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Netflix's Hastings Sizes Up Competitors

3 Nov, 2004 By: Holly J. Wagner

Netflix CEO Reed Hastings “underestimated the likelihood and significance of competition from Blockbuster and Amazon,” partially contributing to a “traumatic” year for Netflix shareholders, he told analysts Wednesday.

“What we underestimated is that there are not many $5 billion markets that are doubling,” Hastings said. “Except for what is happening in search, that is virtually the only other Internet market that we see growing at this level.”

Hastings dissected Blockbuster's nascent online effort for analysts at the Morgan Stanley Software, Services, Internet and Networking conference.

“Blockbuster is massively overinvesting relative to good economic sense,” he said, with subscriber acquisition costs “well north of $50” based on recent comments from Blockbuster CEO John Antioco.

“They talked about getting 10,000 trials a day, but had only 500,000 at the end of the quarter, which puts them at a 10 or 20 percent churn rate,” Hastings said. By contrast, Netflix subscriber acquisition costs are about $37 to $38 per new subscriber and churn rates have fluctuated between 4 percent and 7 percent. Netflix subscriptions are up and churn is down since announcing the price cut that took effect Monday, Hastings said.

The price war — in which Hastings expects a truce until Amazon announces its rumored service's launch — will be good for all online rentals in the end, Hastings said.

“We've been impressed at the elasticity of the market. At $17.99, we are getting a lot of people to sign up that might not have otherwise signed up,” he said. “We are also getting Pay TV subscribers that are shifting over because at $18 you are not only competing with DVD rentals, but with other forms of entertainment.”

Subscribers are not likely to see adult titles or video games on Netflix soon, Hastings said, because none of the online competitors rent adult material, and video games don't yet present the opportunity, although Netflix executives “periodically review” the idea. In all, Hastings seemed optimistic about the future of online rental.

“The overarching thesis is that 8 billion store-based rentals are charging online. That's what's creating this land grab is this enormous growth for both of us,” he said. “In the eventual shakeout that you get when the market stabilizes, Blockbuster stores are untenable if same-store sales continue to drop. Blockbuster is a long-term competitor. Their future is based on ‘how does the 6 billion in store-based revenue evolve? What happens to the profits on that?' If the profits come back on that business, then it can subsidize online. If the profits continue to shrink, when the eventual consolidation comes, we will be very strongly positioned.”

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