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All Queued Up: Netflix

Nov. 1, 2005
How the Netflix distribution network supports the company's business model.
Not many companies go head-to-head with Wal-Mart (Bentonville, Ark.) and not only win, but get the world's largest retailer to refer all of its customers to them. That's what happened in May when Wal-Mart shut down it's DVD rental service and offered its customers a seamless transition to rival Netflix (Los Gatos, Calif.).

The 7-year-old company's rapid growth harks back to the late 1990s, but unlike the Internet startups of that era, the company has been posting quarterly profits. Executives project 2005 revenues of around $685 million, up 35% from last year when revenues jumped 86% over 2003. After passing the three-million-customer mark this past March, they expect to have over four million customers by the end of 2005. Netflix has maintained this rapid growth pace despite the fact that Blockbuster (Dallas), the biggest name in video rental with over 9,000 retail outlets, launched its own online DVD rental program in August 2004 and signed up one million customers.

Netflix's service works like this. Customers sign up online, paying $17.99 per month under the most popular
subscription-plan. They receive three movies at a time and an unlimited number of titles over a given month with no late fees or shipping charges. Using the reviews and recommendations of other customers, they can select from over 50,000 titles, adding movies that they'd like to see to their online queue.

When a customer drops a movie in the mail, the U.S. Postal Service returns it to the nearest of Netflix's 37 shipping centers located across the United States. There an employee opens the distinctive red envelope and scans in the DVD. This triggers an e-mail to the customer acknowledging-receipt and notifying them that the title-at the top of their queue will be shipped out later that day. It also logs the DVD back into inventory and begins the order fulfillment process for the next title. Individual discs received in the shipping centers generally go back out to other customers the same day that they are received. The company has over 40 million DVDs in inventory and mails over one million titles each day.

"Within 10 minutes that a DVD is returned, we've notified you that it has been received, returned that DVD to inventory, and ordered your next one," says Steve Swasey a company spokesman. "It's an amazing process."

The shipping centers themselves don't look that sophisticated, he says. They are basic, air conditioned, high-ceiling warehouse buildings. "The beauty of Netflix is in the software, the algorithms that match movie tastes with the movies you want to watch," Swasey says, offering an example of the website's ability to satisfy customer needs. When the company had 236,000 customers, it had about 100 customer service representatives. With 3.6 million members it now has just 43 customer service reps.

With an average size of 11,750 sq.ft., each shipping facility consists of 30 to 40 people handling envelopes that arrive in standard postal bins, working next to mail-sorting machines that separate the outgoing envelopes by zip code. The leased facilities are staffed by employment agencies such as Administaff, a human resource outsourcing firm based in Kingwood, Texas. Of the 1,200 people who work for the company, about 1,000 work in the shipping centers.

Although most of these people are employees of the staffing agencies, the company works hard to maintain a unique, inclusive culture. New hires start on a temp basis for three months. Those people who successfully complete this probation period are hired full time. At that time they receive a free DVD player and a subscription to Netflix. The site managers, who are direct employees of Netflix, work on the floor next to everyone else. There are no private offices or conference rooms in the shipping centers.

Netflix stores and ships slow-moving titles, about 30% of the total, from a primary distribution facility near company headquarters in Sunnyvale, Calif. Here the DVDs are stored on standard shelves. Employees pick titles using a combination rolling cart and stepladder. This location also receives new releases from the movie studios—thousands at a time arrive on spindles—and sends them out to the regional hubs. When shipping these discs out, the Sunnyvale operation reuses the boxes in which it receives the millions of the specially designed polyurethane sleeves and mailers that the company uses.

"Everything at Netflix is done with cost effectiveness and efficiency in mind," says Swasey. The mailers protect the DVDs but allow them to be shipped at the firstclass, one-ounce rate of 37 cents. Less than one percent of discs become damaged in transit. The company does not do any DVD replicating or copying.

Once a building has been selected—good access to artery roads, good parking for employees, good lighting— opening a new shipping facility has become a turnkey process. Netflix's newest facility is in Albuquerque. It expects to open several more in 2006, but not too many. Strategically located near population centers, at 92% the shipping facilities are already achieving near-optimum next-day delivery to customers. As the number of customers and shipment volumes grow, the number of employees in the existing hubs will grow, says Swasey.

Simply AudioBooks

Online Exclusive! Netflix isn't the only company mastering the mail-based rental model. Industry stalwart Books-On-Tape (a division of Random House) exited the audiobook rental business early this year, but Simply Audiobooks continues to grow on the strength of a solid customer interface and its distribution processes. (