The Future of Netflix… uncertain

Blockbuster launched their online service during my troubles with Blogger, so I didn’t get a chance to pitch my $0.02 into the din of analysis. With the Blogger issues fixed, it’s on with the show…

Aside from Netflix’s new RSS Feeds, the only critical difference I see between Netflix’s service and Blockbuster’s is Blockbuster’s ability to use their physical points-of-presence to solve one critical hole in NFLX’s business from a customer perspective: instant gratification. (Anyone who uses an online DVD rental service has probably experienced this pain… all your CDs are either watched or in route to or fro, and you’re “jonesing” for a movie right now.) Blockbuster solves this elegantly (enough) by giving its online subscribers two free in-store rentals a month (hoping that they’ll make it up when you by a couple of used DVDs, popcorn, or an extra flick.)

Netflix could counter by building out its own stores or placing kiosks in retail locations of a partner (hey, your local grocery store already has a bank, Starbucks and Krispy Kreme outlet)… but that seems highly unlikely.

Rather, NFLX has been telling analysts that it will stay quasi-virtual (ignore those small non-retail distribution centers), and pursue the emerging VOD (video on demand) opportunity, with an initial offering planned for sometime in 2005.

VOD, with sufficient bandwidth, solves the instant gratification need nicely… even more so than Blockbuster’s in-store rentals. Not only do you not have to worry about your favorite title being out of stock, you also don’t need to schlep out in traffic, rain, snow or dead of night oh so prevalent in life these days. Sounds great!

Only one problem, of course… the last mile between the computer and your TV set, the latter of the two likely not having IP connectivity, and equally likely a sufficient distance away from a PC (or Mac) that consumers will be disinclined to run RCA wires to & fro.

And so, NFLX needs a hardware solution to bridge the gap. Old rumors about a hook-up between Netflix and Tivo have recently surfaced again. Tivo is in fairly dire straights (I did a case analysis on them a few months back as part of my MBA work, which I’ll spare you) and clearly needs any help it can get, but that hardly makes them the right partner for Netflix. Sure, they have a couple million units in the field, used by a complimentary audience that already values time shifting, instant gratification and convenience… but they’re a small fish in a big ocean with little marketing muscle and no competitive advantage (verses the cable and satellite companies build DVR into their boxes, let alone Microsoft et al building software solutions for PCs).

A different (and perhaps better) approach would be a more aggressive model, emulating the cell phone and DSL worlds. That is, Netflix could provide a hardware bridge, something akin to Apple’s Airport Express (but focusing on RCA video & sound jacks vs. printer ports) that could relay content from the PC to the TV, subsidizing the cost by requiring a subscription commitment (6, 12 months, again, ala cell phones and broadband). Higher end consumers could pay a minimal incremental upfront fee for a device that also had S-video, component video, etc. This would seemingly have a nice secondary effect of helping to address NFLX’s growth limiting churn rates (last I heard, they were north of 80%, reminding me oh so painfully of our challenges at PointCast).

But this points out another problem. Netflix currently generates its earnings (limited though they are) based on buffet economics. That is, the model works because of delays created by mailing (day 1 receive/consume, day 2 return, day 3 receive/process/ship, day 4 receive/consume, repeat) even in “1 day turn-around” zones, resulting the average Netflix subscriber consuming approximately 6 DVDs a month. Customers like myself, who at times consume as many as 9 to 12 DVDs a month, put the same fear into Netflix as a 400 pound NFL lineman rolling into an all-you-can-eat Chinese buffet.

And so, Netflix instead might have to offer that free hardware bridge in conjunction with a commitment from user’s to download a certain number of movies over a certain period of time, mixing the cell phone model with that of Columbia House/BMG.

And that brings us to the near term end game issue (disregarding the recent speculation as to whether or not Netflix even has the rights to distribute movies online – I’d hardly be surprised after watching the movie co’s form Movielink and destroy early co’s like Intertainer)… suddenly, if Netflix is just a video version of iTunes, we know that the economic value is not in the distribution (unless of course, you’re the content/IP holder), but rather elsewhere in the value chain, and will likely be “won”, at least initially by whomever creates the best turnkey solution (iPod/iTunes, AOL mid ‘90s, etc) and by whomever can extract value from the customers in other ways.

So where does that leave Netflix? Certainly not in a seemingly happy place; and like its alleged partner-to-be, Tivo, without a clear competitive advantage.

So where is the opportunity? I’ll definitely have to give it more thought, but my gut says partner or acquisition. Who would be suitable?

TimeWarner seems like a possibility. Marketing Netflix to AOL’s 25MM+ users (without the affiliate fees) would add a lot of marketing muscle. TimeWarner is a big content owner, with deep enough libraries that other content owners would be better advised to cooperate with vs. fragmenting the rental market. And of course, their cable operations drop Tivo-like boxes and cable modems into millions of households. Only problem… they already have several VOD initiatives.

Apple itself, or any manufacturer of “home entertainment PCs” (HP, Sony, Dell, etc) is also a possibility. They’re already fighting the last mile battle, and all are working to earn share of wallet amongst personal and pro-am content publishers (Apple’s core), who a) could get extra value from a solution that allowed them to stream content from their PC to entertainment devices, and b) buy higher margin hardware, software and peripherals.

One thing’s for sure… Netflix’s success is hardly guaranteed as it battles on multiple fronts (i.e., its current and future business models). And yet, having met many of their folks, and knowing them to be smart and scrappy, my fingers are crossed that they’ll find the answer and win the day.

That’s my opinion. What’s yours?

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