Netflix, Blockbuster, and Video-on-Demand

22 Jan 07

Back in April of 2004, Reed Hastings, Netflix’ CEO, announced that the company would provide a video-on-demand (VOD) service in 2005.   Hastings maintained that the company had always intended to provide VOD services – the use of DVDs and the assistance of the U.S. Post Office was an interim step towards a disk-free future.

On January 16, 2007 (two years late), Netflix announced that its VOD service was finally available.

''This is a big moment for us … I have always envisioned us heading in this direction. In fact, I imagined we already would be there by now.''

Reed Hastings, Netflix CEO, in The New York Times, 16 Jan 07.

  Netflix subscribers will be able to choose from about 1000 titles, and the service will stream the movies to personal computers.  There will be no additional charge for the service, but the number of hours of VOD movies you can watch will depend on your current service plan – 18 hours per month for most current Netflix subscribers, fewer hours for those with the basic plan.

Netflix’ “Watch Now” Service

          Netflix expects to spend an extra $40 million in 2007 on its streaming service, which does not please stock analysts.  They are downgrading their ratings on the stock, and its price is down more than 12 percent in January alone. 

But Netflix has prospered during a tumultuous time in the business that it pioneered.  Over the last three years:

·        Netflix has increased its subscriber base from around two million to over 6 million households;

·        Wal-Mart entered the business and then withdrew (it now recommends Netflix);

·        Blockbuster entered the business, and now has about 2 million subscribers.

Netflix earned about $12 million in net profits in the third quarter of 2006.  Blockbuster, on the other hand, lost about $10 million in the same period. Netflix’ market capitalization is $1.5 billion.  Blockbuster’s is half that, at $780 million.

Netflix’ current position demonstrates the enduring value of being first. Most analysts and investors expected the company to crumble when brand names like Wal-Mart and Blockbuster both entered the DVD-by-mail business.  Netflix stock lost 75 percent of its value during the course of 2004, in expectation that these big names would soon dwarf Netflix in the business that it had created.  

That didn’t happen.  Instead, the company rebounded and tripled its subscriber base in the period.   With this large base, and the recent launch of its “Watch Now” service, Netflix becomes the dominant company in VOD as that technology begins its slow migration to the mainstream.   There are other competitors in the business, with names like CinemaNow, MovieFlix, Movielink, and Vongo, but none of them have anywhere close to the reach of Netflix.

VOD, of course, is still in its early days.  As is the case with many emerging technologies, its appeal is quite limited.  There aren’t many movies to choose from -- Netflix offers 70,000 titles on DVD, as opposed to 1000 on VOD.  Movie studios release their newest and most popular titles on DVD, so the quality of these 1000 titles is not very high – think “B” movies and some classics like “Amadeus” and “Bridge on the River Kwai.” 

And most of Netflix subscribers aren’t all that interested in the service.  Few people currently watch movies on their PC – television is the preferred medium.  And, because the movies are streamed rather than downloaded, subscribers can only watch movies when they are connected to the internet.

But Netflix’ “Watch Now” service allows it to reposition the threat from VOD, as a technology that undermines DVD-by-mail, into an additional distribution channel for the company.  And the VOD business should have even lower operating costs than DVD-by-mail -- there are no people or postal services involved in delivering movies on the internet.  

Blockbuster is innovating too, but it’s going in the other direction.  The company launched its “Total Access” program in the fourth quarter of 2006.  This allows DVD-by-mail customers to exchange their DVDs at Blockbuster stores rather than mail them in.  Blockbuster is integrating its 8500 rental stores as another distribution channel for its subscription business. 

“Total Access” is a wonderful program for subscribers, since it gives them immediate access to movies at the store for no charge.  Since launching the program with an aggressive marketing and couponing campaign on 1 November, the company has been able to increase its subscriber base by almost 50 percent --  from 1.5 million on 30 Sep 06 to 2.2 million by 1 Jan 07.  Its stock price has also gone up more than 30% over this period.

As Harvard Professor Clayton Christensen has noted, disruptive technologies are usually developed by new entrants.  Netflix’ “Watch Now” service demonstrates a phenomenon that has historically been quite rare in commercializing innovation – a dominant company introducing technology that undermines its existing business model. 

“Investors are rightfully scared of single-model companies.”

Netflix CEO Reed Hastings, in The New York Times, 16 Jan 07

Blockbuster is trying to make the best use of the fixed assets and established procedures that it has, which is the more common response of established firms to new technologies.  It’s hard to see, though, how Blockbuster’s service can profitably compete with the very low distribution costs of video-on-demand.

More information:

1. The New York Times’ story on Netflix’ new VOD service, published on 16 Jan 07, is here.
2. Blockbuster 3q earnings report, with a description of its total access program, is here.
3. On Saturday, 20 Jan 07, The New York Times published an interview with Blockbuster CEO John F. Antioco.  That’s here.
4. I wrote a couple of previous updates on Netflix in 2004.  One, on Netflix and VOD, is here.  Another, on the competitive dynamics in the industry, is here. 

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