Tue, Jun 04, 2002 page19

• Netflix striving to beat Blockbuster

  Although the online DVD rental service has first-mover advantage, Blockbuster plans to get into the game

  • NY TIMES NEWS SERVICE
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  As an idealistic Silicon Valley entrepreneur in the 1990s, Reed Hastings wanted to improve California's public schools, particularly what he saw as the dismal state of math and science education in the nation's premier technology corridor.

  He used the money from the sale of his first software company, and the time that afforded, to get a master's degree in education from Stanford. He has since helped lead other local executives in a mission to change public school instruction.

  But Hastings maintained his involvement in the technology business, and now he is bringing his drive to a plan to change the way people rent movies. He is having considerable success.

  

  Reed Hastings, head of online DVD mail-order company Netflix.

  PHOTO: NY TIMES

  Two weeks ago, his online DVD mail-order company, Netflix, went public, raising US$80 million in a still bleak climate that only two years ago had led him to cancel an announced public offering. In Netflix's first day of trading, shares in the company, which has yet to even show a profit, rose nearly 12 percent.

  "It's a lot different market right now," Hastings said. "Now it's neither a halo nor a taint to be a dotcom. These days, the Internet is like electricity -- it's just there."

  The question now is whether Netflix will continue to grow at the same pace. The company recently signed up subscriber No. 600,000, doubling its subscription base in only a year.

  It was in 1997 that Hastings and Netflix's co-founder, Marc Randolph, decided that the DVD, the presumed successor to the videocassette, was set to take off. That turned out to be an understatement. According to the market research company IDC, one of four US households owns a DVD player, making it the hottest selling consumer electronics product in history.

  But to avoid the fate of other online stores, Hastings realized early on that he needed to keep his costs low. To do this, he needed to get films directly from the movie studios rather than to pay wholesalers. As it turned out, Hastings said, movie studios saw Netflix as a way to help diversify a market dominated by one huge seller, Blockbuster. In fairly short order, the company signed revenue-sharing deals with nearly every major studio. This arrangement enables Netflix to carry more than 11,500 titles.

  For a monthly fee of US$20, viewers can receive up to three DVDs at a time and keep them for as long as they wish. Gone entirely are late fees, a standard feature of in-store movie renting that was particularly irksome to Hastings, who once tallied up US$40 in late fees for Apollo 13. When a customer is finished with a disc, he or she simply drops it in a postage-paid envelope that is provided and waits for the next disc from an online request list to arrive.

  But given the brisk sales of DVD players, Netflix's potential market is huge, said Jonathan Gaw, an IDC research manager. And Netflix has an early lead over its competitors, which so far amounts to about 50 mom-and-pop DVD mail-order businesses. Blockbuster, the largest video and DVD chain, is hinting, however, at its plans in the online mail-order market.

  Just as the DVD market has taken off, so has Hastings' effort to help public education. Last year, California's governor, Gray Davis, appointed Hastings, 41, to be president of the California State Board of Education, overseeing more than 8,500 public schools in a state with one of the lowest per-student expenditures in the country. The tasks facing the board are enormous, but the challenge strikes a chord with Hastings, whose interest in reshaping public education began 20 years ago.

  After graduating from Bowdoin College in Maine in the early 1980s, Hastings joined the Peace Corps and spent three years teaching high school mathematics in Swaziland, before returning to California to develop software. Many years later, he took his first company, Pure Software, public and then eventually sold it to Rational. It was around then that he met John Doerr, Silicon Valley's most notable venture capital investor as well as its most vocal advocate for changing public schools.

  Just as Doerr's firm, Kleiner Perkins, was becoming an early investor in Netflix, he and Hastings began joining forces to push for a variety of educational initiatives, including more charter schools and improved math and science education. For a year, Hastings led TechNet, the Silicon Valley political lobbying group founded by Doerr.

  In November 2000, along with Doerr, Hastings helped draft Proposition 39, a hotly contested state initiative to lower the California voter threshold for passing school bonds from two-thirds to a simple majority. Hastings, who sends his own two children to a private school with twice the per-student financing as California's public classrooms, donated US$1 million to the campaign and devoted many hours promoting it, just as he had a similar school bond proposition that voters rejected earlier in the year. In November, Proposition 39 passed by a comfortable margin.

  These days, Hastings says he spends about a fifth of his time on state education matters, racking up miles commuting from Netflix's headquarters in Los Gatos, a wealthy wooded enclave nestled in the southwest corner of Silicon Valley, to the state capital of Sacramento two hours away.

  But while working to improve public schools consumes many of Hastings days, running Netflix continues to be his true passion. "For me, Netflix is pure joy, while education is just satisfying," Hastings said in a telephone interview during a break in school board meetings in Sacramento last week.

  His immediate goal now is to reach profitability, something that may not be far off. In 2001, Netflix recorded a net loss of US$38.6 million on revenue of US$75.9 million, according to Securities and Exchange Commission documents. For the three months ended March 31, things were showing improvement: Netflix lost US$4.5 million on revenue of US$30.5 million.

  But Hastings biggest challenge yet may be just ahead. This summer, Blockbuster is expected to begin trials of a subscription mail-order movie business. But Hastings seems undaunted, even eager for another battle.

  "It's going to be a lot harder for them to stop us now," Hastings said. "There's a pure adrenaline excitement in Netflix, in whether we can take on Blockbuster and win."
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