TMF: Reed, let's consider the next five to seven years. I want to present you four competitive offerings and get your view on them. I would love it if you would rank these for us: Blockbuster
Hastings: Which are the most threatening to Netflix?
TMF: That's right.
Hastings: OK. Most threatening is piracy, second most threatening is Blockbuster, third is Wal-Mart, and fourth is video on demand.
TMF: And why is video on demand such a small threat, in your opinion?
Hastings: Well, because it is much more an opportunity for us. We named the company Netflix and not "DVD By Mail" for a reason, which is we plan to lead the downloading market and over time we will offer both DVDs by mail and downloading. The consumer will be able to choose. Some will prefer downloading to the TV and to the computer; some will prefer getting a DVD by mail because it is portable. They can play it in the car, on the airplane, etc. So we intend to lead both of those sectors. So that is why I look at VOD as more opportunity than threat.
TMF: You listed piracy -- services maybe like Kazaa and others where people can come in and download sometimes-rough versions but a full-length movie -- as No. 1 on that list. I am not sure whether you would consider that a very serious threat or not, but certainly Napster and Napster-like services have hurt the music industry.
Hastings: I think it is a very serious threat, again, over the next five years, not necessarily next year. But over time, if the culture takes hold that no one pays for movies and everyone just steals them, then that is going to hurt the entire industry. There will be less movies made. It will be dramatic. So it is very much in the entire industry's and in the retailer's interest to avoid that. Netflix is one of the services that is a piracy-inhibitor basically because it is such a good value. If for $20 you can rent unlimited movies, your incentive to do piracy is a lot less.
TMF: OK. Are there any specific steps that you expect to be taking as the CEO of Netflix to combat piracy head-on?
Hastings: No. I think the real focus for us is to provide a great legal alternative that is cost effective, has incredible selection, and in that way lessen the incentive for piracy.
TMF: Reed, given your success, is it possible that studios will begin wanting a bigger share of retail profits?
Hastings: Studios always want a bigger share, whether we are successful or not -- they want a bigger share of the movie theater's profits, they want a bigger share of Wal-Mart's profits. That is a healthy and creative tension. They recognize that new channels often bring in new customers. What we have seen over 25 years is growth in the movie market from about $6 billion 25 years ago when it was the movie theater only to nearly $30 billion last year when there is rental, sell through, pay-per-view, all of the different channels and that they really tend to reinforce and grow each other. So the studios have been very supportive of us. Not because they love us particularly, but because they are always supportive of new channels because that creates more revenue for them.
TMF: There has been serious innovation in the provision of entertainment services in America over the last 10 years. How do you think the movie-viewing and movie-making experiences are being changed by all these new services?
Hastings: Movie-making hasn't changed that much. Obviously there is digital cinematography, and that helps to a certain degree. But the film expense is small compared to the actors and the setup of the sets and all of the promotion aspects. On the consumption side, the big change has been home video. Home video is now 59% of the studio's revenue and 41% is everything else combined: the movie theater, pay-per-view, TV, etc. Home video has gone from nothing 20 years ago to essentially 60% of studio revenues. That is a phenomenal engine. DVDs... only about 50% of households have it today. So, we are looking at another doubling as DVD grows, and I think you will see that DVD just becomes a monster success over the next five years.
TMF: Changing gears now, yours is one of the few growing technology companies to begin expensing stock options. Have you received any backlash from other technology companies for breaking from the ranks?
Hastings: No, I think we are in pretty good company with Amazon
TMF: Speaking of Amazon.com, have you ever had any thought about maybe veering away from traditional stock option grants and going more towards the restrictive stock units?
Hastings: We have and we stayed with stock options. We think they are preferable from the employee's point of view because in restricted stock, when the restrictions lapse, then there is tax immediately due, which essentially forces through some sales. That is not true with option vesting. So we believe that stock options are better for the employees.
TMF: OK. We are going to put you on the spot, Reed. Tell us something that might surprise us, something that we don't know about Netflix. It could be corporate culture, what people are wearing, what the work hours are like. It could be an aspect of customer experience that we may not be aware of.
Hastings: We take all of the salaried employees of Netflix to the Sundance Film Festival each January. So we are quite a force there in Park City, if you guys ever get out there. It is part of celebrating the love of film and building that within the culture of Netflix.
TMF: Great. What do people wear on a daily basis when they come to work at Netflix?
Hastings: Clothes. (Laughter.)
Tomorrow: key aspects of the Netflix business model that investors must monitor.