Netflix had it easy in the beginning. DVD was a booming format, and the company's flat fee, all-you-can-rent subscription model was a hit. But is that same model strong enough to survive today's briskly changing marketplace as it rushes to adopt new technologies?

Although the DVD-by-mail company tinkered with a traditional pay-per-title approach in 1998, the monthly subscription model has been its bread and butter for nearly a decade. The setup is simple: Users sign up for the service online, pay a flat monthly fee, order DVDs from Netflix's extensive online catalog, and receive them via snail mail. Finished DVDs are mailed back to Netflix shipping facilities scattered across the country, using the same mailers. There are no contracts, no late fees, and no postage charges for users.

Netflix shook up the brick-and-mortar rental chains when it appeared on the scene, but it took the company almost five years to turn a profit. Since then, the home entertainment landscape has changed drastically. Netflix did well by riding on the success of the DVD format, but new high-definition formats and distribution methods have upped the ante. On one side, Netflix has to deal with the transition to high-definition physical media such as Blu-ray, and on the other, the encroaching threat of online rental and delivery systems like iTunes. To stay relevant in the marketplace, Netflix has to remain profitable while fighting a two-front war.

The company has responded to these challenges by launching its own online streaming service for 6,000 of its titles, and working high-def formats (now mostly Blu-ray) into rotation. Both of these features have been incorporated into the regular subscription fees, which Netflix has been quietly lowering to fend off online rental competitors such as Blockbuster.

In effect, the company has created two troubling loss leaders. HD rentals and online streaming may be viable expansion methods, but they're also fiscally demanding. The company scaled back marketing expenditures in 2007 to offset this, but revenue growth is still losing momentum. According to the company's most recent quarterly report, revenue saw a modest nine percent rise over Q4 2006 to $302.4 million. That compares with year-over-year Q4 growth of 42 percent from 2005 to 2006. Clearly, things are slowing down for Netflix.

Netflix CEO Reed Hastings says this is all part of the plan. During the company's Q4 earnings call, Reed stated that he wants to wait a year before deciding whether to increase prices to account for some of the newer initiatives. Likewise, monetization of the company's online streaming program appears to be on hold until products like its LG-branded set-top box make it to market in Q2 of this year.

The set-top box and subscription fee potential aside, a simpler solution may lie in the company tying an ad initiative to its expansion model. Why not subsidize the cost of converting to the new format by expanding the advertising in the Blu-ray mailers? Subscribers who request the costly discs have already shelled out for the hardware and an HDTV, earmarking them as consumers with disposable income. Even if Netflix wants to stick to movie-centric ad partners, early Blu-ray adopters are undoubtedly a solid group to market to.

On the same note, Netflix's online streaming service seems like a natural fit for movie marketing. The company is already known for its willingness to work with the studios. A joint marketing venture -- like incorporating the site's cache of trailers into cross promotional pre-roll ads -- could contribute to offsetting bandwidth costs. Imagine if the trailers were even tailored to subscribers' tastes (a la its recommendation system), or better yet, if users were able to add movies from the pre-roll directly to their queues?

Missing opportunities like these may not seem like a big deal now. After all, Netflix is still considered an online success story based on several metrics, including its huge subscriber base and its recent quarterly profit statements. However, while the subscription model has helped Netflix profit from DVD rentals, a fumbled shift to high-def media and newer distribution technologies could not only threaten revenue growth, but also increase churn. High-def content and video-on-demand services are on their way to reaching critical mass, and if Netflix wants to maintain its position in the marketplace, its business model must evolve to harness these trends.

Related news, commentary, and predictions:

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• Prediction: Microsoft will make an acquisition offer to Netflix by June 30th
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• Analysis: Microsoft stays mum on Blu-ray Disc support
• News: Netflix surveys Xbox, PS3 owners about movie downloads
• News: Toshiba abandons HD DVD

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