Just The Ticket

Today there are 35 warehouses around the country. Each day they receive 100,000 new movies from Hollywood studios, and mail out 1 million DVDs to customers (their total inventory is 42 million discs). A corner of the original warehouse in Los Gatos serves as the Netflix museum, including plastic remnants of the racks that workers used to pluck DVDs from by hand. Today all of that is handled by state-of-the-art automation. Workers still open envelopes, stopping every 45 minutes to do ergonomic exercises.

They'll need to stay limber: in tech-savvy markets like San Jose, Oakland and Fremont, more than 10 percent of households subscribe to Netflix. Hastings expects to have more than 4 million subscribers at the year-end, and more than 20 million by 2010. Hastings sees downloadable movies as a long-term threat, and predicts that his snail-mail model will be around another 20 to 30 years, both because DVDs are very portable and convenient to customers, and because movie studios "want DVDs to last a long time because it's such a revenue and profit driver." He says what consumers want is only one piece of any industry's economic puzzle: the reason you have to wait a year for books to come out in cheaper paperback form is that it's in the publishing industry's economic interests to sell to you that way.

Remember, Hastings says, the big music companies didn't begin to offer downloadable songs to please consumers. That was a defensive response to free services from Napster and Kazaa, which were cutting record companies out of the revenue equation. "What really drives the market is the content owner's profitability," Hastings says. "DVD might be around for a very long time absent some cataclysmic piracy attack." And even when downloads become popular, people aren't going to suddenly throw away their DVD players, which have a huge installed base. In fact, according to projections by Fox Studios, DVDs won't hit their peak usage until 2013, suggesting the Netflix gang has room to run.

Even if DVDs eventually go the way of the eight-track tape, Netflix boosters say the company stands a reasonable chance of surviving. Marketing textbooks traditionally talk about how railroad companies stopped growing because they saw only railroads, not the wider transportation business; in contrast, analysts seem to trust Netflix's ability to think of itself more broadly as a movie company. Safa Ratschy, managing partner at Piper Jaffray, says Netflix is a lot more than a DVD-by-mail distribution system; its real asset is a strong subscriber base that has grown accustomed to ordering on the Web, and is likely to stick with Netflix as the era of downloadable movies arrives.

Hastings envisions Netflix becoming a destination Web site offering a mix of free, ad-supported content, premium pay-per-view content and subscription services. "No one has figured out what's the right economic model," he says. "We know that we can do all of those and we'll continue to evolve." And with many Americans upgrading to big-screen, high-definition TVs, Hastings is betting they won't watch this fare on their computer monitors. That is part of the rationale behind the deal announced last year between Netflix and ?TiVo, which makes personal video recorders that already connect televisions to the Internet. Although Hastings will shed little light on exactly what these partners are cooking up, outsiders say they are a smart match. "If you can deliver video to the box that's connected to the TV and not to the PC, you're way ahead of the game," says Laura Behrens, a media-industry analyst for Gartner. "This is a good move for Netflix."

In talking about Netflix's future, Hastings repeatedly brings up AOL. He acknowledges it's an odd choice, given the online pioneer's disastrous merger with Time Warner. "AOL has a mixed ending or a bad ending, so it's not like publicly we're going to say 'OK, we want to be the next AOL'," he says. Still, Hastings sees in AOL a subscription-based survivor: once a dial-up service for online newbies, today AOL acts more like an infotainment portal, and has retained many subscribers who get broadband service from another company. He also sees HBO and DirecTV as having elements of the future Netflix model, in that they are both nationwide distributors with a capacity to cater to niche tastes or local markets. Of course, if a big media conglomerate moves in to buy Netflix, a very attractive target, the future won't be Hastings's problem.