Netflix is the company that fixed the annoying rules of movie rentals, you make a queue of movies you want to see, and then they’re delivered in batches of 1,3 or more movies depending on how much you pay every month, you can then keep the movies all you want since there are no late-return fees.

This article is about why I think they will be the real winners of Internet Video, with a different business model than the free/ad based approach of Hulu and Joost.

Their current business model
I’ll attempt to disect their current business model, which has proven to work, they now have over 8 million subscribers and a catalog of over 100,000 movies, revenues of over $1.2 billion, and a net income of $66.9 million last year.

But the goal has always been to deliver the movies instantly, the technology wasn’t there, but now it seems to be here, and probably it’s also gotten to the point that the bandwidth of delivering a movie is cheaper than the associated current costs of delivering a real DVD to your door.

Being a customer for many years, I can guess some of the costs involved per movie are:

• Custom Envelopes (which also make money cause they add advertisement in them)
• Employee Processing costs (cataloging, putting cds in envelopes, receiving CDs in envelopes)
• Shipping costs (at least $0.47 for USPS)
• Replacing costs (many DVDs break, scratch, and get stolen, boy have I gotten my DVDs stolen)
• Royalties costs (no clue, but they must be there)

Somehow, Reed Hastings and his team figured out a way to make money after these costs, maybe from the people that pay every month who don’t really have the time to watch 12 or more movies a week.

Let’s do the actual numbers to get the average customer price.

REVENUE PER CUSTOMER:
$1,200,000,000 revenues /8,000,000 subscribers = $150 a year avg. revenue per subscriber

$150/12 months = $12.5 avg. subscriber monthly rev.

NET INCOME PER CUSTOMER:

$66,900,000 net income / 8,000,000 subscribers = $8.36 a year avg. cost per subscriber

$8.36 / 12 months = $0.7 avg. subscriber monthly rev.

If we substract the net income from the revenue, we’ll get the average costs monthly per user, that’s
$11.8 a month, in costs.

Estimated Cost Per Movie (Now, CDs shipped)
The company ships on average, 1.9 million discs a day, that’s 57 million discs a month. They have 8 million users, that makes the average user watch around 7 movies a month. (I watch at least 3 a week, that’s 12 movies a month, 3 times more than the average user).

So, let’s say the average subscriber watches only 3 movies per week, that’s at least 12 movies every month. We grab those $11.8 and divide it by 12 movies

Average Cost per Movie $11.8/7.125 movies monthly = $1.65

The Online Business Model

Netflix has understood that the key to evolution on the TV/Movie business does not lie on the browser, it’s right there on the TV Room where we have been trained to sit and be entertained for hours. Only us early adopters, or people with no TV really have the adaptation capabilities to watch content on our computer screens, or we know that we need an HDMI cable and can do the whole setup to get our computers to play video on the living room.

This means the audiences for video on the internet are considerably smaller (Today) than those of TV, the best way to put it is by grabbing the numbers of the biggest internet video audience so far, The 2008 summer olympics… they only generated $6 million in ads, vs $1 BILLION that the broadcast generated… why? cause the big audience lies right there in the confort of the Living Room, or wherever you have your tv.

Netflix knows that there’s a great deal of people that have:
– TiVO
– XBox
– Other video game consoles

They made a first step when they came out with the RoKU, their own way of putting Netflix on a box in your living room. They’re cutting out deals with Samsung to put the same technology on Blu-ray players.

They will come out this Nov. 19th on the revamped Xbox Live which sits already on 10 million households with XBox Live Gold Subscriptions. I already have a Netflix subscription, but my guess is that at least 4 million of those 10 million XBox live subscribers don’t have it, and they will be tempted to subscribe. If Microsoft and Netflix are smart, they will allow those users to give it a try, and once they see the benefits, those $9.99 will be worth their while.

Xbox Live gets to keep the user base that’s doubting if its time to buy that PS3 and toss the subscription. Netflix on the other hand will almost double it’s customer base, if it manages to convince 1/2 of Xbox Live subscribers to give this a try.

(I wonder where Boxee stands in all this, they could also cut a deal with Netflix if they amass a millions of users at some point, although they seem to be doing something with Apple, and this would compete against the Apple Store per per view model, which BLOWS!)

