Netflix looks to future but still going strong with DVD rentals

FREMONT, Calif. -- Most of the nearly 200 associates are nearing the end of their 4½-hour shift. Since 3:30 a.m., they have ripped open about 175,000 red envelopes, inspecting each returned DVD to make sure the correct disc was returned, then cleaning and boxing them up to go to the automated sorter.

Within a flash, each Netflix subscriber will get an e-mail announcing a disc's return, along with a notification later that day of what's coming next.

For 10-year-old Netflix, what's next is Internet delivery. Netflix envelopes and radio ads tout "free" online movie viewing for subscribers. Netflix CEO and co-founder Reed Hastings doesn't think his 58 distribution centers are in immediate danger of becoming obsolete, but he knows that day will come.

He believes DVD rentals have four to nine years to keep growing, despite inroads in Internet delivery of movies to set-top TV boxes and other video-on-demand options.

"Over the next five years, there will still be a lot of consumers who don't have broadband and prefer the simplicity of discs," he says. "A lot of people say DVDs have seen its best days, but we see it as a growth product."

Indeed, in the midst of a recession, Netflix has reported record subscriber growth and revenue at a time when DVD sales fell 8% in 2008 and are projected to fall 9% this year.

Netflix says it has 10.3 million subscribers, up from just over 8 million a year ago. It reported revenue of $394 million in the first quarter, up from $326 million in the year-ago quarter and $360 million in the fourth quarter.

Citigroup analyst Mark Mahaney agrees that for all the hoopla over new media formats and streaming video websites such as YouTube and Hulu, there's still enormous demand for DVDs. "People love the functionality of discs," he says.

Additionally, he says, there's no "great" mass market streaming option yet.