What You Can Learn Frm NetFlix

“Build a better mousetrap and the world will beat a path to your door.”Ralph Waldo Emerson

As we told you in Message #1138, NetFlix rents unlimited movies, up to three at a time, for a monthly subscription fee of $21.99. Reed Hastings got the idea for starting the business after he got hit with a late fee from Blockbuster. He thought about the model that health clubs use — having customers pay a flat fee per month for unlimited workouts — and wondered, “Why not do the same for movie rentals?”

Hastings believed his idea was solid, but he was afraid to compete head-to-head with Blockbuster. Start-up costs for multiple retail locations would be huge — too much for him. Plus, it would be too easy for Blockbuster to trump him by adapting his program if it worked.

So he began NetFlix online — and, as more and more people hear about it, business keeps getting better and better.

Our son Liam told my wife and me about it last year. We tried it and have become big fans. Besides the convenience of not having to drive to a store to rent a movie and not having to worry about returning it on time (since there are no late fees), NetFlix gives you the comfort of knowing you won’t spend more than $22 a month, no matter how many movies you rent. And it offers the additional advantage of having an extensive selection of films.

A computer tracks your choices and makes recommendations based on what you have rented and liked in the past. (You can rate the films you watch.) I’ve seen dozens of foreign films I’d never have located at Blockbuster. Although NetFlix is still small in the movie-rental industry, it’s being imitated. In the past year, Wal-Mart, MSN, and others have launched copycat services. Last month, Blockbuster jumped on the bandwagon too.

NetFlix has a head start on the me-too competition, but Blockbuster and Wal-Mart have a big customer bases they can sell to. Maybe more threatening is the looming advent of on-demand movies. Movielink, a joint venture of the major movie studios, is selling downloadable movies. So is Real Networks. And, according to technology-trend follower Kevin Maney, it’s just a matter of time before AOL, owned by movie giant Time-Warner, gets into the picture.

But so will NetFlix. Hastings recently announced that it would start offering downloadable movies online in 2005.

I believe NetFlix was an early investment recommendation by the Oxford  Club — possibly by Steve Sjuggerud. Anyone who put money into it then did very well. Is it still a good investment? Probably not. Here’s what Brian Hunt of Pirate Investor told me:

“It may be a great company, but it’s trading for 60 times expected earnings and five times sales. It’s priced for perfection. One slip-up in the war against Wal-Mart and Blockbuster and it could get hammered.”

Sixty times expected earnings? Oh, boy! I’d stay away from that. But the success of NetFlix reminds us of something it’s good to know — in fact, of three things:

1. You can still create a better mousetrap. And in this case, as in most cases, it happens when someone is dissatisfied with the service, features, or cost of an existing product.

2. The Internet is indeed a viable place to launch new businesses.

3. Although you don’t need to see the business world in terms of a competitive model (a “me-or-them” contest), some entrepreneurs, like Hastings, do. And do well with it.