The DVD Rental Race Analyzed

Thomas Hawk writes "Netflix and Blockbuster have been locked in a price war with regards to the DVD rental space. Wedbush Morgan Equity Analyst Michael Pachter has a $3 dollar price target on Netflix and is in contrast bullish on Blockbuster. Davis Freeberg challenges Pachter's thinking that Netflix will be the loser in the DVD rental battle and Pachter himself responds back on his rationale on why he thinks Blockbuster has the advantage." From the article: "Irrespective of what Pachter thinks about the overall DVD rental business, Pachter's seemingly obvious prediction would appear pretty dire for Netflix. Pacther updated his price target for Netflix On 4/22/05 with the new $3 price. If Pachter is right, then we should expect to see Netflix's stock fall by approximately 75% over the next 12 months."

Comments

I'm no market analyst, just a movie watcher...

[garcia]

If you know someone who is using Netflix right now ask them about the service? Do they like it?

I don't know a single person that uses Netflix so that's rather difficult. I also haven't heard it *anywhere* other than on Slashdot. I wouldn't even know it existed otherwise.

Now go into your local Blockbuster Video store and ask the clerk there how he feels about his employer.

I have a feeling that they will have no comment... We all know what happens when you bite the hand that feeds you.

Netflix's customers are huge evangelists for the service and they view the service as fun, innovative and exciting -- not bad for a growing company with very little debt.

This guy is probably a customer for this young and new company w/o many subscribers (compared to Blockbuster). I really can't speak either way about it though as I have never used them myself.

Blockbuster on the other hand is a bloated company, with tons of debt, who is laying off it's employees, cutting back their hours, fending off a shareholder proxy fight with Carl Icahn, who has had their CEO recently announce that if he was not re-elected he would resign from the company.

Ok, yeah, it's bloated - along with plenty of other companies out there. I am not fan of Blockbuster and their tactics which include blatant lying to their customers and potential customers about their "no late fees" crap.

Cutting back hours? I don't know about that. I know of a couple Blockbusters around here and they are open the same hours they have been for years. At least you know that the movie rental places are open on Thanksgiving and Christmas.

In the long run, all three companies, Netflix, Movie Gallery and Blockbuster will face a tremendous battle to stay alive when Video on Demand becomes widely available, but in the short run, if you agree with Pachter, then you should short Netflix and use the proceeds to buy Blockbuster and Movie Gallery.

I'm not holding my breath for VoD, really, I'm not. Even if/when it does become "viable" I have a feeling it will continue to be expensive and a little bit behind the DVD release dates. I really don't see any advantage to VoD but then again I have ~6 different movie rental places within 5 miles of me. YMMV.

I realize that I am a bit different than most people when it comes to renting DVDs. I'd prefer to buy them. Target has great deals on movies (i.e. Pulp Fiction with extended crap for $10 and many random titles for $7.50). I spend a lot of time looking through the $5 bins at Walmart for movies. I also buy previously rented DVDs which are usually 3 or 4 for $20. I don't frequent Blockbuster as I always feel uncomfortable in their store. I prefer Hollywood Video because of their random titles that are $1 back if you return the movie within 24 hours.

So I really don't care if Blockbuster or Netflix do well or not but I certainly don't believe for a second that the sudden downfall of the rental business will come from VoD. Then again I'm not a market "analyst" blogging away about stock prices... I'm just a movie watcher that doesn't like to pay a whole hell of a lot to watch a movie once.

Re:I'm no market analyst, just a movie watcher...

[winkydink]

I don't know a single person that uses Netflix so that's rather difficult. I also haven't heard it *anywhere* other than on Slashdot. I wouldn't even know it existed otherwise.

They have 1.5 million customers. Clearly somebody is using it. In our little corp headquarters office or 25 people I can think of 4 people who use it (myself included) and the other 3 are definitely not in the Slashdot demographic.

Re:I'm no market analyst, just a movie watcher...

[jp10558]

I've used netflix quite a bit (in fact every time I have a full time job - currently in college though). Their prices aren't bad - especially given where I live there is no cable anyway.

So, for the price of basic cable I can get DVDs right to my doorstep, usually with no more than a day lag time. I can hold on to those movies, with no penalties. They have a selection that puts the "local" (30 mile one way trip) blockbuster to shame.

