As a .Net developer I have a lot to say about Windows 8 and collating  those thoughts is taking a while.  So I thought I’d tackle an easier topic today.  Last week Netflix shares got hammered because they revised their estimates for physical DVD rentals down.  Dan Frommer thinks the share holders who sold are missing the point…

Here’s the thing, though. The future of Netflix is in its streaming business — not its business of mailing DVDs to people via the U.S. Postal Service. And Netflix only trimmed its forecast for streaming customers by 0.2 million, or 1%. The biggest cut, meanwhile, is 0.8 million DVD-only subscribers, or 27% of that customer base. But that’s Netflix’s old business, not its new one.

If anything, Netflix can take these numbers to Hollywood and say: Look, people don’t want DVDs anymore, either stream your best stuff on our site or good luck selling those DVDs at Borders. (And Netflix even says that its financial guidance for the quarter is unchanged.)

Ummmm…..No. 

The problem is this.  Netflix is expected to have 21.8 Million streaming customers.  Only 9.8 Million of those are “streaming only” customers.  That’s out of a possible customer base of 345 million people (U.S. + Canada).  And I’d assume almost all of those people rent movies somewhere.  I don’t know about you but where I live there’s one of those Redbox DVD machines on practically every street corner.

THAT is the problem.

Yes, streaming is almost certainly the future.  But getting people to that point requires a journey.  First Netflix has to convert new customers from whatever local service they’re using.  That means duplicating the product their current service provides (namely DVDs).  Then Netflix needs those people to try streaming and hopefully move to streaming only.  But that process will take years.  People don’t change their habits that easily.

Beyond their current market Netflix is counting on its expansion into Latin America to provide future profits.  Just this month they expanded streaming service into Brazil, Argentina, Uruguay, Paraguay, Bolivia, Chile, Colombia, Peru, Venezuela and Mexico.  But broadband access is lacking in those countries.  Brazil recently announced 14 million fixed broadband access points out of a population of 193 million.   And they lead all other Latin American countries.

Do you know what percentage of the population has broadband in Mexico?

Try 6%.  In fact lets look at the listed countries by percentage of the population who are even on the Internet.  Not the percentage who have broadband but the percentage that have Internet at all.

Brazil: 37.4%

Argentina: 66%

Uruguay: 56%

Paraguay: 17%

Bolivia: 12%

Chile: 55%

Colombia: 50%

Peru: 31%

Venezuela: 38%

Mexico: 32%

Worse yet comScore estimates suggest not all of those people even watch video on internet (we’re not talking Netflix, we’re talking Youtube and other clip sites).  They found only 87% of Mexicans on the Internet watched video clips at all

One more point here.  What do you think is the fasted growing criminal enterprise in Mexico?  Try DVDs…

In this context, Mexico has one of the most competitive pirate DVD markets documented in our study, with widespread, small-scale cottage industry production and retail DVD prices routinely under a dollar. Criminals, as we’ve noted more than once, now have to compete with free.

The stock market over reacts.  I’d never deny that.  But stock price SHOULD depend on estimates of future revenue.  If Netflix vastly over estimated the amount they can charge for physical DVDs that SHOULD impact the stock.  And if the price hike is causing Americans to drop the service you can only imagine what will happen in Latin America.

Netflix’s goal right now is to lock in as many customers as possible.  Because once streaming takes hold everyone will be doing it.  The best strategy for doing that is using their established physical DVD infrastructure to pull customers in and convert them to streaming later.  That’s why weakness in that business is such a big deal to investors.