Battered By Blockbuster, Netflix Cuts Marketing

by Sarah Mahoney @mahoney_sarah, July 24, 2007

Pity poor Netflix. Ever since the novel movies-by-mail company burst on the scene in 1999, it's earned plenty of fans. And thanks to its clever advertising, it celebrated shipping its 1 billionth DVD earlier this year.

But Blockbuster's me-too Total Access program seems to be cleaning its clock, with Netflix announcing over the weekend that it would lower its prices by $1 per month. And Monday, it said its membership--which has grown at an amazing seven-year compound annual growth rate of 79%--actually fell in the quarter.

The company posted disappointing second-quarter results. "Intense competition slowed second-quarter revenue and subscriber growth, even while we delivered near-record net income," the company says. With 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."

At the end of the quarter, Netflix had 6.742 million subscribers--a decrease of 55,000. The company, which had predicted it would end the year with between 7.3 and 7.8 million subscribers, has lowered that estimate to a range of 6.8 to 7.3 million. It estimated that revenues will decline from $1.17 to $1.185 billion--down from $1.21 to $1.26 billion--and that net income may fall as low as $42.4 million, down from $55 million to $60 million.

As of April 1, Blockbuster's had 2.8 million paying subscribers to its Total Access plan, which also allows members to return videos to its stores.

With the price cuts, Netflix will now charge $16.99 a month for a plan that allows subscribers unlimited rentals while keeping up to three DVDs at a time. The price for the unlimited rental plan that allows people to keep one DVD at a time will fall to $8.99 per month. The price cuts match fees charged by Blockbuster for similar online-only services. Netflix's $4.99 and $13.99 plans remain unchanged.

The move made analysts nervous. Jefferies & Co. quickly downgraded Netflix from "buy" to "hold," and in a note to clients, analyst Youssef H. Squali says it means that Blockbuster TotalAccess "has been more successful than initially thought." Blockbuster is likely to keep its pricing structure in tact through year-end, he says--which means Netflix will not be able to raise its prices, either.

Blockbuster, which lowered its prices back in June, predicts that the online rental market will increase 43% during 2007. Netflix projects that the total market will have more than 20 million online subscribers in the next four to six years.

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