Sunday, September 21, 2008

The Case for Netflix, Part 1

Boss Hoover smelled trouble.

The automobile was on the rise, and Hoover he knew it was only a matter of time before his profitable Ohio saddle shop would go on the wane. His sickly tinker of a cousin, James Murray Spangler, had recently taken out a patent on a gizmo he'd invented to help him clean the department store where he worked. Hoover bought the rights to the machine in 1908 and went on to make the vacuum cleaner an essential household tool.

True story.

Hoover had the vision not only to foresee that his saddle shop would falter but also to exploit a new technology. When I think of Hoover, a similar episode comes to mind. In this case, a company that remade a failing industry, then lassoed a developing technology to enhance its strong competitive advantage and position itself to dominate its market.

That company: Netflix.

I'll soon begin a series about this company, which has proven adept at seeing the future and profiting from it. The video-rental company, which mails movies to customers on a subscription basis, foresaw the widespread adoption of the DVD and then revolutionized the way America rents movies, much like iTunes changed how people buy music (and how Amazon's Kindle will change how people buy books).

Netflix took everything that was wrong with conventional movie rental and leveraged it to its advantage. It countered the inconvenience of a round trip to the video store with
free home delivery and return. It didn't just eliminate late fees, it gave customers total pricing control. It built a vast library of movie titles that no brick-and-mortar competitor could match, and then it developed a proprietary system for suggesting movies for its customers. You don't need a membership card. You don't need cash. You don't even get a bill -- payment is automated.

Have you ever met a brand ambassador? Someone so sold on a product that you can't get him to shut up about it? Some people feel this way about their iPhones or BlackBerries. The zeal of the Netflix user comes close.

And, in that vein, the only figure I could find that was higher than Netflix's customer satisfaction rate was the performance of its stock. The company incorporated in 1997 and sold shares to the public in May 2002 for $7.72. They now trade for $32, a gain of +314.5%.

Hoover saw the writing on the wall about the advent of the automobile, and he realized the potential of his janitor cousin's contraption. Netflix, similarly, foresaw the adoption of the DVD and had the vision to change the way people could rent movies. And it is doing it again. Netlfix knows video-on-demand is next. And the company has begun to position itself as a market leader of this new technology. As competitors like Blockbuster are scrambling to catch Netflix in rental by mail, Netflix is partnering with manufacturers to build set-top boxes that will allow downloads on demand. Netflix's real revolution -- and real financial performance -- hasn't even started yet.

I'll lay out my case for this longterm play over the next few days. Stay tuned.

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