new service, the Marquee Program, which allowed members who paid $15.95 per month to pre-select four DVDs, with no late fees or due dates. Customers could also rent new discs each time they returned one and put themselves in a queue for checked-out titles in which they were interested, much as a library had an advance reservation system for popular books. CEO Hastings commented that the new program was possible because the company had achieved the economics of scale, with 10,000 orders processed each day by its own proprietary software system. Despite its growing popularity, for fiscal 1999 the company reported losses of $29.8 million on revenues of only $5 million. Like many Internet startups, 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 a new service, Cine-Match, which compared rental patterns among its customers and looked for similarities in taste, using this information to 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, the company changed the Marquee Program to offer unlimited rentals for $19.95 a month, with a maximum of four titles out at a given time, though 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 $86.25 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. CEO Hastings characterized the firm’s future goal as moving beyond DVD rentals to streaming video, stating, “What NetfFlix is about is owning a transition stage as rental converts to video-on-demand.” During the year, the company continued to expand, with more than 7,000 titles available by year’s end to a customer base of 250,000.

Company Perspectives

Netflix (Nasdaq: NFLX) is the world’s largest online DVD movie rental service offering more than one million members access to more than 15,000 titles. Our appeal and success are built on providing the most expansive selection of DVDs, an easy way to choose movies and fast, free delivery.

Revenue Sharing Agreements Signed in 2000

In December, 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 gave NetFlix 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 and Artisan, 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 a recent arthouse 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 like Blockbuster, and the company 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 a thousand titles in this category, and these 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 that they didn’t already know.

During the winter of 2001, NetFlix secured additional venture capital funds, and CEO Hastings began predicting profitability by the fourth quarter of the fiscal year, when the company’s subscriber base was expected to reach 500,000. During the spring, the company began offering a free six-week trial membership via the popular movie information Web site the Internet Movie Database and began selling off overstocked titles through retailer Wherehouse and e-tailer Half.com. In September, NetFlix partnered with electronics and DVD retailer Best Buy to create a co-branded DVD rental service in the company’s 1,800 stores and on its Web sites. Best Buy also owned several other retail chains, including Sam Goody, Media Play, and Suncoast.

Following the September 11, 2001 terrorist attacks, the company’s monthly subscription rate doubled, due as much to fearful Americans seeking refuge at home as 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.

Initial Public Offering in 2002

In February 2002, NetFlix announced 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 a 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. In conjunction with the IPO, the firm also quietly amended its name to Netflix, Inc., making the “F” lower case. The money was targeted to paying down $14.1 million in debt and covering promotional expenses.

Earlier in the year, the firm had opened new regional distribution sites near Los Angeles and Boston to speed delivery to those areas. These had quickly proven their worth, and by June other sites were open in the Atlanta, Denver, Detroit, Houston, Minneapolis, New York, Seattle, and Washington, D.C., metro areas. Netflix spent approximately $60,000 on each site for computers, bar-code scanners, and printers, and the centers were set up to handle 50,000 orders per day. The locations were situated so that the firm 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, 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, and when an order for an out-of-stock disc was received the firm’s computers would find the closest location of a copy and automatically generate a shipping order to forward it.

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

Key Dates

1997:: NetFlix.com, Inc. is formed in California by Reed Hastings and Marc Randolph.
1998:: The company begins offering DVD rentals and sales.
1999:: Sales are halted; Group Arnault invests $30 million in the firm and a subscription plan debuts.
2000:: Revenue sharing deals are signed with Warner Brothers and Columbia film studios; CineMatch is introduced.
2001:: A partnership with Best Buy 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 1,000,000, and Netflix has its first profitable quarter.

As Netflix garnered more media attention and its subscriber numbers soared, the competition began to heat up. Over the summer, arch-rival Blockbuster began to offer an unlimited, no-late-fee subscription service for DVD rentals in some stores and bought an online DVD rental company which was renamed FilmCaddy. Netflix was also being targeted by retail behemoth Wal-Mart, which had started its own unlimited online DVD rental service. It was priced at $18.86, undercutting Netflix by just over a dollar. Wal-Mart claimed it had 12,000 titles available, comparable to what Netflix then offered. Another major player, Columbia House, was reportedly eyeing a similar plan as well. With these threats, and with Netflix’s subscriber cancellation rate, or “churn,” inching upward, the company’s stock price dropped by more than half.

Responding to these challenges, Netflix announced it would open a dozen more distribution facilities by the end of 2003, servicing major metro areas like Chicago, Dallas, and Portland, Oregon, with overnight delivery. The firm was targeting 5 million subscribers by 2009 and had plans to begin distribution to Canada in the near future. Annual figures for 2002 showed double the previous year’s revenues, $152.8 million, and losses of just $1.56 million, a dramatic improvement over 2001. The subscriber churn rate was also dropping, to 6.3 percent for the final quarter of the year. The company was now spending $33 to acquire each new member, which compared favorably with America Online’s more than $100.

One Million Subscribers in 2003

Netflix hit the one million subscriber mark in February of 2003, by which time it had also opened five additional shipping centers. Its stock price was on the rebound and in the spring hit $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 mid-summer, the company had more than 1.1 million subscribers and a library of 15,000 titles to choose from.

After more than five years in business, Netflix, Inc. was still in growth mode, only just having turned the corner to profitability and still fending off challenges from several heavyweight competitors. It had the advantage of an early start, a strong distribution system, customer loyalty, and the newly received patents for its software programs. The company was also starting to look like one of the rare e-commerce firms that would establish itself as a permanent part of the business world.