The Great Race: EBSCOhost

The Great Race: EBSCOhost 6/01/23, 5:15 a.m.
Título: The Great Race. De: Cohen, Alan, Sloane, Julie, FSB: Fortune Small
Business, 15473171, Dec2002/Jan2003, Vol. 12, Fascículo 10
Base de datos: Business Source Complete
The Great Race

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BATTLE ROYAL
NO STARTUP HAS CASHED IN ON THE DVD'S RAPID GROWTH MORE THAN NETFLIX.
NOW BLOCKBUSTER AND WAL-MART WANT IN, CAN IT OUTRUN ITS BIG RIVALS?
REED HASTINGS PLANS TO tower over his competition, but right now, on this Friday morning
in Silicon Valley, he's towering over his employees. It's the weekly state-of-the company staff
meeting at Netflix, the online DVD-rental service that Hastings founded, and the 41-year-old with
the hipster goatee is up on a bench outside company headquarters, and he's on a roll. In his
affable yet cocksure way Hastings is skewering Wal-Mart, which has been testing a service
that's a dead ringer for Netflix's own. Wal-Mart's test website is supposed to be hush-hush--
indeed, the service wouldn't be announced until the following week--but Hastings found the
super-secret address and signed up. What he hasn't been doing, he happily tells the employees
gathered around him on the grass, is watching any movies. "Most of the titles I looked for were
not in stock, and the ones I ordered still haven't shown up nearly a week later." The crowd
erupts in laughter, and presumably relief.
For all the levity, Hastings is going through what many entrepreneurs before him have
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experienced--great idea, great timing, and, now that the public has vindicated the business,
heavyweight competition. Not only has Wal-Mart entered the market, but Blockbuster is testing
not one but two Netflix-like DVD-rental programs; Columbia House has announced that it will
probably start a similar service; and others are sniffing around too. Hastings sees himself as
Rocky up against Apollo Creed. The twist is that he doesn't mean the Rocky from the first
movie--where the underdog puts up a good fight against the champ and loses--but Rocky from
the sequel, in which the fighter tells the champ to bring it on and then pummels him. "There are
two scenarios," Hastings says: "This is a niche we own, or it's a contested large market. I would
much rather have the latter."
But now that Netflix has company, what's next? More of the same, according to Hastings, who's
so sure of his business model that he has no plans to stray from it. Hastings has been dead-on
about the DVD market so far, but that market--and its players--are still evolving. For Netflix to
stay on top, it must do more than hope its rivals remain as clueless as he depicts them today.
One has to wonder whether Hastings sees the light at the end of the tunnel or just has tunnel
vision.
Netflix is one of the most talked-about dot-coms today because of two traits Hastings displayed
on that lofty perch: a confidence so big it can be spotted from outer space and the canny, quiet
planning that underpins it. Hastings likes to portray Netflix's birth as a no-brainer. Back in 1997,
while the rest of us were still fumbling with our VCRs, the math teacher turned multimillionaire
software entrepreneur became convinced that DVDs were the home-video medium of the future.
He raised $120 million, attracted hundreds of thousands of customers, and took the company
public last May, garnering another $90 million. No sweat. What Hastings doesn't dwell on are the
trials he went through to make his business appear to be a no-brainer. How he tried more than
200 different mailing envelopes before finding the one that let him safely ship DVDs without
spending more than the cost of a first-class stamp. Or how he built the first version of his site
with $2.5 million earned from his last business and won customers before going out and seeking
venture capital.
Hastings's calculated gambles would seem to have positioned Netflix as a big winner in the DVD
boom, one of the fastest-growing consumer electronics markets ever. Some 742,000 movie
buffs today (up from 334,000 a year ago) pay Netflix $19.95 per month to feast on its enormous
buffet of rentals: art films, Hollywood blockbusters (and duds), old TV shows, documentaries
that never made it past Sundance. The result: some boffo box office. Revenue in the third
quarter was up 116% from the year before, to $40.7 million from $18.9 million. And although
Netflix has yet to turn a profit, it narrowed its quarterly net loss to $1.7 million from $5.6 million.
If anybody can make it in the face of ferocious competition like Wal-Mart, Hastings and his
young company are as good a bet as any. For one thing, Netflix isn't your typical dot-com with a
good idea and a short shelf life. In fact, it's more like the dot-com that watched all the other
dotcoms come and go, and learned exactly what not to do. "What no one realizes, except
maybe Blockbuster, is that Netflix is a complicated software company masquerading as a DVD-
rental service," says Mike Schuh, a general partner in Foundation Capital who invested $6
million in the company in 1999. "Its film-recommendation software, its merchandising, and the
