POST OF THE DAY
Netflix
It's Still About the Cost

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By Newsman
August 4, 2004

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We know that Netflix, with its low cost structure, is break-even with about 2 million online subscribers at $20 a month -- if it's spending heavily to promote new signups. And at $22, it's profitable.

Let's not forget the long list of Blockbuster disadvantages. Here are just a few:

1. High fixed costs -- thousands of high-rent local stores AND the additional cost of whatever parallel direct distribution infrastructure they choose to create. Those costs stay the same while they transition some of their customers to lower-margin buffet model service.

2. Large startup losses -- Blockbuster must invest in DVD inventory, IT, and marketing, subsidizing the servicing of the first several hundred thousand customers while it scales up its online operation. It seems unlikely that Blockbuster could do anything but lose money on this niche for two or more years. Meanwhile, Netflix is able to book profits and enhance its scale economies and therefore, margins.

3. Retail business cannibalization. Every retail Blockbuster customer who goes to the online subscription plan stops paying her share of the retail store base costs, while simultaneously renting the same or more movies as before. Online customers don't buy high-margin extras such as popcorn or candy, either, probably the idea behind the two free in-store rentals. Bottom line, every local renter who moves to the online buffet plan goes from a highly profitable customer to a money-losing customer for Blockbuster, a double hit to the income statement.

4. A large organization's lack of agility. Blockbuster must get tens of thousands of employees on board with an quantum shift in the company's way of doing business. You can expect pushback, confusion and disillusionment as a result. Netflix is more nimble and can adapt faster, and for the moment, they just have to keep executing rather than change their corporate culture. This comes at the same time that Blockbuster is spinning off from Viacom as an independent company.

5. A high debt load. In addition to debt on the balance sheet of about half a billion dollars, they just agreed to borrow another billion dollars to pay out a special dividend, most of it to Viacom as a goodbye kiss. The lease obligations on their retail locations across the country constitute an enormous off-balance-sheet debt. Netflix is debt free with $150 million in cash in the bank and generating free cash flow every quarter.

6. Brand image problem. Blockbuster has allowed its brand to become the company that will stick it to you on late fees and offers slack customer service by unmotivated employees. Wal-Mart is the low-cost leader in everything. Netflix is the movie rental company that loves movies as much as you do and gives you the convenience, selection and value you want.

7. Fuzzy marketing message/lack of business focus. What is Blockbuster? A traditional video store? A buffet video store? An online rental service? A place where you buy and sell used DVDs? A place where you buy new DVDs? It becomes hard for Blockbuster to mean anything in particular to a customer. Customers have to wade through an endless array of choices to find a product that meets their needs. Even better, these internal products all compete with each other for each Blockbuster customer. Netflix is the Internet service that sends all the movies you want to your home for $22 a month.

7. Worse positioning for VOD than competitors, including Netflix, cable companies and services like Movielink. Again, that legacy store base of theirs is an albatross. They probably could license their brand to another VOD provider and make some coin, though.

8. Marketing Blockbuster's subscription plans validates and raises awareness of this business model, meaning Netflix spends less of its marketing time convincing customers that it's not a wacky way of renting movies.

9. Starting three laps behind Netflix. Starting one lap behind a discount retailer not even formerly in the space.

--Newmsan


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