Is Netflix Settling for Wal-Mart?

At first glance, it looks like a great deal. Online DVD rental first-mover (and Motley Fool Stock Advisor recommendation) Netflix (Nasdaq: NFLX  ) takes over Wal-Mart's (NYSE: WMT  ) tiny DVD rentals service and, since no cash exchanged hands in the process, gets an estimated 100,000 subscribers essentially for free. These are also likely to be higher-margin customers -- they probably rent fewer movies since they have been willing to put up with Wal-Mart's notoriously slow delivery times. But look beneath the surface, and this move could portend major trouble for Netflix's long-term value.

First, the deal wasn't exactly free. The two companies agreed to advertise each other's complementary services for an unspecified period of time. But who's the real winner here? When I logged into my Netflix account over the weekend I was greeted by huge banner advertising Wal-Mart's cheap DVDs. This is the first time such advertising has appeared on Netflix.com; the company has, until now, been adamant about keeping a very clean brand.

Of course, the deal does go both ways: The DVD rentals section of Walmart.com now guides customers toward Netflix. But is that portal as valuable as it might seem at first? Even with a lower price point in the last two years it has managed to attract only an estimated 100,000 or so subscribers.

Second, and more troubling for long-term holders, it's quite possible this development means there is no deal with Amazon.com (Nasdaq: AMZN  ) in the works for Netflix. Amazon.com is the real partner of value in this race with its coveted IMDB.com movie database and significantly lower customer acquisition costs. After all, it was the prospect of Amazon.com entering the market that prompted Netflix to drastically slash its prices last October and sacrifice profits for customer growth.

My worry is that any deeper deals with Wal-Mart.com mean that Netflix is essentially settling for second best, having been unable to secure an attractive deal with Amazon.com. Also, if Netflix is advertising for Wal-Mart, it also makes any future deals with Amazon.com harder to work out. How can Amazon.com justify partnering with a company that urges its subscribers to buy their DVDs from their top competitor, especially when there is a viable alternative -- Blockbuster (NYSE: BBI  ) -- that does not?

If the Wal-Mart cross-promotion does end up being a deal breaker for a future Netflix/Amazon.com pairing it will be a shame. I've always thought that Amazon and Netflix were a great fit -- aside from the complementary products, the two companies have much in common that should cause their CEOs to see eye-to-eye. After all, Netflix is doing for movie rentals what Amazon.com did for book sales.

But if it wasn't meant to be, partnering with the world's largest retailer will have to do.

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Fool contributor Marko Djuranovic owns shares of Netflix and no other company mentioned in this article.


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