The Motley Fool: One thing during yesterday's conference call that was intriguing was your CFO. With Blockbuster (NYSE:BBI) not releasing its metrics on how its online rental business is doing his model speculated that while your subscriber acquisition cost ran about $36, Blockbuster was running closer to $50, which may have come as a surprise when you figure that Blockbuster has all these stores. It would seem it would be cheaper to acquire customers. Do you know what went into that model or how that number came about?
Reed Hastings: Sure. At various times, Blockbuster has quantified how much money they have spent in their $100 million of new initiatives on advertising. I believe that their right number that they quantified it as over $60 million spent on advertising. So I am sure it is derived from some estimates of that $60 million and how it was spent. A more high-level way of saying it is Blockbuster in Q4 both promoted in the store and promoted online, and it is going by their stated estimates of what they spent externally.
The Motley Fool: During yesterday's conference call, the company said that Netflix (NASDAQ:NFLX) expects to have 70% of the online market by the end of the year and in another statistic earlier in the conference call that it online rentals is projected to be an 8-million-subscriber market by the end of 2006, so growing by, in essence, 40% next year. Do you expect Netflix to still have 70% of the market by the end of 2006 or more or less or still too early to tell?
Reed Hastings: You know, we haven't really given any guidance on 2006. Four million is our own number of what we intend to be at by the end of this year. The 8 million that I referred to was Adams Media Research, which is one of the respected market analysts, of which is the total size of the market.
The Motley Fool: During the conference call it was said that in hitting that 4-million-member mark, the level of profitability will depend on how closely you get to that mark. Does that imply that if you are not getting close to 4 million by the end of the year that another price cut is likely?
Reed Hastings: What we said is for materially off the trajectory to the 4 millionth subscriber, we would look at increased marketing, lowering prices, or other measures to keep our leadership of this market that we invented strong.
The Motley Fool: Reed, in our previous conversations with you, you have said that Netflix plans to lead the downloading market. You have also gone on to say that the company is named Netflix and not DVD-By-Mail for a reason. When do you think downloadable movies or video-on-demand will become the norm?
Reed Hastings: Well, let's see, there have been flavors of video-on-demand by cable systems for about 10 years, and there have been flavors of video-on-demand over the Internet, legal ones, from Cinema Now, from MovieLink, for two or three years. The question is when you say, "becomes the norm," let's interpret that as "becomes the major economics profit driver for the studios."
The Motley Fool: Right.
Reed Hastings: I don't know, somewhere between 10 and 50 years away. The reason is because DVD is so powerful for the studios and DVD sales in particular. It is now generating over half of the studio's revenues. We believe that the studios will continue to protect the DVD-exclusive window on new releases against VOD (video-on-demand) for at least the rest of this decade and perhaps even longer.
The Motley Fool: Talk a little, if you can, about what video-on-demand might look like moving forward as we get past that next decade. Am I downloading a movie like an MP3, or am I playing a film through my cable box?
Reed Hastings: You will be doing both. Cable systems offer VOD, at least digital cable. The penetration right there will grow. It is around 30% or 40% of households have access to VOD today. Those will climb to the 70% or 80% penetration. With satellite, it will be more of a download to the DVR model and cash in the house. With Internet delivery, it will be a mix of both; both real-time delivery for households that have a big enough connection and then download and advance more like satellite for those that don't have a real-time connection.
So you will see all of those variations competing, which will be great for the studios because they will make a lot of money. It will be great for film producers, and consumers will have more options than ever. What we have seen over the past 25 years is filmed entertainment go from an $8 billion market. It used to be movie theaters only. Today it is over $30 billion in revenue. That growth is because there are more channels, more competition and more choices. I see that continuing and rising to an over $40 billion market in a few years because of the more channels and more choices.
The Motley Fool: Speaking of those more channels, what prevents digital cable companies from providing hundreds or even thousands of films as opposed to just the hundred or so today?
Reed Hastings: Well, there are two parts. One is the remote control, which is pretty ineffective for sorting through thousands of titles. Two is some, a few systems do offer thousands of titles and the problem is they are all older movies, My Fair Lady and things, and there is not that much demand for those older titles. The new release titles are exclusively on DVD for a time period. We don't see that DVD-exclusive window changing because that window is actually in the studio's best economic interest.
Stay tuned for Part 3 tomorrow. Did you miss yesterday's installment? Catch up here .
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Mac Greer is radio producer for the Motley Fool Radio Team. Rick Munarriz is a member of David Gardner's Rule Breakers analytical team, seeking out the next great growth stock early in its stage of defiance.
