NetFlix 2007 Annual Report Download - page 20

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recommending that the U.S. Postal Service revise the machinability qualifications for first class mail related to
DVDs or to charge DVD mailers who don’t comply with the new regulations a 17 cent surcharge on all mail
deemed unmachinable. We do not currently anticipate any material impact to our operational practices or postage
delivery rates arising from this report. Also, if the U.S. Postal Service curtails its services, such as by closing
facilities or discontinuing or reducing Saturday delivery service, our ability to timely deliver DVDs could
diminish, and our subscriber satisfaction could be adversely affected.
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 DVD per envelope using standard first class U.S. postage rates. Studios
occasionally provide additional content on a second DVD or may package a title on two DVDs. In addition, the
studios have begun to release certain films in high definition format on Blu-ray and HD DVDs. These new high
definition format DVDs appear to have higher damage rates than regular DVDs. If packaging of filmed
entertainment on multiple DVDs were to become more prevalent, if the weight of DVDs were to increase, or the
durability of DVDs deteriorate, our costs of delivery and fulfillment processing would increase and our costs of
replacing damaged DVDs may rise materially which would depress gross margins and profitability and adversely
affect free cash flow.
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 merchandise 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 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 refinements. In addition, we
cannot assure 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 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 acquire sufficient DVD titles, our subscriber satisfaction and results of operations may be
adversely affected.
If we do not acquire sufficient copies of DVDs, either by not correctly anticipating demand or by
intentionally acquiring fewer copies than needed to fully satisfy demand, we may not appropriately 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.
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