NetFlix 2003 Annual Report Download - page 46

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 are also
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 fail to timely deliver DVDs to
our subscribers, our subscribers could become dissatisfied and cancel our service, which could adversely affect
our operating results. In addition, 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 fees to offset the increase. For example, in June 2002, the rate for first-class postage increased from
$0.34 to $0.37, which has directly impacted 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 U.S. Postal Service were
to change any policies relative to the requirements of first-class mail, including changes in size, weight or
machinability qualifications of our DVD envelopes, such changes could result in increased shipping costs for our
DVDs and our gross margin could be affected adversely. Also, if the U.S. Postal Service curtails its services,
such as discontinuing or reducing 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.
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
usefulness to our subscribers. We may experience difficulties in implementing such refinements. In addition, we
cannot assure you that we will be able to continue to make and implement meaningful refinements to our
recommendation service.
If our recommendation service does not enable us to predict and recommend titles that our subscribers will
enjoy or if we are unable to implement meaningful improvements, our personal movie recommendation service
will be less useful, in which event:
• our subscriber satisfaction may decrease, subscribers may perceive our service to be of lower value and
our ability to attract and retain subscribers may be affected adversely;
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