Now showing: Blockbuster squeezes Netflix

Netflix has a great service. Just not great enough to avoid a bloody price war with Blockbuster's TotalAccess plan.

Netflix has a great service. Just not great enough to avoid a bloody price war with Blockbuster's TotalAccess plan.

On Sunday, Netflix lowered two of its most popular subscription plans by $1 (see statement). The $9.99 a month plan to provide unlimited DVD rentals on a PC was cut to $8.99. A $17.99 plan with unlimited DVD rentals was cut to $16.99. The Wall Street reaction Monday was swift as Netflix shares were hammered. And there's a good reason for that--Thomas Weisel notes that the pricing move will cut earnings by 20 cents a share in the second half of the year. Netflix confirmed the damage in its earnings report.

But Netflix has little choice since it appears to be losing subscribers to Blockbuster. It's no coincidence that Netflix's price cuts to match Blockbuster's pricing.

This battle is interesting on a few fronts. For starters, competition seems to be catching up with Netflix after various tries by Blockbuster. In addition, Netflix's model is arguably better--and the IT behind the model is also interesting. However, Blockbuster has utilized a bricks and clicks model to at least make life difficult for Netflix. The big end game is most likely video downloads. In this case, downloading could do both parties in. Netflix has a downloading strategy that's pretty sound. The big question: Will customers get in the habit of downloading at Netflix?

The extent of the pricing damage was revealed in Netflix's quarterly results. The company reported second quarter earnings of net income of $25.6 million, or 37 cents a share, on revenue of $303.7 million. The net income figure included a one-time gain. Excluding that gain, Netflix's profit was 31 cents a share.

The company was expected to report earnings of 23 cents a share on revenue of $307 million, according to Thomson Financial. For the third quarter Netflix projected net income of 11 cents a share to 19 cents a share on revenue of $284 million to $289 million.

Wall Street expected third quarter earnings of 19 cents a share on revenue of $310 million. Netflix cut its fourth quarter outlook and projected ending 2007 with 6.8 million to 7.3 million subscribers. For the year, Netflix is projecting net income of 62 cents a share to 76 cents a share on revenue of $1.17 billion to $1.85 billion. Those projections are also down from previous expectations.

Netflix's biggest problem in the second quarter (aside from the need to cut prices) was churn. The company said its churn for the quarter was 4.6 percent, up from 4.3 percent.

Netflix CEO Reed Hastings said:

"Online DVD rental is a large and attractive opportunity and we remain committed to investing in our long-term growth. With yesterday's price cuts in two of our most popular subscription plans, together with the reductions in February and June, we are choosing to lower price and reduce marketing as the most efficient means of sub growth and retention in the current competitive environment, and we are lowering our full-year guidance for revenue, subscribers, and earnings accordingly."


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