WASHINGTON—Online subscription movie rental business Netflix Inc. is thriving despite the economic recession and the worldwide DVD sales slump.

Netflix reported $423.1 million in revenue for the third quarter, a 24 percent jump over the same period in 2008 and a 4 percent increase over the prior quarter.

The company had 11.1 million subscribers at the end of the third quarter, a 28 percent increase over the same quarter last year. The overwhelming majority, with the exception of 2 percent of the customers, are paying subscribers.

“Despite a recession, fierce competition and the emergence of online video delivery, the company [Netflix] continues to thrive,” stated a recent report by Knowledge @ Wharton (KW), the publishing arm of the University of Pennsylvania.

“Netflix is now in a race to transition to a business model focused on streaming content online, while continuing to exploit its current model based on physical DVD distribution via the U.S. Postal Service,” the KW report said.

The KW professors were amazed that Netflix took the plunge into digital distribution of its service despite a great number of competitors, instead of just staying with its time-honored product—sending the DVDs by mail. With this, the company is not only embracing the past, but also the present and the future in digital entertainment.

Gaining Market Share

On Oct. 26, Netflix and Sony Computer Entertainment America Inc. (SCEA) became partners in an effort to bring thousands of movies and television episodes to Netflix members with a PlayStation 3 (PS3) video game system.

“PS3 system owners will soon enjoy an unparalleled experience watching their favorite movies and TV shows streamed instantly from Netflix, downloading from the PlayStation Network or watching Blu-ray/DVD media,” Jack Tretton, president and CEO of SCEA, said in a statement.

To entice more people to become a Netflix member, the company invited consumers to watch the “Wizard of Oz” without charge for 24 hours starting on Oct. 3 at 9 a.m.

In September, Netflix and its partner Film Independent, a nonprofit organization, announced that its panel selected aspiring film producer Philip G. Flores of Hemet, Calif., to produce a feature-length narrative film called “Touchback.” Flores received a $350,000 grant to produce the film. Netflix hopes to hold a prescreening during the Los Angeles Film Festival in 2010.

Netflix recently awarded a $1 million prize to a team of researchers who came up with a better algorithm to predict members’ movie-watching preferences. Netflix recently awarded the prize to “BellKor’s Pragmatic Chaos,” a seven member team of researchers, engineers, and statisticians from the United States, Canada, Israel, and Austria.

“The Netflix Prize sought [an algorithm] to substantially improve the accuracy of predictions about how much someone is going to enjoy a movie based on their movie preferences,” said the Netflix Prize Web site.

To gain additional market share, Netflix devised its Netflix Player by Roku, a device that instantly streams movies and TV shows to television. During the same year, the company rolled out its “Watch Instantly” feature to all subscribers at no extra cost, allowing them to stream movies to their home computers.

Surviving in a Dog-Eat-Dog World

Experts say that Netflix has proven its doubters wrong repeatedly, but it is unclear how the balancing act between the company’s old and new business models will play out. “Netflix has won round one with physical distribution of DVDs, but that advantage won’t persist once the game switches to digital distribution,” Wharton management professor David Hsu said in the KW report.

Competition is intense and Netflix has to be on its toes to keep its customers from moving to competitors. Customer loyalty is fickle—whoever gives customers a better deal for their dollar will get the business.

Blockbuster, Redbox, GameFly, Apple’s iTunes, YouTube, and a number of other firms are offering competing products. Cable television could also become a major competitor with its on-demand video and its experimental on-demand video on the Internet.

“But it’s not as though competition is anything new for Netflix. So-called ‘Netflix killers’ have surfaced repeatedly in the last decade,” KW said.

In 2002, Netflix faced the threat of Wal-Mart, which rolled out an online rental program. Consumers did not flock to Wal-Mart and the retail giant tabled the service. In February 2007, Wal-Mart introduced a movie download service with content from major film studios and scrapped it in December of the same year because it could not compete.

Financial and subscriber numbers show that Netflix still rides the tide. Netflix provides its customers with a large number of independent movies, a position that has little competition.

Netflix’s survival depends on maintaining its movies-by-the-mail business model as long as possible, giving it time to be firmly entrenched in the streaming video business model.

Wharton professors are certain that Netflix, having survived the recent economic meltdown and still being in excellent financial condition, is elastic enough to survive any threat to its existence.

“I think among streaming providers, Netflix is a friend. This is an example where good competition will help grow the entire industry, which is still in its nascent stages,” Eric Bradlow, Wharton marketing professor, remarked at the end of the KW article.

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