Netflix streams more vidoes, vows to keep mail service

Stanford, CALIF. — Netflix (Nasdaq: NFLX) is moving to the Internet and substituting its snail mail business model for digitally streamed movies. “Pretty soon, we’re going to be a streaming business that rents some DVDs,” Reed Hastings, Netflix CEO said during a recent industry gathering.

Although change happens fast in Silicon Valley, Netflix actually won’t be a streaming business “pretty soon.” The DVD-delivery service based in Los Gatos, CA won’t fully transition to an Internet company for up to 30 years, until bandwidth is robust enough to support streaming, according to Hastings.

This means the company’s iconic little red envelopes will likely stick around for a few more decades.

“All video is going to become click-and-watch Internet video. Everything,” Hastings said at a Feb. 17 Churchill Club event. “Just like everything is going to become cell phone minutes. Over 50 years, not over 10 years. But we can use DVD-by-mail as our network substitute. You know, DVD-by-mail is actually a very high bandwidth network with 24-hour latency.”

Streaming offers a key opportunity for Netflix to grow, Wall Street analysts concur. In fact, about 48 percent of the company’s subscribers streamed content last quarter, up from 41 percent in the prior quarter.

The company said it’s putting profits towards streaming. “Streamers are our most active subscribers, and with the money we spend less on DVD we pour into streaming,” Hastings said at the Churchill Club.

Netflix hopes customers will continue streaming movies because it reduces the company’s mailing expenses. It costs Netflix about six cents to deliver a film online and around ten times that much, or 65 cents, to deliver the movie through snail mail, according to market analysis website Seeking Alpha.

Postage has been one of Netflix’s largest expenses. But for the first time in the company’s history, Netflix doesn’t expect a postal rate increase this year. Even so, Netflix will spend $600 million on shipping costs in 2010. “Given the rate of video store closures we think our shipments will continue to grow and that our annual postage will grow to over $800 million in a few years,” Hastings wrote in the company’s fourth-quarter earnings report.

But contrary to expectations, Netflix said its streaming hasn’t detracted from DVD shipments. In fact, even as streaming grows dramatically, shipments will continue to grow rapidly, at annual rates of about 20 percent, according to Hastings.

“Obviously, the long-term goal is to use this money to buy more streaming content and become one of the studios’ largest customers,” Hastings wrote in the earnings report. One of the drawbacks to streaming is that it forces Netflix to renegotiate content deals with the studios.

When Netflix first started in 1997, Hastings was literally going down to the local Best Buy, buying DVDs and renting them, he said at the Churchill Club.

Hastings was able to do this because of the Copyright Act of 1976, commonly known as the “first-sale doctrine” allows the purchaser to buy and then sell copyrighted work. This doctrine, however, does not apply to streaming so Netflix now has to buy digital rights to its content, which can be very expensive, especially for new titles.

To counteract the first sales doctrine, in late 2008, Netflix made a deal with Starz Entertainment to sub-license the streaming rights of titles from Disney, Sony and other smaller studios. Within the deal, Starz identified Netflix as a “content aggregator,” a definition that allows sub-license rights to studio content.

Several studios, including Disney, have warned that they won’t renew their contracts with Starz, which expires in 2012, unless it either cuts Netflix out or pays Disney a premium.

Netflix must “fight against [the studio’s] fear that we’ll destroy the ecosystem,” Netflix chief content officer Ted Sarandos said at a Dec. 16 panel discussion. “We’re not destroying anything. We’re creating a new opportunity.”

The most profitable part of Hollywood’s “ecosystem” is the output deals through which studios license movies to pay-to-watch networks. Netflix’s streaming creates a virtual channel that directly competes with networks like HBO.

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