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Things seemed bleak for Netflix (NASDAQ:NFLX) a little more than year ago. The company had set the world ablaze after going public in 2002, revolutionizing the movie-rental business with the convenience of home delivery and postage-paid mailers.
Juggernauts threatened to rain on Netflix's parade. Blockbuster (NYSE:BBI) was committed to extending its offline dominance to the online world, while Amazon.com (NASDAQ:AMZN) had launched a similar service in the United Kingdom.
The very threat of Amazon's entry forced Netflix into a cruel margin-chomping price war. It slashed four bucks off the monthly price of its most popular subscription program, allowing movie buffs to have as many as three DVDs out at any time for just $17.99.
In January of 2005, Netflix spooked the market by announcing that the price of competitive pressures was too great. It would post a loss for the quarter and for the year as a whole. The share price tumbled into the single digits in the following weeks. In Netflix subscription terms, two shares would have been good for a month of service.
Say hello to my little friend
Companies this innovative don't just curl up and die, and Netflix had a few things going for it. In order to speed up delivery, it had opened dozens of low-overhead regional distribution centers, allowing the company to provide overnight access to most of its customers through regular postal rates.
Traditional video-rental chains like Blockbuster and Movie Gallery (NASDAQ:MOVI) had localized access, but they were failing their customers. From their limited selection of titles to the inconvenience of starting your car four times to complete a round-trip transaction, the competition began to look obsolete next to Netflix.
It didn't help Netflix's rivals that Movie Gallery was burdened with debt and other woes after swallowing the Hollywood Video chain. And though Blockbuster pursued Netflix's business, it troubled its antsy creditors in the process, cannibalizing in-store sales for the pursuit of the online business, and arguably bludgeoning its bottom line by scrapping late fees.
As for Amazon, the threat was real, but there was no way the e-tailing giant would enter the market at such low price points. Amazon's time to strike also passed, as Netflix grew from more than 2.2 million subscribers at the time to roughly 5 million today.
Netflix also bounced back to profitability far quicker than even most optimists had expected. The company isn't perfect, but its speedy recovery helped the stock of this turnaround story more than triple from last year's lows.
I think this is the start of a beautiful friendship
The future is bright for Netflix. Critics may argue that the company is a ticking time bomb waiting for the proliferation of video on demand, but who's going to light the fuse? Offerings have improved in functionality and selection, but they may never replicate the DVD advantages of special features and bonus goodies.
Netflix knows its customers well. The company's proprietary software feeds off information provided by its community of users to deliver relevant recommendations. Few competitors can duplicate anything like that.
Netflix also enjoys various advantages of scale. Because it goes through so many discs, it can allow subscribers to purchase overstocked titles at $10 or less apiece, giving movie buffs cheap used discs while making more from the sale of excess inventory than it would have fetched elsewhere. Reaching millions of affluent customers also put Netflix in the sweet spot of hiring an interactive-entertainment ad executive from Time Warner's (NYSE:TWX) AOL to launch an ad sales program last year.
The Netflix model and its established network of efficient distribution centers can be easily tweaked to move into other media like video games. The company has long denied an interest in that sector, but it's one of many cards that Netflix can play if it ever needs to.
Come with me if you want to live
I've been a Netflix shareholder since the fall of 2002. After a stock split, my cost basis is in the single digits, and I wasn't the only one to be enamored with the model so soon.
David Gardner recommended the shares to Motley Fool Stock Advisor newsletter subscribers a few months later. He suggested that readers cash in after the stock had nearly tripled, but once more recommended the shares after their price dipped to attractive levels early last year.
Netflix's ability to deliver its flicks so quickly is celebrated as speedy turnaround. The company's stock? It can also be celebrated for completing a speedy turnaround. Sometimes, it seems, good things come in red packages.
Netflix , Amazon.com, and Time Warner have all made the cut as active Motley Fool Stock Advisor recommendations. To see all of the recommendations, click here for a free trial.
Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and investor since 2002. He is a member of the Rule Breakers newsletter team. The Fool has a disclosure policy .