At what price?

Here’s where the analysis gets tough. Microsoft has huge infrastructure, and Netflix just announced another partnership with TiVO (see, they know the war is won in your living room), but someone has to pay for all this bandwidth.

Engadget also confirmed that their streaming quality will be nothing but HD! (only 300 titles to start though)

So we estimated that currently netflix has about an average cost $1.65 per movie shipped (might be less if the average user watches less than 12 movies a month) and we see that bandwidth costs are dropping. Let’s take Amazon EC3 (which is expensive to me, given we can do it at a much lower price at MyBloop.com):

“Over 150 TB per Month $0.10 per GB”

If you’ve ever watched a movie compressed in DivX, you know you can get a feature film at very good quality eating up only 700Mb… let’s say that Netflix will actually do this in HD, and they had films in double the DivX quality, and each film would be 1.5Gb, it would only cost them $0.15, hell, even if it was 3 Gb or even 5 Gb per movie, you’re still below the 50 cent price, add to that royalties and other costs, at you are still way below the $1.65 cost per movie of today. Let’s say it’ll cost $0.65 per movie streamed.

That’s a saving of $1 per movie, however this convenience will make the number of movies delivered (streamed) to increase, but this might mean they’ll cut better deals in bandwidth getting the costs even lower.

Not to mention the savings to the environment, less DVDs would need to be printed, less paper and ink wasted in envelopes, no gas burnt by USPS, and all the carbon emissions generated in each step of the CD delivery process.

What this means also, is that Netflix will probably get rid of many of its +2000 employees, bringing costs further down, I will add less and less DVDs to my queue as the online catalog grows.

Helps fight Piracy

Another big plus of a full blown catalog (maybe available a few years from now) is movie piracy mitigation. Instead of the MPAA suing their customers, or making things hard for everyone being forced to distribute content with DRM based solutions that never work, what you need to do is have your product easily accessible to as many people, legally. I strongly believe most people are good, otherwise you couldn’t go out on the street and make it back in one piece every day. As a side note, I find it very funny that the MPAA is always asking Internet Video distributors (including netflix) to add DRM to their streams, but they don’t put DRM on their DVDs, anyone could get the 6 DVD subscription to Netflix and copy all the DVDs, there’s just no need to do it, cause Netflix makes it so convenient for you to get more and more movies.

So Why do I care?
I’m just very interested in what happens with TV, how it will manage to survive or evolve, but in this case, there’s a financial incentive.

Ladies and gentlemen, just check out the price of netflix on the stock market, we’ve been blessed with a recent crash, If I were you, I’d be buying NFLX right now.

So the question is, what’s gonna be the price of NFLX a few months or years from now? I’ll leave that answer to Henry Blodget, I think it all depends on execution (get XBox right and then expand to other services and the user base will easily double or triple for Netflix, then go international), they’re targeting the biggest audience ever, the living room audience, the one that makes billions of dollars in the Olympics, the one that’s fed up with the passive entertainment model and who wants to see what they want whenever they want, to share this experiences with friends.

I also care since I no longer have cable TV and I’m constantly looking for legal video entertainment of professional quality. Companies like Hulu and Joost should follow the same steps and try to go to our living room, Netflix not only has a great catalog of movies, but they have entire shows, some you can already watch, for example I got to stream 2 seasons of the office back to back on Netflix, before they were available on Hulu.

(Hulu || Joost) for Free TV streaming on the living room

As for Joost, they should probably acknowledge they’ve lost a great deal to Hulu, which streams 100 million videos a month, it would take a major breakthrough in content to beat Hulu, and even though Hulu is putting big numbers, they just can’t compare with the ad revenue that you can generate on the living room. For Joost (if Hulu didn’t start already) there’s still the opportunity to port their tecnology to PS3, to Wii, why not even come out with an Xbox free download that will allow you to watch Joost on your living room. There’s certainly going to be a lot of people not willing to sign up for Netflix, and the Free TV offer Joost has would be of interest to this audience. If I were Michael Volpi I’d try to use a considerable part of my resources geared in this direction, If Hulu gets in the living room before Joost, it’s game over.