I think services like NetFilx will be able to find a niche if they want to - specifically with rural america (which is pretty big IIRC from the last election etc...).

With gas costs rising, do you want to drive 20+ miles to get to blockbuster, and then drive back, and then be locked into driving them back within a week (or 2 now?) or else fees? Gas is somewhere around $2.20 a gallon most places in the US.

I think the average gas mileage is 25MPG or so. So figure on average 3 gallons per trip out to blockbuster for many rural americans. That's 6 gallons once you return the movie. So, it cost you around $13 just for travel, not counting wear and tear on the vehicle or time. That one trip to blockbuster just about paid for a standard NetFlix monthly package, before you rent one video. And this assumes your time is worthless.

Of course, we try to make our blockbuster trip coincide with other shopping and such, but that's not always feasible, though the new extended time (I think, I haven't really looked at whatever the "end of late fees" became) it's a lot easier compared to the 2 day turn around time on new releases previously.

With more TV shows coming out on DVD a year later, and with our situation in the country, when the analog TV goes dark, we'll just up our NetFlix subscription. Better quality, better choice(4 analog tv stations on a good day), and no commercials.

So, I think NetFlix can do very well if they don't mind catering to the rural market.

Re:I'm no market analyst, just a movie watcher...

[badasscat]

They have 1.5 million customers.

They have 3 million subscribers, not 1.5 million (I hate to link to such a dire-sounding headline, but the article does have a lot of hard info). And their subscriber base is growing rapidly.

Every day at my office you can see a bunch of those red envelopes in the office inbox. And a lot of us that subscribe get them at home, so clearly there are more where I work than I even know about.

This is a popular service and one that people really like. One of the first things I learned when picking stocks is that the bottom line is the product has to be something people want. The quick test of any stock is to look around at what people are saying about the company, not from a business perspective but as customers. I have honestly heard the words "I love Netflix" more times in one week than I've probably heard the words "I love Blockbuster" in my entire life.

That doesn't mean the company's on the road to success, but it does mean they have the basic building blocks right. Blockbuster's really got nowhere to go but down at this point.

Re:I'm no market analyst, just a movie watcher...

[Surt]

1.5 million customers + 4 in your office of 25 people => skewed sample.

If one in 6 working age americans used netflix that would be a customer base more like 30 million.

Netflix needs to be acquired

[winkydink]

It's pretty clear that Blockbuster has the size, relationahsips, channel, and most importantly, money to crush Netflix. Each day that passes is, in reality another day that the value of the company decreases. Rather than "talking with Amazon" or thinking they can get a bazillion dollar deal, Netflix should get off their collective butts and start shopping around.

Who would buy them? Well Walmart is an obvious choice. The current offerring sucks. Barnes & Noble? Target? I'm sure there are others, these are the only ones that immediately jump to mind.

Re:Netflix needs to be acquired

[shayne321]

Netflix should get off their collective butts and start shopping around.

I keep reading people saying this, but my question is: Why? Every interview I read with the founder of Netflix says he's having a ball running the company as is, they're moderately successful, profitable (how many startups can you say THAT about?), and have a strong brand.

What would the deep pockets of wal-mart, amazon, or blockbuster give them? It's not like there's a lot of room for innovation in the online rental market. I go to the site and request a disc, they mail it to me, I mail it back. What sort of value added service are they going to provide, offer to mail me popcorn with my disc? Thanks but no thanks.

I think Netflix has a good thing going, and the founder has said repeatedly he is not going to get into a price war with blockbuster, he is going to compete on service.

Granted I'd love to see netflix do away with throttling, but for my $18/month I'm happy.

Re:Netflix needs to be acquired

[Morinaga]

Blockbuster has the size, marketing and money to TRY and crush Netflix. However, they also have overhead, tons and tons of overhead. Retail consumer locations cost money but nothing in comparison to the empolyment costs of having people in those buildings. When you run a company that floats a margin above large amounts of overhead your company's profit margins look like the DOW with very high Highs and very low Lows. Overhead produces the types of losses you see from Airlines and car manufacturers. They have fixed costs in this massive retail chain that don't change without significant closings, firings etc...

Netflix on the other hand has a much more flexible overhead structure. They have fewer customers? Well first, they KNOW how many fewer they have because they have subscribers and a predictable cash flow regardless of customer usage unlike Blockbuster. Second, if they get fewer customers they spend less on postage. Perhaps they reduce purchasing on new titles. At worst perhaps they lay off employees.