inventory-control systems are sophisticated. It isn't that they couldn't be replicated, but they're
hard to do, and it'll take a lot of money, time, and commitment to get it right as Netflix has."
And Hastings isn't your typical dot-com entrepreneur either. Sure, he may look the part, walking
around Netflix's home base of Los Gatos, Calif., wearing a Netflix polo shirt, ready to discuss the
merits of his service with every dog walker and café patron. He has the requisite cockiness
down too, jumping into the shark-infested waters of consumer entertainment services after just
one corporate gig -- helming Pure Software, a company that built software tools for computer
programmers. But Hastings knows that the company is more than him. He built a reputation at
Pure for hiring topflight executives who could fill in the gaps in his own management expertise,
something he has repeated with Netflix. He's already recruited Leslie Kilgore, former director of
Amazon's U.S. marketing, as Netflix's vice president of marketing, and Ted Sarandos, vice
president of content acquisition, who was in charge of product and merchandising for Video City,
a 299-store chain. Netflix's investors see more in Hastings too. "He's a deep technologist, but he
has tremendous sensitivities to the nuances of a market and how to create a go-to-market
strategy around a product," says Tim Haley, a partner of Redpoint Ventures, who consulted at
Pure and was Netflix's first outside investor.
NETFLIX ALSO HAS SOME KEY strategic advantages over its competitors. It's up and running
nationwide while the others are still feeling their way around. Blockbuster's in-store subscription-
rental program, called DVD Freedom Pass, has been active for only a few months and in just
five markets (New York City, Houston, Phoenix, Seattle, and Salt Lake City). In addition, the
Dallas-based mega-renter is experimenting with an online Netflix clone called Film Caddy, which
debuted in October. Wal-Mart and Columbia House are expected to launch their services
officially early in 2003, and both plan versions that mimic Netflix step by step, with online queues
for desired discs, no late fees, and postage-paid return envelopes.
Hastings & Co. have the advantage of experience as well. In its four years Netflix has tweaked
the inventory-management software so that new orders are automatically generated even as the
old orders are returned, and all 12 distribution centers can be polled before a customer is told
that the movie he wants next is out of stock. It has made revenue-sharing deals with 50 film
distributors (including most of the major studios), giving it its large inventory of 12,000 titles,
dwarfing the 7,000 to 8,000 available at Blockbuster's largest stores. (That does come at a price:
Netflix shared 19.2% of its subscription revenues with partners in the second quarter.)
In FSB's spot checks, Netflix consistently had titles in stock that Wal-Mart's site didn't (but never
vice versa). And although Blockbuster stores testing Freedom Pass had plenty of copies of big
Hollywood hits available, they carried far fewer lesser-known titles--art films like Kissing Jessica
Stein or Croupier; those were usually checked out. Of course, anyone who's ever faced a wall of
Mr. Deeds already knows this, and Hastings is counting on that to pitch his service over
Blockbuster's in-store program. "If they launch in the stores, we emphasize our customer service
and broad selection."
Hastings revamped Netflix's distribution model this past year in an effort to improve customer
service with faster delivery times. The service started with just one warehouse in San Jose but
began building regional mailing centers (it now has 11) when it noticed that its customer base in
the Bay Area was five times higher than its national average. "Customers in San Francisco got
their movies in one day." Hastings explains. "Customers in New York got them in four." The
regional centers have already had a significant impact: Netflix has experienced a surge in
popularity in cities such as Boston and Sacramento that are now within one-day mail distance of
a Netflix distribution center. Blockbuster's Film Caddy site ships all DVDs from a central
warehouse in Mesa, Ariz.; Wal-Mart from its main fulfillment center in Carrollton, Ga. Hastings
sees this as proof that his rivals have discovered the market but not the logistics needed to win
it. "Wal-Mart won't be competitive until they've got 25 shipping centers like we'll have by the end
of 2003," he says. Wal-Mart spokesperson Cynthia Lin says the company has no plans to use
regional distribution points, but Columbia House president Brian Wood is more open to the idea.
"Right now we have one warehouse in Terre Haute, but if it takes multiple warehouses, we'll do
it," he says.
DESPITE ITS EARLY LEAD, NETFLIX faces steep odds moving forward as it goes up against
these giants. Can it change the entrenched customer behavior of going to the video store? Is it
possible for the startup to outspend Blockbuster and Wal-Mart on marketing? Or beat them on
price?
The biggest threat Hastings faces is the size of the online DVD-rental subscription service
market itself. Hastings's plan is to grow the Netflix subscriber base from 742,000 customers to
