Big, Bad Amazon

Why is everyone so afraid of Amazon (Nasdaq: AMZN  ) ? I mean, sure, the leading online retailer made brick-and-mortar crybabies out of companies such as Toys "R" Us (NYSE: TOY  ) and Target (NYSE: TGT  ) before they decided to let Amazon run their dot-com storefronts. On Thursday Amazon's wave of fear struck again with Netflix (Nasdaq: NFLX  ) sacrificing near-term earnings growth by shaving $4 off its basic monthly subscriber rates because it heard that Amazon was ready to ramp up a similar service. Blockbuster (NYSE: BBI  ) followed with its own price cut on Friday.

Netflix CEO Reed Hastings appeared on The Motley Fool Radio Show over the weekend and shed some light on the events that led to his company's cutthroat pricing strategy in an exclusive interview. Two weeks ago the company heard that Amazon was going to enter the DVD-rentals-by-mail business in a few quarters. When other sources confirmed the rumor, Netflix figured that its best defense would be the proactive margin-munching price cut.

While the market pounded the stock on Friday -- Netflix shares surrendered a little more than 40% of their value -- it's a move that Hastings sees as strategically necessary. Amazon is more than just a pioneer in e-commerce and a major seller of DVDs. Through its IMDB.com site, it also owns the eyeballs of many movie buffs whom a Netflix clone would be perfect for. Netflix can still turn a profit at $17.99, and this consumer-friendly move may very well double the company's customer base next year from its current head count of 2.2 million subscribers.

Hastings is serious about vanquishing Amazon before it becomes a threat. Blockbuster can afford to treat its online service as a loss leader to fend off obsolescence, but Amazon won't stick around if there isn't money to be made. Netflix is even delaying its launch into the United Kingdom until next year so it can devote its efforts to solving the matter at hand. It will also wait until 2005 to reveal the details of how it plans to team up with TiVo (Nasdaq: TIVO  ) to enter the video on demand market. Right now, those may be seen as distractions when Netflix simply wants to grow its stateside DVD rental market quickly.

Once considered a niche player by Blockbuster, the popularity and profitability of Netflix proved to be too rich to ignore. Showing that it is willing to sacrifice high margin profitability for the sake of high-profile popularity should be enough to scare Wal-Mart (NYSE: WMT  ) out of the rental game. It may also spook some potential entrants -- including Amazon.

Will lower prices win you over when it comes to DVD rentals? Will Netflix ever be able to hike its rates? Will this be enough to scare off Amazon? All this and more -- in the Netflix discussion board. Only on Fool.com.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and investor -- since 2002. He is part of theRule Breakersanalytical team that will be looking to unearth the next Netflix early in its growth cycle.


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