Netflix is a remarkably proficient business model. The biggest issue is that since they went Public in '02 they have become part of the beast that is stakeholder appeasement. They are a 'growth' stock. Shareholders want growth so a company has to invest in infrastructure, marketing, promotions and everything under the sun to show revenue growth. It frankly doesn't matter if the growth is done smartly as long as it's not slowly. The board of directors gets pressue for stock growth, which bears pressure on the CEO for that same growth (who is beholden to their own income (ie options) to show growth). The days of developing a solid income stock company are dead. Profits be damned if revenues grow by 19.5%!! Who cares if you lost 100 million in a quarter. Anyway, that's all a tangent rant but suffice to say that because Amazon posted losses during their growth years doesn't mean the business model won't work. It also doesn't mean there's no place in the market for retail when a web service is available.

The Other Kind of DVD Rental Race

[Doug Dante]

I get DVDs back from Netflix in about 48 hours. The US Postal Service gets my videos to Netflix in 24, they ship the same day, and I get them back the next day. It doesn't happen all of the time, but it's pretty impressive when I'm about 100 miles from my local Netflix processing center.

I wonder how quickly Blockbuster returns videos for what percentage of the population as compared to Netflix?

Re:The Other Kind of DVD Rental Race

[jfengel]

Of course that has more to do with the post office than with Netflix or Blockbuster. I use Netflix, and they generally put a movie out in the afternoon mail if they get it in the morning mail. That's about as fast as one can ask.

I assume that Blockbuster is the same way. If not, then they're in serious trouble. I'm not going to say it's easy to achieve on a large scale, but they'd better not be any slower and I bet they can't be any faster.

I don't usually get 48 hour return time, even thoug my local distributor is only an hour's drive from here. But that's mostly the post office adding an extra travel day on one end or the other.

One could choose to alter their model to allow even faster service; say, the ability to request that a movie be sent when you put it in the mail, rather than when they get it, and trust you to be honest (and drop you if you're not). But that would involve them letting out more movies at once, which would cost them more.

Blockbuster could add service whereby you could exchange either by mail or at their place. That might work well for them, since it would mean that they could batch up returns. Mailing costs have got to be a huge chunk of Netflix's cost, since those recipient-pays envelopes have a significant surcharge. A big box of returns would cost only a few dollars. But that would mean making more copies available at the individual stores...

Re:The Other Kind of DVD Rental Race

[Chupa]

Blockbuster has a 2-day turnaround for me...although I live just outside the DC metro area and the distro center is only about 40 miles away.

Last month I went through 15 movies, which could've cost me $45-60 to rent locally (assuming I could even find that many movies worth watching amidst the rows upon rows of garbage), but instead was only $15.

I used to split Netflix with my roommates in school...but I have to say I went with BB on my own because of the price and the two free movie/game local rental coupons per month.

Investment Rule

[stecoop]

7.5% of Netflix is currently owned by Netflix Co-Founder and CEO Reed Hastings. Given that Netflix stock has already fallen by 60% over the last 12 month and that their stock is currently one of the largest short postions on Wall Street, a $3 price target seems a little aggressive .

Second rule in investment is never say a stock can go no lower. The trip to zero is a hard fall at any price.

First rule, you probably are wondering, is: buy low and sell high.

adult

[blackmonday]

I can't believe neither service rents porn movies. I think it would boost service considerably. Just keep it on the down-low. Hide it under "romance".

Re:adult

[mmkkbb]

greencine.com offers adult movies and a more eclectic selection than either. however their service is slower and their prices are higher.

One important thing Michael Pachter is missing

[Emperor Shaddam IV]

Is the fact that Blockbuster's previous practices of changing late fee's that were outlandish, has pissed a ton of people off. Also, Blockbuster used to not carry a lot of movies because they were too of the wall or "racy" or "sexually" oriented.

Blockbuster pissed me off so bad in the 1990's I haven't rented from them in several years, nor would I even consider renting from them if they charged less than half what Netflix did.

Check out the other people they pissed off:
http://www.google.com/search?hl=en&q=blockbuster+s ucks

War of attrition

[C_Kode]

A war of attrition (price wars) are a top cause of business failures. Read any guide to the top reasons businesses fail. A war of attrition will be listed.

