I have been a Netflix customer for some time now and it has been interesting to see the company grow and evolve, given the changing dynamics of their space. Netflix pioneered the DVD rentals-by-mail market and have managed to grow to over two million subscribers since their launch in 1999. With their success, they have attracted the attention of 800 lb gorillas such as Blockbuster and WalMart who recently launched similar services.

This pattern of innovators (usually startups) creating a market and then attracting followers (usually larger companies) is something that we all see again and again in the technology space. The billion dollar question for Netflix is, can it survive and continue to lead the market?

I personally think they can. However, I don’t think they are going to compete effectively through better execution. The DVD rentals-by-mail market is quickly going to move to a commodity market with the introduction of the superior pricing power, distribution network, and retail presence of a WalMart or Blockbuster. The only way Netflix is going to compete with the 800 lb gorillas is to change the playing field.

The best way of changing the playing field is to innovate to provide a compelling value proposition that significantly differentiates you from your competition. There has been a lot of buzz around recent rumors that Netflix and TiVo will enter into a partnership to allow customers to download Netflix movies onto their TiVo devices over a broadband connection. There are issues around licensing and distribution rights that need to be worked out, but if both companies can make the deal happen, it could be an important innovation that completely changes the playing field for both companies and their competitors. With such a deal, Netflix would now be a pioneer in the DVD rentals-by-internet space, whereas Blockbuster and Walmart would still be stuck in the DVD rentals-by-mail space.

Although the internet delivery of movies is exciting, I do not think that the real future and long term success of Netflix lies with their fulfillment technology. As a consumer, the convenience of receiving movies by mail or over the internet is compelling, but at the end of the day, the value is time and cost savings since I don’t have to drive to the video store and wait in line. Don’t get me wrong, saving time is not a trivial thing since we all lead busy lives.

However, what I find even more compelling about Netflix is the ability to track new DVD releases and maintain a growing list of movies that I would like to see. I can even add and track movies that have not been released in theatres or on DVD. Netflix can then provide automatic management of new DVD releases into my viewing list on a schedule that I can adjust. On top of that, Netflix provides recommendations and reviews from critics as well as the Netflix community. The net effect is that I now have a relationship with Netflix where Netflix is my personal “movie concierge” or “movie butler”. By providing these personalized services, Netflix is enhancing my overall movie watching experience by ensuring that I see more quality movies that align with my interests and tastes. This value is something that allows Netflix to maintain a premium over other companies that solely focus on delivery efficiency, as well as ensure stickiness that increases switching costs for customers.

The sad thing is that I don’t think Netflix quite gets the “relationship” aspect of their business. The website really hasn’t change very much since its launch and the interface and services it provides for managing your viewing preferences arepretty primitive. They have also discouraged third parties from writing applications that provide a better user experience. On the other hand, TiVo is one company that understands how TiVo enriches the viewing experience by helping people manage their viewing schedule and preferences. TiVo closely monitors the usage patterns of their customers and it is reflected in their superior user interface. I wish Netflix would do the same since that's where they can add value above and beyond what a Blockbuster or Walmart.

Both Netflix and TiVo have done a great job of attracting the early adopters who have become evangelists for their service. Maybe the TiVo-Netflix partnership/merger will go through and we’ll see positive changes from a breeding of the two corporate cultures. Given how many hours the average American spends watching TV and DVD’s, I’m sure we’ll all benefit.