five million in the next five to eight years, a target he claims is conservative. "Five million
subscribers is $1 billion in revenue but just 10% of the total rental market," he says. Hastings's
nonchalance aside, five million subscribers is stunningly ambitious. Blockbuster estimates the
total potential online market to be between two million and three million subscribers. And Netflix
own growth, while impressive, doesn't seem to justify Hastings's optimism. With just over 100
million households in the U.S., Netflix would need to be in about 5% of homes to hit his target.
But even with subscribers more than doubling in the past year, the percentage of households
using the service inched up from 0.57% to 0.63%.
Hastings cites Blockbuster's in-store program as his biggest worry--and with good reason. "It's a
big threat," he says. "It's instant gratification." Indeed, Blockbuster's own surveys show that for
90% of its customers, the gap between the time they decide to rent a movie and the time they
actually rent it is four hours. Hastings, who relies on the Postal Service to deliver his product,
would have to trade in his stamps for a fleet of Concordes to match that time frame. And
Blockbuster's Freedom Pass looks headed for a national launch in 2003. "On average, we're
making more in revenue and profit dollars on subscription customers than we did on them
before they joined the program," says Karen Rafkopf, Blockbuster's senior vice president for
corporate communications.
If Netflix is to keep growing it needs to persuade new customers that it's okay to wait for their
movies. And that's going to take a lot of marketing. Thus far Netflix has been relatively frugal,
spending $34 to acquire a customer. The company claims that 70% of new subscribers come
via referrals, some primed by cheap Internet marketing; signup offers included in DVD-player
boxes and a partnership with Best Buy make up the rest. An aggressive marketing push could
be a financial drain on a company that has yet to turn a profit. And Netflix already has one strike
against it: The service isn't immediately understood. "We spend three of every four marketing
dollars trying to explain how it works," says Leslie Kilgore, Netflix's vice president of marketing.
Blockbuster, with 5,000 stores and 48 million customers, is in a more enviable marketing
position. While Netflix relies largely on word of mouth to educate customers, Blockbuster can
pitch its subscription service every time a customer stops by for a Saturday-night movie.
Retaining customers may prove as challenging as finding them. Netflix's turnover rate has
averaged about 7% a month for the past two years. Although Hastings downplays that number
as insignificant--and so far the company has more than made up for the losses with new
subscribers--he's concerned about low-volume renters. "The people who watch just two movies
a month may realize that they don't use us enough to justify the price." So he has steadily been
investing time and money to boost rental rates (the average Netflix customer rents five movies a
month). He thinks the company's proprietary CineMatch software, which takes ratings that
customers assign to movies they've rented and suggests others (significantly, it won't steer you
to an out-of stock title), is the key to holding on to customers. "Over half of our rentals come
through the recommendations system," Hastings says. "It really keeps users active."
CAN NETFLIX MAKE IT? THERE'S certainly precedent: Who would have bet that Intuit would
succeed as a software company, especially when Microsoft challenged it? But questions abound
for Netflix in addition to its fierce competitors. The DVD market itself is still far from established.
With satellite and digital cable growing, the ever-nascent video on-demand industry seems to be
showing signs of life, which would give home viewers a cheap--and instant--DVD alternative.
And studios have been loading DVDs with lots of extras, marketing them as collectibles, so no
one knows how much their burgeoning sales will eat into rentals.
Hastings not only dismisses these scenarios as unlikely, but also rejects natural extensions for
his business such as game rentals. Hastings has had that luxury because his early investors
have given him free rein. But Netflix is now a public company, and shareholders have been
voting with their feet. Its stock has been battered with the news of its bigfoot competition, dipping
below $5 a share shortly before Wal-Mart's announcement. As of early November, the stock had
rebounded to $9, still well below its high of $18.19. The low stock price makes Netflix an
attractive acquisition candidate, but Hastings, with an intense fervor, denies he would sell.
Hastings no doubt sees his competition doing the one thing he's not: hedging their bets.
Blockbuster has its stores, its site, and even a video-on-demand deal with DirecTV; Wal-Mart
and Columbia House, their retail and forthcoming rental operations. Point that out, however, and
Hastings gives his now predictable shrug. "The only way to build a successful business is to
make a bet that some macro trend will happen." And Hastings is betting big.
How Netflix Works