Blockbuster is a fat cow. Netflix will die by the very sword they have drawn.

Offer what the others don't, and offer it at a good price. It doesn't have to be the lowest. I buy from NewEgg not because they have the best price, but because I get what I ask for and they are quick to fix it if I don't.

Re:hmmmmm

[winkydink]

Well, reading TFA, it would seem that video on demand from cable is in this race, and looks to be the odds on winner...

Really? Do you think you'll be able to watch the movie as many times as you want in a given period for a fixed fee? Can you "lend" your copy to a friend? I'm also pretty sure that they will devise some way to "force" you to watch advertising (granted, DVDs do this too, but it appears that may be changing based on recent proposed legislation).

I'm sorry, but I believe that saying Video on Demand will replace DVDs is a lot like saying eBooks will replace paper (and I'm a big eBook proponent).

no no no....

[rayde]

every smart investor knows to skip these guys and just invest in the DVD+/-R manufacturing sector.

;-)

Financial analysts

[Petronius]

These are the same people that predicted that Enron and Worldcom were the companies of the future, that Lucent was going to grow forever, that QQQ was the ticket to retiring at 30. Who gives a shit about their opinion? Listen to successful investors: W. Buffett, Peter Lynch, they'll tell you that the best thing to do about analysts is to ignore their predictions. So what does this guy know about Netflix? Has he actually even tried their service?

Re:I just use On Demand

[Emperor Shaddam IV]

If you have a widescreen HDTV, Video on demand sucks. All the video on demand I've seen in my area from Comcast, is crappy, standard 4:3 format, and has bad artifacts. It looks just like standard digital Cable or Satelite signal, which ain't great on a 55 inch widescreen.

At least with a DVD, I can play anamorphic Widescreen with 480 progressive scan DVD player and get something that looks half-way like the movie in the theatre. DVD still has artifacts, but they aren't nearly as bad as Video on Demand.

In my experience

[Anita Coney]

Blockbuster is a joke. An extremely bad joke. Netflix gives me a three day turn around, e.g., I mail on Monday, they receive it and mail a new one on Tuesday, then I get it on Wednesday.

Compare that to Blockbuster that gave me about a 18 day turn around. About 9 days to get my returned DVDs. About 9 days to get new ones back. It was ludicrous! Here's an even better example: Two months after quitting I get an email saying they finally received one of the DVDs I had sent out OVER two months prior!

Blockbuster is SO bad I seriously think it's a ploy to make internet/DVD rental services look back to protect their brick and mortar stores.

And the winner is... THE CUSTOMER!

[dpbsmith]

Yes, indeed, vibrant competition, the miracle of the marketplace, and Adam Smith's "invisible hand" ensure that by golly, no matter what happens, the customer will always win.

The only reason Blockbuster ever used to charge those late fees is because, gosh, it's what customers wanted. And now that customers want something different, Blockbuster is responding to demand.

You can look forward to a ever-brighter future of more and more choice, lower prices, and, of course, better movies.

Because... everything is for the best in this best of all possible worlds.

Beating the Street, a good read

[John Seminal]

These are the same people that predicted that Enron and Worldcom were the companies of the future, that Lucent was going to grow forever, that QQQ was the ticket to retiring at 30. Who gives a shit about their opinion? Listen to successful investors: W. Buffett, Peter Lynch, they'll tell you that the best thing to do about analysts is to ignore their predictions. So what does this guy know about Netflix? Has he actually even tried their service?

I took Peter Lynchs advice as the best. His whole opinion of stocks boils down to one question: "Do I like their product, their service, the way they treat me", "Will I be buying from them again, and like it", "Will other people like them". He says, if you anwser yes to these questions, chances are you have a good company. Lynch said the best companies he invested in, the big ten-bangers, were companies he really liked, or noticed other people liked.

People can read all about P/E ratio, how fast a company is growing, and the rest. But this will not tell you who will suceed. These numbers should just tell you if there is a red flag, if a company could collapse on itself.

It all boils down to a good product. Price is very important, but if someone sells you crap, or bad service, people will not buy from them, and their buisness is doomed.

