12/19/11

Video Rentals

• During the videotape and early in the DVD era, the common practice in renting movies was to go to the local video rental store.

Video Rentals

• Then in the late 1990s and early 2000’s a new company, NetFlix, offered a different distribution model: DVDs by mail.

Video RentalsThe convenience of this distribution model was that a video was ordered online, delivered by mail, and returned by mail. No more travel to the video store. Simply pay a subscription fee and rent DVDs online.

Video RentalsThe success of this model was immediately apparent. Revenue for its first four years show dramatic growth.

Video RentalsMore importantly, the net income (the total revenue minus expenses) showed even more dramatic growth. This is the profile of a very profitable company.

Video RentalsThe driver of this profitability was the number of subscribers to NetFlix, whose monthly fees were the source of NetFlix’s revenues.

Video RentalsA profitable company’s stock price almost always goes up, and you can see NetFlix’s stock price jumping as its profitability increased. Note that the stock split in 2003 makes the stock price in 2004 and beyond seem artificially low. It isn’t.

Video Rentals

• In 2007, NetFlix started including free streaming video content for its subscribers.

• This would be the beginning of another revolution.

Video RentalsAs NetFlix’s revenues continued to increase, so did the demand for video streaming content.

Video Rentals

• As more portable technologies that accessed the Internet became available, it was clear that a new business was emerging: online streaming delivery of content.

Video RentalsBut by this point (around 2010), digital streaming was a part of NetFlix’s standard subscription, allowing customers to order DVDs or watch videos online. The streaming service was free.

$$FREE

Video RentalsSo, in the summer of 2011, NetFlix announced that it was splitting its DVD and streaming services in two. “NetFlix” would henceforth be the streaming service, and a new company, Qwickster, would handle DVDs.

Video RentalsEach division would now generate revenue and would, in theory, grow the company dramatically. From NetFlix’s perspective this was a win-win.

$$ $$

Video RentalsBut from a customer’s perspective, price increases, coupled with a potentially confusing distribution system were an unpleasant shock.

$$$$

Video RentalsNot surprisingly, NetFlix’s stock price began to drop as customers began to drop their subscriptions. From a high of $300 per share, it has plunged to under $100.

Video RentalsOne immediate change was to eliminate the separate organization, Qwikster. All business would be henceforth handled through NetFlix, but there would still be two revenue streams, one for digital streaming and one for DVDs.

$$$$

Video RentalsYet, NetFlix’s stock continues at a low price. Has this affected the company’s profitability?

Video RentalsThrough September 2011, NetFlix’s revenues and gross profits are already greater than all of 2010’s. Whatever shortfall there is through the rest of 2011 is more than offset from the first nine months of the year.

Video RentalsNetFlix continues to be a very profitable company, and long-term its stock price is likely to return to its previous high and go higher.