NetFlix 2006 Annual Report Download - page 23

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 adversely affected;
• our ability to effectively merchandise and utilize our library will be adversely affected; and
• our subscribers may default to choosing titles from among new releases or other titles that cost us more
to provide, and our margins may be adversely affected.
If we do not correctly anticipate our short- and long-term needs for DVD titles, our subscriber satisfaction
and results of operations may be adversely affected.
If we do not acquire sufficient copies of DVDs, we may not satisfy subscriber demand, and our subscriber
satisfaction and results of operations could be adversely affected. Conversely, if we attempt to mitigate this risk
and acquire more copies than needed to satisfy our subscriber demand, our inventory utilization would become
less effective and our gross margins would be adversely affected. Our ability to accurately predict subscriber
demand as well as market factors such as exclusive distribution arrangements may impact our ability to acquire
appropriate quantities of certain DVDs.
If we are unable to renew or renegotiate our revenue sharing agreements when they expire on terms
favorable to us, or if the cost of purchasing titles on a wholesale basis increases, our gross margins may be
adversely affected.
We acquire DVDs through a mix of revenue sharing agreements as well as direct purchase arrangements.
Whether we enter into a direct purchase or revenue sharing arrangement depends on the economic terms we can
negotiate as well as studio preferences. Starting in 2000, we entered into numerous revenue sharing arrangements
with studios and distributors which typically enabled us to increase our copy depth of DVDs on an economical
basis because of a low initial payment with additional payments made only if our subscribers rent the DVD.
During the course of our revenue sharing relationships, various contract administration issues can arise. To the
extent that we are unable to resolve any of these issues in an amicable manner, our relationship with the studios
and distributors may be adversely impacted.
As the revenue sharing agreements expire, we must renegotiate new terms, or shift to direct purchasing
arrangements, under which we must pay the full wholesale price, regardless of whether the DVD is rented. We
have seen the purchase mix shift toward direct purchasing arrangements as revenue sharing agreements expire. If
we cannot renegotiate purchasing arrangements on favorable terms, the cost of acquiring content could increase
and our gross margins may be adversely affected. In addition, the risk associated with accurately predicting title
demand could increase if we are required to directly purchase more titles.
If the sales price of DVDs to retail consumers decreases, our ability to attract new subscribers may be
adversely affected.
The cost of manufacturing DVDs is substantially less than the price for which new DVDs are generally sold
in the retail market. Thus, we believe that studios and other resellers of DVDs have significant flexibility in
pricing DVDs for retail sale. If the retail price of DVDs decreases significantly, consumers may choose to
purchase DVDs instead of subscribing to our service.
We may seek additional capital that may result in stockholder dilution or that may have rights senior to
those of our common stockholders.
From time to time, we may seek to obtain additional capital, either through equity, equity-linked or debt
securities. The decision to obtain additional capital will depend, among other things, on our development efforts,
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