The startup firm is a complicated software company disguised as a DVD-rental service. The six-
step process behind every rental.
DAY ONE, 9 A.M

At Netflix.com, customer picks movies he'd like to see and the order he wants to receive them
in, then returns any he has now in a postage-paid mailer.
DAY TWO, 9 A.M

DVDs received by the closest of Netflix's 12 regional distribution centers, all of which are located
near a large post office to expedite delivery.
DAY TWO, 9 A.M.-11 A.M.

Employees scan disc to indicate it's been returned; the computer then looks up what movie
you're due next and prepares it for shipping.
DAY TWO, 11 A.M.-1 P.M.

The trucks are loaded up with outbound DVDs and head off to a nearby post office. Some 95%
of discs come in and go out the same day.
DAY TWO, 2 P.M.

Post office receives the Netflix mail and sends it out. Netflix is most popular in cities one day
away by mail in each direction.
DAY THREE, 4 P.M.

Customer receives latest Netflix shipment and can keep it for as long as he likes with no late
fees. The record is more than three years, for The Mummy.
Netflix vs. Blockbuster

The upstart has a long way to go to catch the giant.
PRODUCT MIX Netflix differentiates itself from the corner Blockbuster by pushing its selection of
older titles, keeping customers renting even when there's nothing new.
NETFLIX
30% new releases

70% back catalog
BLOCKBUSTER
70% new releases
30% back catalog
SOURCE: USB PIPER JAFFRAY
ANNUAL REVENUE (2001) Netflix is growing more than 100% from 2001, but Blockbuster's
rentals are up as well, as are its sales, which Netflix doesn't focus on.
NETFLIX: $76 MILLION
BLOCKBUSTER: $5.1 BILLION
CUSTOMERS Netflix wants five million customers in the next five to eight years. Blockbuster
sees only two million to three million customers in the online market,
NETFLIX: 742,000
BLOCKBUSTER: 48 MILLION
SOURCE: COMPANY FINANCIALS
The Power of Netflix

Using its CineMatch recommendation software, Netflix has successfully driven rentals of lesser-
known films, far outperforming big hits, and winning it clout with the studios.
MONSDON WEDDING: 10%
AMELIE: 8%
(percentage of total U.S. rentals for each title.
MAJOR HOLLYWOOD MOVIES
THE FAST AND THE FURIOUS: 2.2%
OCEANE'S ELEVEN: 4.2%
(percentage of total U.S. rentals for each title.
SOURCE: NETFLIX
The Booming DVD Market

Netflix has capitalized on the boom through deals with manufacturers to insert a trial offer in new
DVD boxes, a major source of new customers.
GRAPH: PERCENTAGE OF U.S. HOUSEHOLDS WITH A DVD PLAYER
GRAPH: DVDs POPULARITY FUELS PRICE DROP
PHOTO (COLOR): Reed Hastings Will staying the course keep Him from getting crushed?
PHOTO (COLOR): Leslie Kilgore Can she explain Netflix to newbies without draining the
company's earnings?
PHOTO (COLOR): Ted Sarandos Can he keep the selection of DVDs broad and deep?
~~~~~~~~
By Alan Cohen
Reporting by Julie Sloane
©Meredith Corporation 2002. All rights reserved. No part of this material may be duplicated or
redisseminated without permission.
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The Great Race: EBSCOhost 6/01/23, 5:15 a.m.

Base de datos: Business Source Complete

The Great Race

for desired discs, no late fees, and postage-paid return envelopes.

How Netflix Works

DAY ONE, 9 A.M

DAY TWO, 9 A.M

DAY TWO, 9 A.M.-11 A.M.

DAY TWO, 11 A.M.-1 P.M.

DAY TWO, 2 P.M.

DAY THREE, 4 P.M.

Netflix vs. Blockbuster

30% new releases

SOURCE: USB PIPER JAFFRAY

NETFLIX: $76 MILLION

BLOCKBUSTER: $5.1 BILLION

SOURCE: COMPANY FINANCIALS

The Power of Netflix

MONSDON WEDDING: 10%

(percentage of total U.S. rentals for each title.

MAJOR HOLLYWOOD MOVIES

THE FAST AND THE FURIOUS: 2.2%

OCEANE'S ELEVEN: 4.2%

(percentage of total U.S. rentals for each title.

The Booming DVD Market

GRAPH: PERCENTAGE OF U.S. HOUSEHOLDS WITH A DVD PLAYER

GRAPH: DVDs POPULARITY FUELS PRICE DROP

Reporting by Julie Sloane

redisseminated without permission.

Para tutoriales, materiales de apoyo y capacitación, acceda a: http://bit.ly/ayuda-ebsco

administrado por EBSCOhost

© 2023 EBSCO Industries, Inc. Todos los derechos reservados.

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