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Netflix CFO Tells Analysts Software Is Key

19 Mar, 2003 By: Holly J. Wagner

Proprietary software is the engine that will drive growth for Netflix, the company's CFO told a group of analysts at a Dana Point, Calif., roadshow.

“If you want to compete with us in the category we created, we believe you have to be a great software company also,” Netflix CFO Barry McCarthy told the group. “We are not a distribution company, we are a software company, and great software is what makes it possible for us to operate at the margins we have. ... It's what makes it possible for us to rent 97 percent of our content.”

Competitors like Blockbuster Video and Wal-Mart don't worry Netflix executives, because they believe brick-and-mortar companies are ill-equipped to compete in by-mail rentals. Ditto for video-on-demand (VOD), because “it would cost at least 10 times the shipping cost of DVDs to stream the same volume of data,” McCarthy said.

Netflix, co-founded by software engineer Reed Hastings, was the first to create software to accommodate DVD rental by mail, and even its imitators admit there is no off-the-shelf program available to facilitate the model. That forces even established potential competitors to develop fill-in gaps in their systems to take on Netflix.

“If we continue to grow the category, then I expect to have competition. I expect it to come from companies like Amazon and Yahoo,” McCarthy said. “The dilemma for a company like Yahoo is they don't own anything and we own a lot of DVDs. For Amazon, they do a great job form remote locations shipping a lot of stuff one way.”

The trick, McCarthy said, is closing the loop: No other business is equipped to manage 100 percent returns.

Netflix ships a million DVDs a week to its subscribers and hopes to grow 30 percent per year to make that a million discs a day by 2010, McCarthy said. The key is distribution centers, which cost about $60,000 each to open but have no inventory costs.

Responding to questions, McCarthy said Netflix has no plans to expand to game or adult video rentals.

“If the [video] games manufacturers would agree to rev-sharing of content, we would consider moving into the game rental space,” he said. “On the other hand, our company mantra has been focus, focus, focus.”

McCarthy made his comments following a glowing introduction from a representative of conference host Roth Capital Partners, which initiated coverage of Netflix March 14.

“If this company can be half as successful in the rest of the United States as they have been in the Bay area, then analysts' projections, including my own, are conservative,” he said. The company set a $20 target for Netflix's stock price, which seemed to respond. It closed at $18.75 March 18 after apparently getting a kick from the analysts' comments, besting its previous 52-week high of $18.19.

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