The Movie Is in the Mail

By Chris Taylor/Los Gatos

The world didn't exactly shake when Betsy Daly stopped going to Blockbuster a year ago, but the movie-rental giant would be smart to ask itself whether this 33-year-old San Jose, Calif., mom represents the future. Daly now pays $15 a month to order her DVDs online. They arrive in the mail in a day or two, she gets to keep two at once (for $5 more a month she could keep three), and she mails them back whenever she feels like it. "I love that the movie can sit on the counter for weeks, and it doesn't matter," she says. "I got so tired of late fees at Blockbuster."

The online service Daly uses, called Netflix, just passed the 500,000-subscriber mark, riding a boom in DVDs and discontentment with the old rental model. Indeed, founder Reed Hastings got the idea for the company when he was hit with a $40 late fee for a copy of Apollo 13 back in 1998. "If I'd returned it on time," he says, "we wouldn't be here today." Now Jupiter Media Metrix rates Netflix.com as one of the 10 busiest e-commerce sites, a list that also includes eBay and Amazon. Every day 82,000 DVDs roll through the conveyor belts of Netflix's headquarters in Los Gatos, Calif., and its hubs in Boston and Los Angeles. Last week, as Hastings filed with the sec to take his company public and dreamed of raising a cool $115 million, there was only one thing that could spoil his party: the possibility that Blockbuster might soon adopt his business model.

Unlike DVD-delivery dotcoms back in the boom time--like Kozmo.com which spent more money sending a guy to your door than it was likely to earn on your order--Netflix uses the lightweight DVDs and the ubiquity of the U.S. mail to full effect. "Putting a DVD into an envelope for 34 [cents] and having it mailed back in the same prepaid envelope is just brilliant," says Jonathan Gaw, research manager for the analyst firm IDC. Though Netflix took a net loss of $38 million on $76 million in revenue in 2001, the young company expects to have an operating profit this quarter and revenues of at least $100 million by the end of the year. Every third family in America now owns a DVD player; most were unwrapped last Christmas, and people are hungry to feed discs into them.

The demographic that rents the most movies--18- to 35-year-olds with children, like Daly--is also the one most likely to look for them on the Internet. There are about 20 online DVD-rental services, but what makes Netflix by far the most popular is its recommendation system. Rate each movie you rent, and Netflix will match you up with movies you're likely to enjoy that you might never have heard of. This is a boon for independent movies like Nice Guys Sleep Alone--which couldn't get distribution but did get picked up by hbo after its success on Netflix. "Where we're really powerful is the non-Top 100 films," says Hastings. "We're trying to stay out of the way of the 800-lb. gorilla."

For the moment, the gorilla is returning the favor. While it eliminated 25% of its VHS tapes last year, Blockbuster also saw a 160% rise in DVD rentals. The company thinks most consumers don't plan their rentals in advance--they do it on impulse, the same way they buy Milk Duds at the register. But that doesn't mean they'll always think that way. "If we can figure out a way to make money doing what Netflix does, we'll do it," says Blockbuster vice president Ed Stead.

Meanwhile, Netflix has a chance to patch holes in its service. Customers on the East Coast have to wait twice as long for their DVDs as those in the West, so Hastings plans to open enough distribution centers to have the whole country within a day's coverage. The recommendation service needs tweaking too: "I've rated 600 movies, and it's still telling me I would like to see Star Trek," says Kendra Jacobson, 31, of San Francisco. Still, she liked the service so much she turned her mom onto it--and both have stopped using Blockbuster.