Psst, Netflix -- Kill Your DVD Service Now

You won't often see Netflix (NAS: NFLX) and AOL (NYS: AOL) in the same sentence, but it seems as if the popular video service provider is taking a page out of AOL's 2008 playbook.

AOL chose to bludgeon a cash cow a few years ago, deciding to accept the gradual demise of its flagship dial-up service and focus its efforts on a digital future.

Isn't that what Netflix is doing now in letting its mail-based DVD and Blu-ray service die on the vine as it continues to position itself as a streaming provider?


The good news for Netflix is that it's realizing this early in the platform's descent. Members on DVD plans have only declined for three consecutive quarters. AOL's usage peaked at 26.7 million customers paying for access 10 years ago. It didn't publicly decide to all but turn its back on America Online -- tearing down the wall to make many of the premium services free for those with broadband connections and hoping to make up the difference in higher margin display advertising -- until several years later. By then the access customer base was closer to 10 million.

The problem with holding on to a dying business
We can argue about the merits of AOL's decision then just as we can complain about Netflix now.

Disc-based customers, for now, are far more lucrative to Netflix than its larger base of streaming accounts. Netflix's 10.1 million disc-based customers generated $146 million in contribution profit. The 23.4 million domestic streaming subscribers only generated $67 million in contribution profit, and that was more than offset by the loss on its international streaming business.

However, the same thing could've been said about AOL. Why should it unload a declining business that's making gobs of money?

Well, the problem is that AOL could've sold off its American Online access business to EarthLink (NAS: ELNK) or a cable or telco giant and made a lot more off the service then with 10 million customers than it would be able to now with less than 3.3 million domestic AOL-brand access subscribers.

Right now, Netflix just broke below the 10 million mark of paid disc-based subscribers. In three quarters, it has reversed nearly three years of growth. Even Netflix concedes that this will continue to shrink in perpetuity. In a few years, investors will lament why Netflix didn't sell its mail-order business to Coinstar's (NAS: CSTR) Redbox now instead of riding it all the way down.

Let's revisit the first quarter. The number of subscribers fell 10% sequentially, but the revenue fell by 14% and contribution profit tanked by 25%. Expect that to continue. As Netflix neglects the service -- and it will -- those on the plans will keep moving out or downgrading to cheaper plans. This is a scalable model, and we all know what that means in retreat. The same investors who are cheering the company's DVD business for padding the blow right now will be cursing at how it's holding back streaming margin growth in the near future.

Why not sell to Redbox -- the only company that's still ordering a ton of discs for rental -- or perhaps even Blockbuster? Let someone else take the blame for doing what Qwikster was supposed to do in dividing the disc and digital platforms last summer.

Who are you kidding, Reed Hastings. You know you're just dying to rip off that Band-Aid in one swift pull. Just do it, dude.

Netflix circa 2015
Analysts asked Netflix about selling its DVD business and the introduction of tiered services during this week's conference call.

Netflix dismissed the propositions. The company is either in denial or it's afraid of going all Ozzie Guillen on its couch potato disc lovers by speaking its mind. Deep down inside, this has to be what Hastings really wants to do.

Let me tell you exactly what Netflix will look like in three years, and you're more than welcome to email me in three years with a link to this article to taunt me if I'm wrong.

There won't be a DVD service. Netflix will continue to lead the market with its streaming platform, with tens of millions of customers worldwide. The $7.99 a month plan will still be there, and maybe it'll be closer to $9.99 a month.

However, Netflix will also have a ton of new releases and older movies that aren't part of the all-you-can-stream buffet available at additional cost. Maybe it'll be as simple as a $19.99 a month plan that includes unlimited streaming of Netflix's main digital library and three or four premium rentals. Through tiers or just outright fees, it's going to happen.

The laws of supply and demand will let Netflix and content creators decide if a movie can make more money for the studio as a premium title or at a flat fee to go into the unlimited pool. The model will make sense for both sides, and Netflix will no longer be the enemy. It will be a monster that Hollywood will embrace because Hastingzilla will make it rain royalty payments to the companies making content worth watching.

Amazon.com (NAS: AMZN) is sort of there already with its piecemeal collection of premium rentals alongside the 17,000 titles that it makes available to Prime customers at no additional cost. If Netflix doesn't see this as the future -- or if it somehow believes that hot new rentals will ever be willing participants of a $7.99 a month smorgasbord plan -- then maybe it's better off selling more than its DVD business.

I'm glad I got that off my chest.

Stream on
Motley Fool co-founder David Gardner has been a fan of Netflix as a disruptor for nearly a decade, but there's a new rule-breaking mutlibagger that's getting him excited these days. Learn more in a free report that you can check out right now.

At the time this article was published The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services have recommended buying shares of Netflix, Coinstar, and Amazon.com. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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