Netflix ( NFLX) is a surprising success considering one analyst calls its business model lame and the company's spokesman calls it lucky. Yet for competitors such as Blockbuster ( BBI), the Netflix story offers lessons in well-timed innovation. Michael Pachter, research analyst with Wedbush Morgan, says that Netflix has been incredibly serendipitous, with much of the success due to founder and CEO Reed Hastings' vision and his persistence. In fact, the company's success is even more shocking considering how unsexy the business idea was at its conception. "There are plenty of guys that have visions that don't turn out to be right. So when I say he was lucky, I mean that Reed had an idea that sounded lame to me," Pachter said. "The vision of renting movies over the Internet is pretty simple and pretty lame. Taking that and turning it into digital delivery of their catalog and offering it as free as a substitute for the physical copy is brilliant." While the S&P 500 has dropped 10% this year, Netflix shares have surged 45% and the stock now sits at a new 52-week high. But even without using the share price as an indicator, it's obvious that Netflix is doing something right. The online DVD-rental company recently topped 10 million subscribers, all of which have bought into the simple business model. No matter how the company's success is viewed, there is something everyone can learn from Netflix, a name investors have already come to adore (and not just because a DVD copy of The Dark Knight was delivered in the mail during the same week it was released in stores).
The recipe for Netflix's success involves an incredible amount of luck and perfect timing, evangelistic subscribers that spread the word about the company, the entrepreneurial spirit, and a laser focus on the core of the business. If any one ingredient were absent, Netflix would likely be a laggard and not the leader in the movie rental and Internet streaming space. "The movie is the same. How you get it, the amount you pay for it, and the experience you have acquiring it is where Netflix wants to differentiate," said Netflix spokesman Steve Swasey. "Netflix wants to make it the most enjoyable experience with the greatest value and convenience at the lowest cost."
"Not all of this is brilliant strategy. A lot of it is luck," he said. "Netflix grew and created efficiencies into DVD-by-mail from 1999 until 2004. But if Blockbuster had taken this seriously and entered in 2001, I probably wouldn't have a job. Netflix built up both scale and efficiency by the time Blockbuster entered. Blockbuster spent $500 million trying to create the scale and efficiency that Netflix has and it didn't work."
Most Netflix subscribers that receive DVDs by mail also have free access to the Internet streams, whether it be to their computer or a number of supported devices, including Microsoft's Xbox 360, Roku set-top box, or Samsung Blu-ray DVD player. The free "Watch Instantly" program gives Netflix a slight advantage over paid streaming products from Apple and Amazon. "Streaming is going to be the future," Swasey said. "But in the mean time, we have a subscriber base of 10 million that are getting DVDs from us. We revolutionized the way Americans rent movies about 10 years ago, and now we're revolutionizing again by doing the streaming. It is really exciting to watch this unfold."
Perhaps the best advantage Netflix has is the 10 million passionate subscribers spreading the word about the company. Netflix does all it can to enhance the customer service, the most notable feature being the algorithm it developed to deliver personalized video recommendations based on customer ratings and reviews, quite similar to the system used by Amazon. "The biggest driver of Netflix marketing over the last 10 years has been solid, positive word of mouth," Swasey said. "People love to talk about it with their friends. They're evangelists for the service. It's an iconic brand fueled by those associated with it."
Believers in Netflix say it is a great example of how having a vision and being completely focused can pay huge dividends. With two million DVDs shipped per day and Internet streaming usage increasing, Netflix may teach its competitors more lessons in perseverance. "You learn to get a vision, stick with it, and figure out how to make that vision a reality," Pachter said. "Then you have a competitive advantage."