NetFlix 2002 Annual Report Download - page 35

If we experience delivery problems or if our subscribers or potential subscribers lose confidence in the U.S. mail system, we could lose subscribers, which could adversely affect
our operating results.
We rely exclusively on the U.S. Postal Service to deliver DVDs from our shipping centers and to return DVDs to us from our subscribers. We are subject to risks associated with using the
public mail system to meet our shipping needs, including delays caused by bioterrorism, potential labor activism and inclement weather. For example, in the fall of 2001 terrorists used the
U.S. Postal Service to deliver envelopes containing Anthrax, following which mail deliveries around the United States experienced significant delays. Our DVDs also are subject to risks of
breakage during delivery and handling by the U.S. Postal Service. The risk of breakage is also impacted by the materials and methods used to replicate our DVDs. If the entities replicating
our DVDs use materials and methods more likely to break during delivery and handling or we otherwise fail to timely deliver DVDs to our subscribers, our subscribers could become
dissatisfied and cancel our service, which could adversely affect our operating results and increased breakage rates for our DVDs will increase our cost of acquiring titles.
Increases in the cost of delivering DVDs could adversely affect our gross profit and marketing expenses.
Increases in postage delivery rates will adversely affect our gross profit if we elect not to raise our subscription rates to offset the increase. For example, in June 2002, the rate for first−class
postage increased from $0.34 to $0.37 which increase will directly impact our cost of shipping DVDs. In addition, the U.S. Postal Service has announced long−term plans to reduce its costs
and make its service more efficient. If the Postal Service were to change any policies relative to the requirements of first−class mail, including changes in size, weight or machinability
qualifications, such changes could result in increased shipping costs for our DVDs and our gross profit could be affected adversely. Also, if the U.S. Postal Service curtails its services, such
as by the discontinuation of Saturday delivery service, our ability to timely deliver DVDs could diminish, and our subscriber satisfaction could be affected adversely.
Currently, most filmed entertainment is packaged on a single lightweight DVD. Our delivery process is designed to accommodate the delivery of one DVD to fulfill a selection. Because of
the lightweight nature of a DVD, we generally mail one envelope containing a title using standard first−class postage. However, studios occasionally provide additional content on a second
DVD, or may package a title on two DVDs. If packaging of filmed entertainment on multiple DVDs were to become more prevalent, or if the weight of DVDs were to increase, our costs of
delivery and fulfillment processing would increase. In addition, we expense shipping costs of free trial programs to new subscribers as marketing expense. Therefore, if the cost of delivering
titles were to increase, our marketing expense would be adversely affected.
If we are unable to effectively utilize our recommendation service, our business may suffer.
Based on proprietary algorithms, our recommendation service enables us to predict and recommend titles and effectively merchandize our library to our subscribers. We believe that in order
for our recommendation service to function most effectively, it must access a large database of user ratings. We cannot assure you that the proprietary algorithms in our recommendation
service will continue to function effectively to predict and recommend titles that our subscribers will enjoy or that we will continue to be successful in enticing subscribers to rate enough
titles for our database to effectively predict and recommend new or existing titles.
We are continually refining our recommendation service in an effort to improve its predictive accuracy and therefore its usefulness to our subscribers. We may experience difficulties in
implementing such refinements. For example, in the fourth quarter of 2002, we did not launch a new version of our recommendation service due to implementation difficulties. While we did
launch the new version in the first quarter of 2003, we cannot assure you that we will be will be able to continue to make and implement meaningful refinements to our recommendation
service.
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