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Netflix CFO: No Download 'Eco-System'

9 Mar, 2006 By: Erik Gruenwedel

While Netflix CEO Reed Hastings has previously declared war on video stores, CFO Barry McCarthy last week told an investor conference in San Francisco he was “delighted to see [Blockbuster Inc.] grow strongly” in the online space.

“They're making good progress in righting the ship,” McCarthy said at the Thomas Weisel Partners Internet and Telecom Conference. “They've been financially challenged and they appear to be less so, so credit the management team.”

That said, the CFO said he had expected Blockbuster Online to more be more “present” as a competitor. Big Blue, he noted, had not been able to market the service since early last year and may revive marketing plans.

“The more subscribers they have online the fewer customers they will have in stores,” McCarthy said. “And the faster it will accelerate the tipping of the stores.”

He said he expects Blockbuster and Movie Gallery to collectively shutter 300 stores this year.

“Every time a store closes a portion of those customers will come online,” McCarthy said.

He said continued downward pressure of Netflix's subscription plans are designed to undercut growth of Blockbuster Online, drive earnings growth and develop a larger base for a future download business.

McCarthy acknowledged the business is headed toward digital downloads but he said a couple of “big problems” are preventing any type of an “eco-system” to grow.

“You've got to get the content and when you do it has to be better than what's on TV,” he said. “If all you are doing is replicating the [VOD] cable model that is a path to nowhere.”

The CFO said current online download services such as Movielink and CinemaNow are stymied by limited content and show no appreciable growth with less than 10% market penetration.

“I mean, who cares?” McCarthy said.

He said success of digital downloads will have to overcome basic studio economics and current cable licensing agreements. With DVD sellthrough representing a $24 billion annual business, studios considering digital downloading want to see how price elastic the market is, McCarthy said.

He said a typical download could cost a consumer $4, including $2 in content fees to the studios. However, a studio sells a DVD to Wal-Mart for $18.

“There has to be nine downloads for every DVD sale,” McCarthy said. “If you can show that will happen and if I could unlock content not encumbered by [cable] pay-per-view rights, then the studios would begin to consider how much content to license for downloads.

“But they need proof the market is that elastic. I'm anxious for it to come because it opens up borders and bunch of interesting options for the Netflix business model.”

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