On a Mission to Change the Economics of Hollywood
In the mid-1990s, as the rest of Silicon Valley was dreaming up futuristic visions for the Internet, Reed Hastings was starting a firm that let people use the World Wide Web to rent an unlimited number of movies for a monthly fee.
He built his novel concept around a decidedly un-futuristic strategy, however: Hastings’ Netflix Inc. delivered discs through the mail, not downloads through the Net.
“Not many people thought that made sense,” Hastings said. “But the only time when you really succeed at a company is when you have something that most people think is idiotic and it turns out to be really important.”
Los Gatos, Calif.-based Netflix has grown faster than anyone expected. After a 30% jump in the first three months of 2004, the company has close to 2 million subscribers paying $20 a month to keep up to three Netflix DVDs for as long as they wish. Hastings, the self-assured chief executive, talks confidently of hitting 10 million.
On Thursday, shares of Netflix rose $2.02, or 6%, to $37.65 on Nasdaq.
His ambition isn’t just to make Netflix the dominant online movie rental company, but also to change the economics of Hollywood. Netflix encourages its subscribers to rate movies so it can recommend others to them. With this kind of targeting, Hastings says, Netflix can deliver lesser-known movies to the right audience, enabling the studios to take chances on more films.
Hastings recently discussed the company’s plans with The Times.
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Question: Your biggest competitor for online movie rentals has been Wal-Mart Stores Inc. How serious has the challenge been?
Answer: Wal-Mart entered the market two years ago, and there was a big ballyhoo about how Netflix isn’t going to survive. Back then we had 400,000 subscribers. Now we have almost 2 million. In Wal-Mart’s case, great company; how’ve they done online? Not very well. So the fact that we’re beating Wal-Mart is not really testament to how great we are. It’s because Wal-Mart.com is completely clueless.
The only company in DVD rental that we fear is Amazon. We have 24 [distribution] plants; they only have five. We send out about 3 million packages a week, which is higher volume than all of Amazon worldwide.
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Q: What about the threat posed by movie download services?
A: There’s a couple things to understand. The studios will protect DVD sales for as long as they possibly can because it’s now about 60% of domestic revenues, and it’s growing. When the studios sell a DVD, the average retail price is $18. They get about $15 of that. Then there’s a bunch of price points that are $4: pay per view, rental, downloading, on and on. Studios get 2 bucks, in that range.
Any smart studio exec says, “I don’t want to put out paperback at the same time as hardcover.” So that gives DVD a long-term advantage -- not a three-year advantage, but more like 10, 20. The service that wins the downloading battle is the service that can do both [discs and downloadable files], and that’s what we can do.
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Q: So when do you get into the downloading business?
A: We’ll start offering downloading sometime next year, limited selection, as much as we can do. We think there will be very limited consumer demand. But it’s good to get out there, and we should be early rather than be late.
Our view is also [that] downloading to the PC is not very relevant or interesting. We’ll [eventually] have wireless access to all kinds of devices in the living room, but in five years, it will still be 80% DVD.
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Q: Will that be download to rent or download to own?
A: Download to rent. Our view is, one subscription, 20 bucks a month, unlimited DVDs and unlimited downloads, and we just mix the two modes.
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Q: What is Hollywood’s stake in Netflix?
A: The way we’re trying to transform the movie business is not actually digital delivery per se; it’s really about creating demand. And what we’re trying to do is figure out, for each person, what are the best movies for them. We have 20,000 movies. There’s 450 new [Hollywood studio] movies each year, there’s way more than anybody can watch, and you can’t generally as a consumer figure out which ones are best for you.
The studios have this monster problem, which is they spend an ungodly amount of money marketing their movies, and because of that, it’s very homogenizing. They have to make movies that appeal to a wide range of people. Your “Adaptation”s and “Whale Rider”s fall by the wayside and you only get the big movies.
What we’re trying to do in the demand creation is really changing those economics by matching from the ratings and recommendations and the other things [users are] doing.
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Q: How many people use your recommendations?
A: Over half of the subscribers are active with recommendations, but that still leaves us half a million people who we haven’t sold the benefits to.
For most people, 1 out of 3 movies that you watch you just rave about, you love, it’s a goose-bump moment. And we look at ourselves and say we’re in an adrenaline-emotion-delivery business, like Starbucks is in the caffeine-delivery business, or R.J. Reynolds in the nicotine-delivery business. We deliver emotional jolts better than a lot of people but still nowhere near what we want to do. If we can bump that to 2 out of 3, you’ll just stop going to sports, you’ll stop watching TV because every time you watch a movie, you love it.
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Q: How much effect can you have on a movie’s popularity?
A: “Whale Rider,” which is a pretty small film, took $28 million [at the box office], and for us, it [rents comparably to] a $100-million film. So what we’re able to do is take all the midrange films that are not very successful for the studios commercially, and in our channel they perform like $100-million films, giving the titles a real second life.
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Q: Can a studio pay you to recommend its movies?
A: No. I think as long as it’s disclosed, it’s not unethical. But we have chosen not to exploit that area. You can’t buy your way into recommendations.
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Q: Will there be any future for you in renting video games?
A: Sure. We’re growing this year, about 80% year over year, so we are stretched thin. We don’t need to go into any new markets right now. But at some point, we’ll get to a certain size in the movie market and our growth will slow, and that will be a natural expansion to keep things growing at a fast rate.
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Q: Has there been any thought of changing your prices?
A: Yeah, there have been always a $15 [per-month subscription plan], a $30, a $40 and stuff. But they’re more or less specialty programs. The main thing we think about is raising prices in the $20-a-month service. We had the same price for four years. If we can charge more, we can also get more new releases in, invest more in content and build a better and better service.
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Q: What’s the ultimate alliance for you?
A: We’re hopeful that there’s an opportunity here to build an independent company for 10 or 20 years, for a very long time. If we can get [a digital connection] to the television, then we don’t need anybody else. We can deliver directly to the television and stay as an independent company for a long time. If I can’t get that unencumbered pipe, then it’s time to have alliances.
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At a glance
Netflix, the leading online DVD rental firm, charges subscribers $20 a month for up to three films at a time, with no due dates and thus no late fees.
Headquarters: Los Gatos, Calif.
Shipping centers: 24
Chief executive: Reed Hastings
Employees: 700
Rental service launch: 1999
Initial public offering: May 23, 2002
2003 revenue: $272 million
2003 net income: $6.5 million
Subscribers: 1.93 million
Titles available: 18,000
DVDs shipped per week: 3 million
Website: www.netflix.com
Source: Company reports
