These are trying times for Netflix (NASDAQ:NFLX). The video rental giant's shares have surrendered nearly 40% of their value since peaking back in April. Between last week's rollout of Amazon.com's (NASDAQ:AMZN) new Unbox service and Apple Computer's (NASDAQ:AAPL) likely entry announcement tomorrow, the fear is that digital downloading will kill the Netflix model.
I don't agree with that theory. Naturally, as a Netflix shareholder, it's the last thing I'd want to have happen, but I don't think I'm just seeing through rose-colored glasses. Throughout its history, the Netflix model has frequently been underestimated. You don't make Wal-Mart (NYSE:WMT) say "uncle" and hand you its puny subscriber list if there isn't something special in the recipe. You don't find a company like Blockbuster (NYSE:BBI) tripping over its blood-red financial statements just for the luxury of being a distant second in your niche. How soon the market forgets.
The ads have it
It's been a year since Netflix hired Peggy Fry away from AOL to head up a new ad-selling department, and the new sponsored initiatives are beginning to bear fruit. With more than five million subscribers, the company is processing roughly a million transactions every single day. Netflix was slow to cash in on its mailers as a sponsored gateway, but those days are changing.
This summer, my Netflix mailers have started coming with colorful ads for things like upcoming theatrical releases and cable television shows. Last week I even received a bright 10% off coupon on all Dell (NASDAQ:DELL) televisions. Advertising may never fully subsidize the cost of the mailings, but it's a move worth respecting, even if it merely offsets a piece of the overhead.
It doesn't end there, of course. In June, the company began selling ads on its site. According to Alexa.com, Netflix.com ranks 204 out of the millions of established websites, in terms of traffic. Yes, traffic has slipped at Netflix over the past few months, but the same is true for the websites of rivals like Blockbuster and Amazon.
The centers of attention
One key to Netflix's popularity is its network of regional distribution centers that allows it to deliver the vast majority of its titles within a single business day for the cost of basic postage.
Although Netflix is focusing on celluloid at the moment, this positioning could allow the company to cash in on the delivery of other forms of media. Yes, I know I've been saying this for years. And for years Netflix has turned a blind eye to niche operators like Gamefly (with video games) and Simply Audiobooks (for audiobook CDs). At this point, it's easy to ignore the specialized sites. Netflix knows that it is a flip-switch away from burying the competition. I would be surprised if Netflix doesn't enter the console and audiobook market in a few years, and that's to say nothing of trickier markets like music CDs and software.
The point is that Netflix is a well-oiled machine, and transplanting its success in the DVD rental market over other media formats is a real possibility
Understating the obvious overstatements
In the music biz, where compressed files are just a few megs thick, digital downloading has been a slam dunk. Naturally, given the nature of video quality, video files are much larger and compression is more critical.
Companies have been offering movie downloads for years. It will be a few more years before they become mainstream consumables, but it will happen. How can it not? But downloading films currently takes a couple of hours at best; the DVD burning process is tedious (when it's even allowed); and the end user is still missing many of the conventional DVD offerings, like special features and commentary tracks. It's a very incomplete solution, despite the aggressive pricing.
Until we get to the point where full-length feature downloads are a bit more conventional, Netflix has the time to expand its business model. It's been securing film rights to independent releases and making its sites stickier as it turns its recommendation database into a multimedia piece of flypaper. Judging the role that Netflix will play in the Hollywood of the future is not possible until we see what the company's wingspan will look like in a few years.
So good luck, Amazon. Bring it on, Apple. It may be showtime, but we're still a few reels away from the feature presentation.
Dell, Amazon, and Netflix are all Stock Advisor recommendations. Wal-Mart is an Inside Value newsletter pick.
Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and shareholder -- since 2002. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. T he Fool has a disclosure policy.
