NetFlix 2008 Annual Report Download - page 18

technology, including equipment and related software, is intended to allow our nationwide network of shipping
centers to be operated on an integrated basis. We continually enhance or modify the technology used for our
distribution operations. We cannot be sure that any enhancements or other modifications we make to our
distribution operations will achieve the intended results or otherwise be of value to our subscribers. Future
enhancements and modifications to our technology could consume considerable resources. If we are unable to
maintain and enhance our technology to manage the processing of DVDs among our shipping centers in a timely
and efficient manner, our ability to retain existing subscribers and to add new subscribers may be impaired. In
addition, our subscribers may instantly watch movies and TV episodes but they must maintain their connection to
our service for an uninterrupted viewing experience. If our software fails to satisfactorily display the available
titles, our ability to retain existing subscribers and to add new subscribers may be impaired. Also, any harm to
our subscribers’ personal computers or other devices caused by the proprietary software could have an adverse
effect on our business, results of operations and financial condition.
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 or disruptions caused by inclement weather, natural disasters, labor
activism, health epidemics or bioterrorism. Our DVDs are also subject to risks of breakage and theft during our
processing of shipments as well as 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 and theft rates for our DVDs will increase our cost of
acquiring titles.
Increases in the cost of delivering DVDs could adversely affect our gross profit.
Increases in postage delivery rates could adversely affect our gross profit if we elect not to raise our
subscription fees to offset the increase. The U.S. Postal Service increased the rate for first class postage on
May 12, 2008 to 42 cents. The U.S. Postal Service has announced an increase in the rate for first class postage
effective in May 2009 by 2 cents to 44 cents and it is also expected that the U.S. Postal Service will raise rates
again in subsequent years in accordance with the powers given the U.S. Postal Service in connection with the
2007 postal reform legislation. The U.S. Postal Service continues to focus on 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 or higher breakage for our DVDs, and our gross margin could be
adversely affected. For example, the Office of Inspector General at the U.S. Postal Service issued a report in
November 2007 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 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.
Studios have begun to release films in high definition format on Blu-ray. This new high definition format
DVD has higher damage rates than we currently experience with standard definition DVDs. If we were to see a
significant increase in the number of Blu-ray DVDs we ship or an increase in the percentage of Blu-ray DVDs
our subscribers take and the damage rates remained higher than standard definition DVDs, our gross margins,
profitability and cash flow could be adversely affected.
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