Netflix's shrinking DVD service faces uncertain future

SAN FRANCISCO -- Originally cast in a starring role, Netflix's original DVD-by-mail service has been reduced to a bit player -- one that eventually may get killed off as the company focuses on its booming video-streaming service.

Netflix's fourth-quarter earnings report released Wednesday provided the latest glimpse at the DVD service's descent into oblivion as the streaming service hogs the spotlight.

The DVD service shed 159,000 subscribers during the final three months of last year to end December, with 4.1 million customers. That's an 11-year low for a format that gave Netflix its initial shot at stardom, allowing it to out-innovate and outmaneuver Blockbuster Video, then the king of home-video rentals.

Now, the DVD service operates mostly as an afterthought that caters to a shrinking audience of die-hards who prefer to watch movies and TV shows on discs instead of streaming or downloading them onto a mobile gadget.

Streaming gets top billing

Meanwhile, Netflix's streaming service has been reshaping the world of entertainment, attracting converts to the convenience of streaming video at any time on any device with a high-speed internet connection.

The streaming service boasts nearly 94 million subscribers in 190 countries after adding another 1.9 million in the U.S. and 5.1 million in its overseas markets during the final three months of last year.

RBC Capital Markets analyst Mark Mahaney predicts Netflix will have 160 million streaming subscribers by 2020. The company is coming off its biggest quarter of customer growth.

DVD subscribers may be fleeing, but the service boasts a library of more than 90,000 titles, including recent films that usually aren't available to stream for nine to 18 months after they leave theaters -- or sometimes at all, at least on Netflix.

The streaming service had about 4,600 titles as of late last year, down from about 6,500 in July 2015, according to the research firm Ampere Analysis.

Netflix has trimmed its selection of outside streaming titles as it has ramped up production of television series and films that can be viewed only on its streaming service.

Cash-cow discs

Though the DVD service has lost nearly 10 million subscribers over the past five-and-half years, Netflix keeps it around because it remains tremendously profitable.

The company makes an operating profit of about 50 percent on DVD subscriptions after covering the expense of buying discs and postage to and from its distribution centers. The DVD service doesn't even have a marketing budget; by comparison, Netflix spent almost $1 billion last year promoting its streaming service.

The DVD profits have helped subsidize Netflix's streaming expansion outside the U.S., a push that has accumulated losses of nearly $1.5 billion during the past five years. The DVD service has made $1.9 billion during the same period, enabling Netflix to remain profitable and helping its stock price rise by 13-fold since the end of 2011.

"We've never discussed shutting down DVDs since there are still lots of folks who subscribe, often to both streaming and DVD by mail," Netflix spokeswoman Anne Marie Squeo said.

End of the show

Eventually, though, most analysts believe it no longer will make sense to keep mailing out DVDs in Netflix's red envelopes.

Wedbush Securities analyst Michael Pachter said Netflix's DVD service still could be around for another five to eight years, based on its pace of decline, before the company shuts it down.

He believes the moment of reckoning may come when there are only 1 million DVD subscribers remaining.

At that point, Pachter said, Netflix likely will begin closing most of the warehouses that store and distribute DVDs to different parts of the U.S.

"As they consolidate those warehouses, the turnaround time is going to be slower," he says. "Then, it's not going to take two days for the next DVD to arrive, it's going to be more like six days. Then people will be upset and quit."