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I’ve been a long time Netflix customer.  I begrudgingly tolerate Netflix’ well documented throttling practices. (For those unfamiliar: throttling was the name applied to the intentional slow down of deliveries to insure an revenue maximizing ratio of movies delivered per rental fee).  I also tolerate little annoyances like bonus-feature discs (eg/ a disc with nothing on it but directors commentary and deleted scenes) being counted as a separate rental, or the lack of availability of an occasional title.  As a movie fan, I used to hate going to rent a film only to find my local store had none available, nor anything else I wanted to see. Netflix’s larger pool of titles, the convenience of home delivery service and lack of late fees won me over despite the occasional frustrations.

Netflix retains my business today because they have provided the best service of its kind.   They offered a real value. Now, in the increasingly competitive and bloody battles of the movie rental world, that value proposition is degrading.

Netflix is due to announce earnings January 24th.   The expectation is that both subscription and revenue numbers will be up and I imagine, will exceed expectations.  It’s also expected that battles with Blockbuster and ongoing litigation are taking a toll. Operating expenses, including heavy marketing costs (to fight Blockbuster), as well as legal expenses, will be way be up year over year. Whatever the numbers, or the reaction from The Street, Netflix faces a difficult future. In the spirit of analyst’s reviews around earnings announcements, here are three talking points from a list of their troubles:

• DANGER OF DOWNLOADS
• the future is coming and the danger is obvious.  Technology for delivering DVD quality, full-length downloadable movie content is far from perfected.  DRM issues are also slowing deployment. It may be a year, or five, before standards are determined, licenses signed and the long promised hope of downloadable video is fulfilled.  Still, sooner or later, downloads are coming. And once downloads are here they’ll provide the kind of convenience and value proposition over Netflix that Netflix used to trump in-store rental services when it premiered.
• Netflix and Blockbuster can coexist, to some degree, side by side with download services but to sustain customer base and grow membership, they’ll have to include top tier level download services in their product offerings.  Given that kind of technology development is not in either company’s core area of expertise, partnerships or acquisitions will likely be necessary).  Finding a suitable 3rd party technology and getting an exclusive license to use it will be difficult, if not impossible. An acquisition, whether of companies like CinemaNow or Movielink, or a pure technology, are more realistic.(Note: Netflix’s “Watch Now” download feature just began a very limited roll out and it’s too early to tell if it will be a success or failure)
• DANGERS OF TITLE EXCLUSIVITY
• In November Blockbuster signed a first of kind exclusive distribution deal with the Weinstein Co.  According to the terms, effective January 1, 2007, Blockbuster will gain exclusive rental rights for Weinstein Co. films.  For the privilege, Blockbuster will pay a minimum guaranteed fee (based on box office results) to Weinstein Co, and the two will otherwise share revenue from rentals.   While the valuable Miramax library that made the Weinstein brothers famous remains a Disney holding, as a production house, the Weinstein Co. can be expected to back at least a handful of major theatrical releases per year.  At a few a year, the volume of titles this one deal excludes from the Netflix library may not be big enough to bother most customers, but if more deals like this are signed, it could be a major disadvantage to Netflix.  Even the absence of one title, if popular enough, could drive a customer to migrate away from Netflix or use both services.
• DANGER OF SERVICE REPLICATION AND LITIGATION
• Blockbuster has increasingly replicated the features Netflix offers.  As a result, services which were once unique to Netflix have become somewhat of a commodity.   Without the exclusive advantage of these features, Netflix is in trouble and Blockbuster gains an advantage: Blockbuster’s ability to marry in-store and mail order service provides an expediency and convenience that pure mail order doesn’t.  To that end, Netflix sued Blockbuster in April 2006 claiming patent infringement on many of its pioneering processes.  The outcome of that suit will have significant bearing on Netflix’ future. 
• Elsewhere in litigation, Netflix has been damaged by class-action suits against it for its throttling practice.  Netflix was also named a defendant in a patent infringement suit filed by Lycos on January 3, 2007.   That suit names Tivo, Blockbuster and Netflix as defendants for their use of recommendation services.  While the novelty of these features are not essential to Netflix’ (or Blockbuster’s) success or core rental practices, the cost of defending the suit, and the potential harm a negative outcome could have on the user experience, are not trivial.