August 28, 2003, 12:00 AM

Now playing: Netflix shows how to be new-age web entrepreneur

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Two years ago, he notes, the average length of time a customer remained a subscriber was one year. “Now it’s about 1-3/4 years,” Hastings says. “The longer the better.”

Digital delivery

Within 10 years or so, the distribution of movies to the home will likely occur electronically, as increased bandwidth and digital compression technology cuts the time it takes to electronically receive a full-length movie to about 10 minutes, Rashtchy says. It would take over an hour with current technology, he notes.

Whether electronic delivery of movies occurs through cable TV or the Internet, or both, Netflix will be in a position to play a major role, Rashtchy says. It would likely get directly involved in Internet distribution once that becomes more feasible and in demand, but its subscriber base alone would be valuable to a cable distribution system as well, he says. If future digital movie distribution takes off through cable TV systems, he adds, Netflix could command a hefty premium for use of its subscriber list by a TV network operator.

In addition to its growing subscriber base, Netflix is making other subtle moves that could help it play an important role in the future of movie distribution. Its board members, for example, include Michael Ramsay, co-founder, CEO and chairman of Tivo Inc., a service that lets people automatically record TV programs on a special DVD-playing system. If TV does indeed play a bigger role in distributing movies, Ramsay could help find a way to leverage Netflix’s expertise, such as its movie recommendation service, in adding value to a TV-driven market. “Netflix is setting itself up to have long-term value,” Rashtchy says.

Rashtchy notes that Netflix could make a good partner for, the movie industry’s own startup system of digital distribution. Hastings says Netflix is not cooperating with Movielink, which offers a limited selection and requires users to have high bandwidth and the latest computer system upgrades, but adds that he’ll watch how it develops and leave open the possibility of a role for Netflix. “It’s expensive to pioneer a new market, so we’re glad they’re willing to do that,” Hastings says.

In the meantime, he figures Netflix has its hands full trying to continue growing in the U.S. DVD rental market. Other potential markets on the Netflix horizon include Europe and a broader range of entertainment products, Hastings says. But analysts suggest that it may have to secure its patent through court action to provide for an easier foray beyond DVDs.

Patenting the process

Netflix’s patent covers the process by which it sells and distributes products as well as methods of using computers to channel customers’ requests for DVDs. Because Netflix’s model is based on distributing DVDs from a broad base of DVDs pre-selected by customers-instead of having to find and ship specific DVDs for each order-it can manage its inventory with a high degree of efficiency. Combined with the market reach and self-service advantages of operating online, Netflix’s distribution method is key to its ongoing success whether it deals in DVDs or other products, Rashtchy says.

“Every patent has to be upheld in court, so Netflix will probably have to sue other retailers for infringing on its patent, then the courts will have to decide if its patent is too broad or should be upheld. If the courts uphold it, it could be significant for Netflix,” Rashtchy says. He adds that a favorable court ruling could help Netflix get established in new product markets. “If Netflix can get this upheld, they can use their process for other types of products like books, music and games,” he says.

Further possibilities

Indeed, Netflix’s patent points out that it is designed to also apply to products other than DVDs, such as video games. But it may have to act soon to build a market share in the game rental business, which others have already entered. Gamefly Inc.’s offers rentals of video games for $19.95 per month under terms similar to Netflix’s DVD program, and Blockbuster lets customers sign up on for its $19.99 monthly Freedom Pass for games rented through its stores.

But whether Netflix will seek legal action to enforce its patent remains to be seen, Hastings says. “We’re studying our options,” he says. “Our main focus is on providing a great customer experience. That’s how you win as a consumer brand.”

And if it succeeds in building its brand, Netflix will be in a position to withstand challenges from price-cutting competitors, analysts say. “That’s how Amazon became a successful brand, by satisfying customers at a decent price,” says Majestic’s Preissler. “Netflix won’t have to be the lowest price in the market.”

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