Post office drawback cited in dark forecast for Netflix

A research note issued by Citigroup on Tuesday said 70 percent of Netflix return mailers must be sorted by hand.

When Netflix's 7 million subscribers send their DVDs back to one of the rental service's 47 distribution centers, the discs do not represent many happy returns for the Postal Service.

According to a recent audit by the service's Office of Inspector General, the adhesive flap that seals the Netflix mailers often jams machinery and requires sorting by hand, adding $21 million a year to the service's labor costs. The Office of Inspector General has recommended a 17-cent surcharge on every package that requires hand sorting (not just Netflix discs).

A research note issued by Citigroup on Tuesday said 70 percent of Netflix's return mailers must be sorted by hand. Netflix "is not specifically mentioned" by the postal audit "but is implied," according to Citigroup. A representative of the Postal Service declined to comment.

A Citigroup analyst who wrote the report, Tony Wible, said Blockbuster's return-mailing envelopes do not cause this problem and that the issue could make a big competitive difference for the companies.

If Netflix "has to bear the full brunt of this increase (without other cost offsets), monthly operating income per paying subscriber would fall 67 percent, from $1.05 to 35 cents," Wible's report states.

In the report, Wible reiterated his sell rating on Netflix and his buy rating on Blockbuster. "Given the magnitude of this risk," he wrote, Netflix is most likely to "work towards resolving this issue by redesigning its mailers."

Steve Swasey, a Netflix representative, said the company has gone through 40 to 50 iterations of the mailer since Netflix started shipping DVDs a decade ago and that it is open to further adjustments.

"If the specifications of the post office were to change, we would change the mailer as necessary," he said. The company ships 1.6 million DVDs a day and offers nine monthly subscription plans, from $4.99 to $47.99.

Far from being a drag on the post office, Netflix is a help, Swasey said. "We save them about $100 million a year," he said. "We pick up the returns from the post office. They are not delivered to Netflix, even though we're paying for it" by buying first-class postage for the DVDs.

"Even if there is some validity of the cost of hand sorting to the post office, it is more than made up for in the costs we're saving the post office every year," Swasey said.

Blockbuster, which started mail rentals more than three years ago, "looked carefully at the design of our envelopes," said Karen Raskopf, a company spokeswoman, "and we worked with the post office to make sure they could go through the machines and that the DVDs would be safe."

Wible said in an interview that Blockbuster is edging in on Netflix: "They've got their store content, delivery by mail, and downloaded delivery."

Blockbuster, which has 3.1 million online subscribers and 60 million customers overall, is "offering more convenient access to media than Netflix," Wible said. "Netflix either has to spend more on marketing or lower pricing to increase growth," he added. "So they have these rising costs--including postage increases."

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