Netflix Fizzles Despite Big Talk

The company waxes on about a 20-million-subscriber opportunity --when it has just 2.2 million users now.
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Netflix (NFLX) - Get Report insists that its brand and expertise will lay the foundation for its future success.

But the lessons of history -- in particular, the failure of cable TV Internet company

Excite@Home

-- undercut that argument.

Netflix's shares tanked Friday, following the Thursday evening announcement by the mail-order DVD rental house that it was

cutting subscription prices and taking other measures to build up its subscriber base amid growing competition.

Shares were trading at $10.59 Friday, down $6.84, or 39%.

In a conference call with analysts, Netflix CEO Reed Hastings indicated that part of the goal was to preserve domination in the mail-order DVD rental market -- a pretty good business in and of itself, considering the efforts of deep-pocketed rivals like

Blockbuster

(BBI) - Get Report

.

Mail-order rentals, he said, could perhaps even exceed $2 billion a year -- plenty of growth for a company with $360 million in revenue in the first three quarters of the year.

But Hastings, as have Netflix's supporters in the past, asserted that the real payoff is when Netflix transforms its business from delivering movies via U.S. Mail to zapping them to subscribers over the Internet.

"It has become clear to many," Hastings said Thursday, "that whichever company leads the Internet DVD market is very likely to be able to extend that leadership into the era of Internet electronic delivery of movies."

And that, unfortunately for Netflix, is where the example of Excite@Home becomes relevant.

Hastings indicated that the Netflix name and the company's particular skills will be valuable assets once electronic delivery of movies becomes widespread.

"We are developing and perfecting Internet movie choosing, subscriber acquisition, personalization, and other network-effect technologies," he said, "and most importantly the brand."

That type of argument sounds awful similar to the arguments made by Excite@Home, back when it was developing the business of offering high-speed access to the Internet over cable TV systems. Starting when that company launched as @Home, its supporters said that only it had the expertise that cable companies needed to deliver this service to their subscribers. Excite@Home bulls also said the company was building a brand that consumers were gravitating to.

Neither argument proved true. When cable operators dumped Excite@Home in favor of homegrown high-speed access, they were able to make the transition shockingly quickly. And cable operators, in no mood to elevate another company's brand, found that customers were quite satisfied with Internet access that was the same brand as their TV service.

It doesn't seem like a stretch that

Comcast

(CMCSA) - Get Report

, which is already working hard to deliver alternative-technology programming, video on demand and personal video recorders, could concoct a movie rental system with pretty good movie-choosing and personalization technologies. Consider its recent deal to offer movies from

Sony

(SNE) - Get Report

and

MGM

(MGM) - Get Report

.

One particularly curious statement in this context was Hastings' Thursday assertion that Netflix's distribution system -- that is, whether it delivers movies via the postman or via a broadband net connection -- "is only a small part of the overall consumer solution."

Au contraire. In this case, distribution is everything. Just ask any small cable TV programmer who has tried to get a channel added to a cable system.

And just ask yourself after Comcast one day launches its own Netflix-like service. The immediate availability of that service in Comcast's 21.5 million homes is a huge part of the consumer solution -- and such a venture's eventual success.

But the comment from Hastings that perhaps best illustrates the gulf between where Netflix is now and its vision for ultimate success was this: "If we are able to achieve 20 million Internet DVD subscribers and then can offer them the option of electronic delivery, we will have more reach than any satellite or cable company in America, other than Comcast."

How true. But first, a reality check: Netflix now has 2.2 million subscribers. It will end next year with a little over 4 million subs, estimates Citigroup Smith Barney's Lanny Baker, who just lowered his rating on the company from a buy to a hold.

There's a long way to go there, from 2.2 million to 20 million. It's sort of like a kid in little league saying he'll be as big as Sammy Sosa, as long as he sticks to his plan of hitting 70 homers a year once he makes it to the majors.

"We are building a huge strategic asset in our subscriber base," Hastings said Thursday.

Excite@Home had a huge strategic asset in its subscriber base, too.