Updated from 11:51 a.m. ESTNetflix ( NFLX) signaled Tuesday that it's taking a step toward its long-term goal of distributing movies over the Internet, but its biggest hurdle still lies ahead. Over the next six months, the company plans to roll out a new "watch now" feature on its Web site that allows subscribers to watch some movies and TV shows immediately on their personal computers. While customers can continue to receive DVDs by mail, they will have the additional option of watching around 1,000 titles using technology that allows a video to be viewed at virtually the same time it is being delivered to a user's computer over the Internet. The move marks the beginning of Netflix's quest to cut the U.S. Postal Service out of its business model. The company, however, can only offer limited selections with its new service because most popular film titles are tied up in long-term electronic subscription distribution agreements between the major film studios and premium cable channels, like Time Warner's ( TWX) HBO and Liberty Media's ( LCAPA) Starz Entertainment Group. "This is the next step of the evolution of Netflix's business, but acquiring content is going to be a long painful process for them," says Michael Goodman, analyst with The Yankee Group. "Distribution is going to be a huge roadblock for them for at least four or five years."
Steve Swasey, a spokesman for Netflix, acknowledged that the 1,000 titles offered initially on the service is a relatively small offering, but he pointed out that when the company started in the late 1990's, its DVD catalogue had a similarly small selection. Now, the company's flagship service boasts an industry-leading 70,000 titles. "Whether it's Netflix, Apple ( AAPL), Amazon ( AMZN) or anyone else who is doing Internet distribution for movies, we all face the same obstacles, which is the content availability from the studios," says Swasey. "They have a tremendous revenue stream from licensing content to broadcast and cable, and that's an impediment to everyone else in the entire industry." But Goodman says Netflix will face more restrictions than distributors that sell downloads, like Apple, because the long-term agreements differentiate between those and subscription-based services. He points to Vongo, a fledgling subscription service launched by Starz, as a competitor that could represent a long-term threat to Netflix. As a subscription cable channel, Starz already has access to a large number of blockbuster movies. While Netflix has gained considerable popularity with its rental service that pioneered DVD delivery by mail, investors have been wary of the company's uncertain future as movie downloads gain prevalence. The company's new plan will allow users to bypass the download process, which is cumbersome, and save money by continuing to pay a relatively small, monthly subscription fee.
"Netflix has proven that there is a large market for a subscription-based movie service," says Aram Sinnreich, managing partner with Radar Research. "It's kind of an accident of technology that they launched it during a time when it made more sense to use the U.S. mail than broadband Internet connections to deliver movies, but that time is coming to a close. Apple has been very successful selling video content through iTunes, and it's clear that where we're going in the long-term is Netflix minus the postal service, and this is the beginning of that." The company's closest competitor, Blockbuster ( BBI) has managed to grab back some market share by adopting a subscription service of its own and using its vast network of stores throughout the country to offer consumers instant gratification in receiving new movies. Internet distribution offers Netflix a way to one-up Blockbuster when it comes to convenience. To be sure, Netflix's plan does have drawbacks aside from the limited offerings. At first, Netflix's "watch now" feature will only be available for use on Microsoft's ( MSFT) Windows operating system, which excludes the growing population of Mac users. Swasey says the company is targeting PC users first because "the vast majority of folks" are Windows users. Ultimately, he says, Netflix wants to be "the company that delivers movies over the Internet on whatever platform you're on."
Also, streaming content can suffer from service disruptions. It will require an Internet connection with a minimum bandwidth of one megabit per second. Better connections will result in a higher quality experience. "The bit-rate won't be great, which means you're not going to be able to deliver high-definition content," says Sinnreich. On the upside, Netflix said most subscribers' movie selections will begin playing in their browser in as little as 10 to 15 seconds, following a one-time installation of a simple browser tool. "This market really takes off when fiber to the home and next-generation broadband becomes more common over the next three to five years and high-definition movies on demand can be streamed on the Internet," says Sinnreich. "Everyone knows that's where it's going and everybody wants to have a stake in that business, including Apple, Microsoft, Google ( GOOG), Yahoo! ( YHOO) and all the cable companies." Netflix said most of the major and many independent studios are "supporting" the introduction of the new feature, including General Electric's ( GE) NBC Universal, Sony Pictures ( SNE), Metro-Goldwyn-Mayer Studios, News Corp.'s ( NWS) 20th Century Fox, Viacom's ( VIA) Paramount Pictures, Time Warner's ( TWX) Warner Bros., New Line Cinema and Lionsgate ( LGF). "Over the coming years we'll expand our selection of films, and we'll work to get to every Internet-connected screen, from cell phones to PCs to plasma screens," said Netflix CEO Reed Hastings in a statement. "The PC screen is the best Internet-connected screen today, so we are starting there."