In just five years, Netflix Inc. shot out of nowhere to create a new segment in the movie rental business with a simple business model that allows people to rent popular DVDs online and have the flicks arrive pronto in the mail, all for a monthly fee.
Netflix's success spawned competitors, but few so far have been able to chip away at its 95 percent share of the market.
But that may soon change. Netflix warned investors this week that it is taking drastic steps to prepare for a new era of competition from Amazon.com Inc.
Netflix executives told analysts during a conference call Thursday that the company will cut monthly fees by 18 percent and postpone its plans to expand in Europe so it can focus on meeting the threat from Amazon.
The news sent shares of Netflix down $7.13 to close at $10.30.
Netflix executives said they picked up rumors about the development several weeks ago and have been able to confirm them from several sources. Amazon has declined to comment on any plans to enter the DVD rental business. "Our customers have encouraged us to offer low price online DVD rentals but we have no announcement to make at this time," said Amazon spokeswoman Patty Smith.
If Amazon enters the rental market, it could create a showdown between two survivors of the Internet bubble that collapsed in 2000. While Amazon has become the Wal-Mart of the online world, Netflix has remained focused on the DVD rental business.
Through Netflix, customers can pick from more than 25,000 titles online and can keep rented movies as long as they want. When they return one film, another is sent. Netflix's "no late fee" model has proved popular and played a significant part in the company's ability to sign up 2 million subscribers. The company is planning to report $500 million in revenue this year, up 80 percent from last year.
Netflix already has new competition in the form of Blockbuster Inc., the nation's largest movie rental retailer. Earlier this year, Netflix increased its monthly fees to $22 despite Blockbuster's entry into the market with an offer of $19.99 a month.
Netflix reversed course on Thursday and said it would cut the fee to $18 a month in response to the possible arrival of Amazon. Blockbuster soon followed suit and said yesterday it would cut its monthly fee from $19.99 to $17.49.
During a conference call with analysts, Netflix chief executive Reed Hastings said he never viewed Blockbuster as a significant threat, but he said he has long been concerned about potential competition from Amazon.
The Internet retailer "was the only company that had the e-commerce ethic, understood the customer base and that was a credible and significant threat," Hastings told the analysts.
Hastings said in an interview yesterday that the growing competition shows the potential of the online rental market.
"Blockbuster and Amazon have realized it is not a niche market and online DVD rental is very mainstream behavior. Both are now scrambling to get a piece of the market."
As a result of cutting its fee, Netflix also reduced its annual profit estimate from 50 cents per share to 27 cents per share. Hastings told analysts that the company planned to break even in 2005 as it increases spending on marketing and expanding its operations. Netflix currently has 29 distribution hubs around the country, allowing it to provide next-day service in all but the largest cities.
The company is planning to double its subscriber base from its current 2 million customers to 4 million in 2005, Hastings said.
But even as it defends against new competitors, Netflix is preparing to open a new front in the online movie rental business. Earlier this year, Netflix signed a deal that will allow it to deliver digital copies of movies over the Internet to TiVo Inc.'s 1.5 million subscribers.
Subscribers would be able to download the movie onto the TiVo digital recorder and replay it, just as they do with television programming that has been stored on the device's hard drive.
Cable and satellite companies are already delivering similar video-on-demand services. In many cases, cable companies give customers up to 48 hours to view the movie with all the same features as a VCR, including the ability to fast forward, rewind and pause a program.
But Hastings said it is likely to be several years, possibly decades, before the movie rental business moves completely online.
"DVDs will be the dominant medium for movies for perhaps as long as the gasoline engine," he said.