DVD Evangelism

[brontus3927]

I have to agree with Freeberg. Short of changing their corporate direction like NetZero (not that it hasn't worked for NetZero, emphasising the low-cost pay service over the ad-based free service), NetFlix is always going to have high popular opinion. NetFlix customers are very similar to Apple customers in that regard. They see themselves in a good vs evil fight with a giant corporation (Blockbuster for NetFlix, Microsoft for Apple). Netflix customers are fighting the good fight. Despite this, everyone thinks in the Microsoft business model of "there can only be one company in a given market" Two (or more, and more is better) companies can peacefully co-exist in teh same market. I use Netflix. My sister uses Walmart's service. My neighbor stopes at Blockbuster on the way home from work to rent DVD's because their an impulse item for him. To each their own. I don't see any of the services as inherently better or worse than the other.

illegal in some places

[John Seminal]

if a dvd mail rental place exists in SF for example, how will they know it is illegal to rent porn in a specific county in Georgia, that it violates community standards?

Re:illegal in some places

[MacJedi]

Thanks to visionaries such as Adam & Eve's Phil Harvey, the right for a company to sell pornography, sex-toys, contraception, and other "obsecne" material over the internet and via mail-order has been upheld.

Re:First Post

[anagama]

I think the price is fine right now. I suspect that if it became too low, the good service I get with Netflix would suffer. Realistically, the cost is about what I'd expect to pay to rent 4 or 5 movies per month. It's easy to get 3 movies a week if you watch and return quickly so the price can be roughtly 4x cheaper than renting at a store. That's a bargain.

But the real value is in the selection. Netflix stocks a lot of things that aren't easily found locally. If the price becomes too low, they won't be able to afford buying anything but the most in demand titles. That would suck.

Finally, I did a free trial w/ Blockbuster. They were missing an entire season of one of the Star Treks (a middle season like season three or four -- I can understand not having the last season, but why have 1,2,3,__,5 ... crazy!). The selection wasn't as diverse as netflix's. And finally, Blockbuster's website was annoying and ugly -- it looked like a WinAmp skin designer had made it up after huffing glue. In contrast, Netflix websitte is very useable, very simple. It isn't gaudy and flashy, but conveys information efficiently and accepts user input efficiently. I really like it.

So, while I don't think of myself as Netflix zealot -- I will become one if it means keeping Blockbuster from dominating the DVD by mail rental market.

Netflix Totally Gets It

[Teddy_Roosevelt]

I've been a Netflix customer for several years. They totally get it. It's like someone went through every aspect of the customer experience looking for anything that might slow down, confuse, or annoy a customer, and then they eliminated it. This is the way businesses should be run, now that the Internet allows the customer to be king.

Netflix, Amazon, Google, Apple and others get this, while, for example, Enterprise Rent-A-Car definitely does not. See http://www.failingenterprise.com/.

Both have physical distribution - Netflix wins

[SuperKendall]

The assumption that Netflix does not have physical distribution methods (such as Blockbuster stores) is just plain wrong.

The reality of physical distribution nodes is that Netflix has a lot - they are called distribution centers! In fact they are far better off than Blockbuster in that regard.

Yes for perhaps 10-20 titles you might get stuff a little faster at Blockbuster. However a lot of stuff people rent is not going to be something carried at your average Blockbuster - and then the advantage of Netflix becomes apparent, in that you are going to get ANY movie no matter how obscure pretty quickly. Not just the 10-20 post popular at the moment.

So basically Blockbuster has a lot of distribuition centers, but with poor stock. You can think of it like a really badly run cache management scheme, where Netflix fares much better.

And both are just idling until online distribution takes place in large quantities - I'll bet that Netflix is more nimble in this regard.

Yeah I worked there too

[CiXeL]

store #06516 hermosa beach,ca back in '97

and yes it really REALLY sucked working there. The number one thing i couldnt figure out was why they would try to sell all that movie merchandising crap but it was a loss every damn month when they would put it at 99 cents clearance just to get rid of it piling up. also i hated how they would have us specifically mislead the customers for their rewards cards and return times.

Blockbuster censors movies, Neflix doesn't

[tomRakewell]

I am definitely rooting against Blockbuster. Don't forget, Blockbuster has been known for censoring movies -- editing them to make them more palatable for family viewing. Try renting a movie like 'Y Tu Mama Tambien' from Blockbuster or Walmart. You will end up seeing a version that has been edited for content.

Maybe I'm 'misunderestimating' the maturity of the average American, but I think that as long as Blockbuster and Walmart have crappy policies like this, there will be a nice niche for the comparatively corageous Netflix.