When Will Netflix Kill Its DVD Service?

By Rick Munarriz Markets Fool.com

Netflix (NASDAQ: NFLX)may be closing in on 100 million streaming accounts worldwide, but its base of disc-based subscribers continues to shrink. Netflix revealed on Monday that it had 3.944 million subscribers still receiving DVDs and/or Blu-ray discs by mail. You have to go all the way back to the third quarter of 2005 -- nearly a dozen years -- to find the last time that Netflix had fewer DVD accounts.

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Disc-based accounts at Netflix peaked near 20 million in 2010, and they've been shrinking ever since. Netflix saw this coming, making the gutsy call to be its own disruptor when it pushed into digital streaming.

"We expect DVD subscribers to decline steadily, every quarter, forever," CEO Reed Hastings said in an early 2012 earnings call.

Hastings was right, as he usually has been. The real question now is: How long can Netflix keep its shrinking DVD rental business going?

Image source: Netflix.

To DVD or not to DVD

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Logic would dictate that Netflix has nothing to lose until its DVD rentals start losing money. Netflix is holding up just fine on that front. It scored $60.2 million in contribution profit from the $120.4 million in revenue that it received from DVD subscriptions during the first quarter. In short, the business is incremental.

One would think that profitability would be cascading with this scalable model driving in reverse for seven years, but that's not the case. The 16% year-over-year decline in contribution profit over the past year actually is holding up better than the 17% slide in subscriber counts and DVD revenue. Netflix has simply gotten better about managing this perpetually declining business, just as it doesn't have a problem spending big money on content for its thriving streaming platform.

Netflix is adjusting. I'm in Miami, and the DVDs that I used to mail to the nearby distribution center in Fort Lauderdale now travel to Orlando. Netflix hasn't discussed its plans for its once massive network of distribution centers, but it's not a surprise to see those hubs scale back for a platform that's servicing 80% fewer accounts than it did in 2010.

The DVD division obviously no longer accounts for the lion's share of the revenue or the profitability at Netflix the way it did just a couple of years ago. Its share of Netflix's overall top-line results has declined to less than 5%, accounting for an 8.5% slice of Netflix's overall contribution profit.

DVDs still matter. As long as Netflix doesn't offer all DVDs or TV shows on its digital platform the way that smaller rivals do on a pay-per-stream basis -- something that Netflix insists that it has no intention of offering anytime soon -- this shrinking mail-based program is the only way that users can get their hands on most new releases without leaving the Netflixecosystem. DVDs may seem like a distraction of Qwikster-like proportions for Netflix these days, but it's not likely to cut the cord.

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Rick Munarriz owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.