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DVD price wars: How low can they go?

Plunging prices and new competition from Blockbuster and Wal-Mart are pressuring pioneer Netflix.

Wal-Mart Stores has struck the latest blow in a burgeoning DVD price war, putting new pressure on online rent-movies-by-mail pioneer Netflix.

The retail giant this week cut the price of its DVD Standard Plan by 7.5 percent, from $18.76 a month to $17.36. The reduction trumps recent price cuts from Netflix and Blockbuster, which now offer similar plans for $17.99 and $17.49, respectively.

The new Netflix price, which came about last month when the company slashed $4 off its flagship monthly plan, entitles subscribers to unlimited rentals, with three movies out at any time. The company had raised its prices to $21.99 just six months earlier and had counted on the extra revenue to help compensate for rising costs.

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What's new:
Plunging prices and new competition from Blockbuster and Wal-Mart are putting pressure on online movie rent-by-mail pioneer Netflix.

Bottom line:
Unless significant cost savings can be found elsewhere in the business, Netflix could be dangerously close to losing money on many subscribers, but the company isn't standing still.

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Netflix has acknowledged that the aggressive actions of its rivals this year took it by surprise. The next year, and perhaps longer, will be a "land grab" period in which profits will be hard to come by despite extraordinary growth, the company's executives said.

"We underestimated the likelihood and significance of competition, primarily from Blockbuster and Amazon," Netflix CEO Reed Hastings said Wednesday at a Morgan Stanley investor conference. "We came to the view that if (they) were going to enter, they would have done it in 2002, when the market was smaller, or in 2003."

The last several weeks saw a flurry of price cutting as Netflix jockeyed with Blockbuster and Wal-Mart for consumers' dollars, and as all three looked to the possible entry of Amazon.com into the DVD rent-by-mail business.

The price wars are helping fuel demand for what may be the lowest-tech high-tech business around. While Internet companies start to lay the groundwork for true video-on-demand service, the DVD-by-mail business has already gone a long way toward replacing the old video store rental business.

The buzz
Netflix, Wal-Mart, Blockbuster--they all want your DVD rental business. Who has the best service? Tell us what you think.
Indeed, in recent filings with federal securities regulators, Blockbuster cited competition from online DVD rental companies as a chief reason for declining rentals in its core local store business.

The result has been sudden and bitter competition in a market that Netflix, which now has more than 2.2 million subscribers, has had largely to itself for years.

A year ago, Wal-Mart was the first to enter the fray. The bellwether retailer followed its usual strategy of undercutting the market, offering a low-cost $15.54 plan limited to two DVDs at any one time, a middle $18.76 tier allowing three DVDs, and a top $21.99 tier offering four DVDs a month. (This week's price cuts affected only the middle tier.)

That wasn't enough to keep Netflix from raising its long-standing price from $19.99 a month to $21.99 a month last June. But Blockbuster's entry proved more serious. The company opened its online DVD movie rental service for $19.99 a month in August, and then followed news of Netflix's price cuts last month with its own $17.49 plan.

"We were growing our business at a very nice clip, but would not have elected to lower our prices," Blockbuster Chief Executive Officer John Antioco told Reuters last month. "Having said that, we are determined that we are not going to be beaten from a price-value perspective."

Netflix executives have said they expect Amazon to enter the market, but the online retailer has not confirmed those plans.

Impulse rental rivals
Even the giants could soon be facing sharper competition from local retail outlets, in the form of kiosks offering 99-cent-a-day DVD rentals.

Tiny DVD Station, with just 20 employees, has kiosks in about 14 retail outlets so far, including Sony's Metreon center in San Francisco. Another kiosk maker, Los Gatos, Calif.-based DVDPlay, is testing 99-cent DVD rentals in partnership with McDonald's.

DVD Station offers retailers everything they need to set up a rental service within their stores, with up to 25,000 titles. The DVDPlay kiosks stack from 100 to 350 movie titles in a vending machine, offering mostly new releases.

"The selection is obviously not comparable to Blockbuster, but they do have new releases, and it's cheaper than Blockbuster," wrote a Colorado resident who has seen the DVDPlay machines in McDonald's.

DVDPlay CEO Jens Horstmann said he believes free video rentals may soon be coming in the form of incentive programs with retail stores. For example, he said, some stores using DVDPlay's kiosks currently offer free rental coupons for customers who spend a certain amount of money on groceries or other products.

Down the road, he said, these deals may become automated through partnerships with customer loyalty programs by major chains such as Safeway. He said no such deals have yet been worked out, however.

Biting the bottom line
The price cuts will undeniably make Netflix's business trickier to manage.

The company has found in recent months that one of the prices of a successful service has been rising costs. In recent reports to federal regulators, the company said its customers are now on average renting about 6.6 movies per month, up from 5.6 last year.

Losing close to 18 percent of its subscription revenue as a result of the price cuts could help push the profitable company underwater. In the quarter that ended in June, the company had a net profit of just $2.9 million, with subscription revenue of $119.7 million.

Nevertheless, Netflix's Hastings said the price cuts had galvanized subscriber growth and reduced churn rate, so that the company has already reached the low end of its predicted year-end goal, about 2.3 million total subscribers. He said the company will maintain a break-even financial performance despite the cuts.

"All subscription DVD rental businesses have a hard time meeting demand for new releases."
--Jens Horstmann, CEO, DVDPlay

Nor is the company standing still. Its spending on marketing has more than doubled in the last year, and it has partnered with TiVo to start testing a video-on-demand service that would take advantage of the digital video recorder company's network and hardware.

Industry insiders say Netflix also has pioneered measures that help control its costs. One key factor has been the development of a user interface that steers subscribers toward renting back-catalog movies instead of new releases. This allows the company to have fewer expensive copies of the latest movies on hand, industry insiders said.

"All subscription DVD rental businesses have a hard time meeting demand for new releases," said DVDPlay's Horstmann. "Sometimes customers have to wait a month or two" to see the latest movies.

According to Bill Fischer, vice president of corporate development at DVD Station, rental businesses that make appropriate use of technology can double or triple interest in catalog titles. For example, Fischer said 40 percent of DVD Station's rentals make up titles more than six months old, compared with just 11 percent for Blockbuster.

Hastings said the "land grab" in the coming months will be driven by huge marketing expenditure on all sides. Netflix itself will spend about 20 percent of its revenue on marketing next year, he told the investor conference on Wednesday.

More broadly, the company is betting on its experience to keep it afloat through all the competition, he has said.

"We think we will compete successfully with (rivals) because we have great scale, we ship 3 million DVDs a week, and we have five years of experience in this market," Hastings told CNET News.com in an interview last month.

CNET News.com's Michael Kanellos contributed to this report.

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