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Looking for Mr. Hastings' 'Tipping Point'

6 Feb, 2006 By: Kurt Indvik

Yeah, we got a few letters recently about Reed Hastings and his statements regarding taking down the brick-and-mortar rental model. Some of them aren't very friendly toward Mr. Hastings, who might be advised not to be seen wandering the aisles of the next VSDA convention without some sort of professional protection.

But facts is facts, and when you have Netflix increasing its revenue in 2005 by 36% to $688 million in what is arguably a flat rental market, then someone is losing money. Netflix grew its subscriber base by 60 percent in 2005 to a little more than 4 million paid subscribers, with an eye to boosting that to 5.9 million by the end of 2006. That was considered a modest goal, since at least one analyst I read believes that as many as half of the 65 million households who rent videos in the U.S. could eventually migrate to a rent-by-mail model.

I am not sure about that, but what we do know both anecdotally and through consumer polls is that Netflix has been attracting the most lucrative part of the market; the heavy renter. The person who is an eclectic renter, interested in more than just the latest hit releases, and who has a lengthy queue of requested titles. How much they have been disenchanted with some of the issues surrounding Netflix handling of customer queues (for which Netflix recently reached a tentative settlement in a class action lawsuit) can't be known, although the online rentailer's churn rate has remained fairly steady. That's a customer brick-and-mortar retailers need to figure out how to keep happy.

But how about the not-so-heavy renter? Netflix is pushing its two-out $9.99 plan to lower activity customers to see if encouraging them to downsizing increases their satisfaction level as a customer. Anecdotally, this is certainly an issue Netflix has to consider. We hear of customers who let their discs languish by the TV, waiting to be played, knowing full well there's no immediate need to watch or return them. No matter how cheap the plan, at some point some infrequent renters may question the value of the plan based on the convenience of letting DVDs age by one's TV.

As Netflix penetrates deeper into the U.S. video renting market, where most are not heavy renters, it'll be interesting to see if it can maintain its 4% churn rate, even as its customer acquisition costs have risen.

But make no mistake, there appears to be plenty steam left in the Netflix engine that's rolling across the home video landscape. If its goal is to grow market share at the expense of brick-and-mortar rentailers, at what point does Mr. Hastings' “tipping point” occur and we begin to see store closures on some sort of noticeable scale?

I'd be interested to hear from brick-and-mortar rentailers what they have heard from their customers about Netflix and what, if any, strategies they have for counteracting the Netflix effect.

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