July 30, 2008, 12:00 AM

Netflix casts the die for a future tied to digital entertainment

Netflix is migrating away from a pure movie rental subscription shop and into a digital services entertainment company. But the majority of revenue will still come from its subscription business, CEO Reed Hastings is telling Wall Street analysts.

Netflix is making progress toward its goal of migrating away from a pure movie rental subscription business and into a digital services entertainment company.

But the transition won’t happen overnight and for at least the next five years Netflix sees the majority of revenue coming from its core subscription business, CEO Reed Hastings told Wall Street analysts on the company’s second quarter earnings call. “We think that DVD by mail will continue to grow for five to 10 years, despite overall DVD rental flatness, as e-commerce continues to grow generally and as video store economics force more store closures,” Hastings told analysts. “As we expand more into streaming, we are improving our core consumer proposition of unlimited enjoyment for a low monthly fee by combining unlimited DVDs by mail with unlimited streaming.”

Netflix, No. 17 in the Internet Retailer Top 500 Guide, is investing heavily in digital content and in developing relationships with consumer electronics and other brand manufacturers. In mid-July Netflix teamed with Microsoft Corp. to begin offering digital movies and television shows on Microsoft’s Xbox 360 consoles. The deal gives Netflix access to an audience of more than 10 million Xbox 360 users.

In May, Netflix also introduced the Netflix Player by Roku, a $99 device that enables users to view movies and shows whenever they want, for no additional fee beyond their monthly subscription. “Our goal is to have our streaming software integrated into Blu-Ray players, game consoles, connected DVDs and standalone Internet devices,” Hastings told analysts. “Our substantial streaming content, available to consumers on an unlimited viewing basis makes it attractive for consumer electronics companies to integrate our streaming software because it increases the attractiveness of their devices and we promote their devices to our large subscriber base.”

Netflix, which has another relationship with LG Electronics, says the deal with Microsoft will be its only exclusive arrangement. “We were willing to do an partnership in the game console segment because of the very large installed base of 10 million households that Xbox has developed,” Hastings told analysts.

Over the last 18 months Netflix has expanded its digital entertainment offerings from 2,000 to 12,000. But the digital entertainment portion of its business will take time to build, Hastings said.

In the meantime, Netflix will continue to concentrate on its DVD subscription business. “The rise of DVD rental kiosks shows that the DVD franchise is still very strong with mainstream consumers,” Hastings told analysts. “In the long-term, we think it is likely that DVD by mail and DVD rental kiosks will continue to increase their share of the DVD rental market at the expense of stores.”

In Q2 Netflix reported an 11.1% increase in revenue to $337.6 million from $303.7 million in the second quarter of 2007. GAAP net income rose by 3.9% to $26.6 million from $25.6 million in the prior year.

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