Netflix looks to future but still going strong with DVD rentals
FREMONT, Calif. -- It's 7 a.m. here at the Netflix nflx shipping facility that serves half of California.
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.
Amazon and Apple are Netflix's two main competitors in streaming videos to TVs from the Web, via set-top boxes. Netflix also works with set-top boxes, plus Blu-ray players from LG and Samsung and the Microsoft Xbox 360 video game system.
Amazon and Apple charge more for movie rentals, at about $3.99 apiece, while Netflix's on-demand films are free to subscribers.
Apple has new flicks such as Gran Torino and He's Just Not That Into You, and Amazon touts Slumdog Millionaire and Marley & Me. Netflix — which has more than 100,000 titles available via mail, including current hits — promotes mostly older fare for instant streams, such as Hancock and Braveheart.
Hastings won't say exactly how popular the online streaming is but says it's seen "phenomenal" usage. "We've got millions of subscribers using it and are very happy, but the DVD is growing faster." He admits the titles aren't up to par with the competition but says for now he "can't afford" to pay the higher prices the studios request for newer movies.
Hastings believes offering both mail rentals and free streaming gives subscribers "the best of both worlds — that's our differentiator. You can get streaming and the backup of 100,000 titles on DVD."
Netflix's main competitor, Blockbuster, offers a rental-by-mail option, although it's far behind Netflix. Meanwhile, up-and-comer Redbox is aggressively putting its vending machine rental program into supermarkets and drugstores. Redbox has only a handful of titles in machines, compared with Netflix's vast selection. "Redbox is growing substantially, but it's not much of a threat to Netflix," Mahaney says.
An edge in customer service
Hastings' attention to customer service is acclaimed, with quick DVD turnaround and instant e-mails announcing returns and upcoming titles.
He'll soon be paying $1 million to programmers looking to collect the "Netflix Prize," a contest aimed at improving the effect customer ratings will have on other subscribers.
Meanwhile, Netflix's eventual move to digital distribution will mean dramatic cost savings — no more physical discs, envelopes, postage or large employee base to staff his distribution centers.
Now, the company has distribution centers in every state except the Dakotas. Subscribers know that if they return a disc on Monday, they can expect to have something new by Wednesday. The company recently added a sixth day of operations, with Saturday processing.
At the centers, after the envelopes are opened and processed, the discs are scanned by a huge automated machine, to determine whether they are going back out that day or returned to the library. If they are going out, they're rescanned and labeled — at which point the e-mail goes out to the subscriber announcing which new disc can be expected the next day.
"Ten years ago, when we started, it was a bunch of us sitting around card tables, stuffing and licking envelopes," Hastings says. "It was pretty chaotic. Then we added bar coding and got better with our automation."
As orderly as the operation is, Hastings isn't satisfied. He's still investing heavily in it.
"The facility is horribly inefficient compared to how we want it to be and where it will be in three years," he says.
Exactly what he has in store is "top secret," he says, but does admit that the processing of the discs could be improved for more consistency. "I'd like to see us move from 99.5% correct to 99.9% correct. That may sound easy, but it isn't."