Note to Netflix: Roku box needs latest movies

news analysis Netflix, don't take half steps with your digital-delivery service. Give your users what they want, and what they want is the latest hit movies.

CEO Reed Hastings and his management team have hit a home run--or at least a solid run-scoring triple--by partnering with Roku, the company behind the Netflix Player. The $100 device enables customers to stream movies from the Web to their TVs. Most reviewers have applauded the device for its low cost, easy setup, and viewing quality (a good Internet connection means no stalling or long download delays).

But a month after the Netflix Player went on sale, I haven't read a single review that hasn't deducted points for the lack of films available with Netflix's streaming service. It's the biggest complaint from device owners I've spoken with.

Mr. Hastings, you've done a good job by setting up your "Watch Now" streaming service with 10,000 catalog titles, but you need to go further. Let customers purchase new releases on a per-video basis if they want. Some might resent being asked to pay in addition to their monthly subscriber fees, but if you explain that Hollywood charges more for new releases, your customers will understand. Give us choice.

"Why would anyone feel alienated by this?" said Michael Pachter, a financial analyst with Wedbush Morgan Securities. "You can't get a better deal elsewhere. Netflix would be essentially giving you Apple TV without charging you for the Apple box."

This is an important comparison because Apple has already begun offering new releases for rent via iTunes. Trust me on this Netflix, you don't want to fall behind to Apple. And let me be clear. Hollywood hasn't barred Netflix from obtaining the latest releases. Netflix managers have acknowledged that they could have received the same deal as Apple. They chose not to, and I think that's a mistake.

Pachter disagrees with me. While he said he wouldn't be surprised to see Netflix experiment with streaming new releases, he likes the current hybrid approach: offering catalog titles for Internet streaming and mailing new releases in the form of physical DVDs.

"What Netflix is saying to customers is 'We're going to give you new movies on a disc and we're going to give you as much catalog and streaming as we can possibly deliver to you for (the same monthly subscription),'" Pachtel said. "That's a smart business model."

Netflix executives said during the company's investor day last month that most of the movies it rents are catalog titles.

But by ignoring the digital distribution of new releases, the company is leaving the door open to competitors.

In January, Apple cut a deal with the movie industry that allows iTunes to rent new releases 30 days after the flicks become available for sale on DVD. It would be nice to get them sooner, sure, but Apple is providing an option that Netflix is not.

It's important to note that Netflix's traditional mail-order business isn't affected by the same 30-day restriction. This is one of Netflix's biggest advantages over anyone delivering movies over the Web or on VOD.

Netflix buys physical DVDs as soon as they go on sale and, by law, Hollywood is powerless to dictate what the company does with its property. This means that by the time iTunes or VOD services are allowed to start renting movies, Netflix has been shipping those little red packages for a full month.

But discs are not the future. And I'm not the only one who thinks this way. Hastings predicted last month that DVD rentals will peak within the next 5 to 10 years, yet Netflix is leaving the Internet delivery of new releases to Apple and other competitors.

Here's why they may have gone this way.

Netflix doesn't serve a la carte
Subscription fees have helped make Netflix the No. 1 online video rental service. Founded in 1997, the company started out charging customers on a per-video basis and switched to subscriptions two years later. Not long after that, Netflix began offering unlimited rentals for a flat fee.

Since then, Netflix has steadily grown and snatched market share. In the quarter ended March 31, Netflix saw net profits jump 36 percent to $13.4 million, or 21 cents a share. The number of subscribers grew 21 percent to 8.24 million.

So why go back to charging users for each video they rent? They obviously are attracted to the all-you-can-eat model.

Netflix customers will gradually move to the Web
The Web hasn't taken over yet. There's plenty of time to boost the quality of Netflix's streaming library and consumers may not fully embrace Internet video until it's as good as watching a DVD.

While Roku's Netflix device offers easy access to movies and does away with the long download delays, it still doesn't offer the best-looking picture.

But improvements in download and streaming technology are coming rapidly. The Roku device is perhaps the best example of this. Adoption of Internet movie rentals could occur faster than anyone realizes.

And remember that advantage Netflix enjoys by being able to mail DVDs a month before Internet or VOD distributors? It's possible that might vanish soon.

The studios have a distribution structure whereby they cut deals to provide exclusive access to films for specific periods known as "windows." Theatrical releases typically come first, followed by home-video release, then pay-per-view channels, then regular cable, etc. This is why Apple and VOD services must wait 30 days before distributing rentals.

Take a look at this excellent story from the Los Angeles Times. Executives at some of the major studios, who used to believe that the Web and VOD services could hurt DVD sales, are experimenting with limiting the time an outlet has exclusive access to films. Others studios are testing whether it pays to make Web and VOD rentals available when DVDs go on sale.

Early indications are that Web sales don't eat into DVD sales.

This means Hollywood could conceivably break down the walls and give VOD and Web-movie distributors access to films as soon as Netflix gets them.

And look at the growing competition that's swarming into the sector. Apple, Amazon, Microsoft's Xbox, cable companies, and Hulu are all out to use digital distribution to offer consumers instant gratification.

Reader, I don't know about you but I'll choose instant gratification over waiting for the postman every time. I'm a film buff. Why should I be forced to decide what I want to watch in advance? Let me push a button and choose whatever movie I want.

I'd be willing to pay a premium for that.

So come on, Netflix. Spend big, move fast. Get your customers thinking of you when it comes to instant gratification. Gather expertise on streaming technology and pricing before your competitors.

The Internet and movie rentals are supposed to be your turf.