How Netflix Works

SAN FRANCISCO, California (AP) -- Preparing for the eventual extinction of its DVD-by-mail rental service, Netflix Inc. on Tuesday is introducing its first solution for subscribers who want entertainment delivered directly to their television sets with just a few clicks on a remote control.

The breakthrough comes in the form of 5-inch-by-5-inch devicetailored for a year-old service that uses high-speed Internetconnections to stream more than 10,000 movies and TV shows fromNetflix's library.

Although it's provided at no additional costto most of Netflix's 8.2 million subscribers, the streaming service hashad limited appeal so far because it doesn't include the latest moviesand couldn't easily be watched on anything but a personal computer.

At $99.99, the Netflix set-top box is priced like a DVD player and isjust as simple to hook up to a television. A high-speed Internetconnection can either be plugged into the box or the device can pick upa wireless signal.

Similar Internet-to-TV devices made by Apple Inc. and Vudu Inc. cost $229 to $295.

"We think this is something that offers a big value at a low cost," said Reed Hastings, Netflix's chief executive officer.

The Netflix box, made by Silicon Valley startup Roku Inc., is the firstof several devices that will pipe Netflix's streaming service to TVsets.

LG Electronics is expected to include the streaming capability in aBlu-ray DVD player that it plans to debut during the second half ofthis year.

Without providing further details, Netflix has saidtwo other major consumer electronics companies are working on set-topboxes for its streaming service.

Hastings is confident that thedemand for DVD rentals will remain strong for at least several moreyears, partly because movie studios aren't ready to fully embracedigital distribution.

But as technology makes it easier to rentand buy movies within a few minutes instead of waiting for them to bedelivered through the mail, Hastings realizes his Los Gatos-basedcompany won't survive unless it evolves.

That's why Netflix haspoured more than $40 million into its streaming service, called "WatchInstantly," and is now trying to encourage its subscribers to use itmore frequently even though it doesn't generate more revenue.

Ifanything, the streaming service is eroding Netflix's profits becausethe company's licensing fees are based on how frequently subscribersuse it. And any customer who pays at least $8.99 per month for a DVDrental plan gets unlimited access to the streaming service.

Because the new set-top box figures to spur more usage, Netflix expectsits profit margins to be squeezed later this year. Even so, the companyis still projecting a profit of as much as $83 million this year, upabout 20 percent from last year. The bright outlook has helped liftNetflix's market value 16 percent so far this year.

Hastingseventually hopes to recoup some of the added expense by having to spendless money to attract and retain customers as more people enjoy theconvenience of the streaming service. Netflix has no plans to startcharging an additional fee for the streaming service this year.

Cowen and Co. analyst James Friedland believes the number of Netflixsubscribers interested in purchasing the new set-top box will berelatively small.

Part of the problem is that few recent moviesare available on Netflix's streaming service. That's a majorshortcoming because nearly one-third of the rental requests onNetflix's DVD service are for new movie releases, Friedland said.

"You can't really drive consumers to do anything before they're ready,"Friedland said. "You can only give them options. And Netflix seems tobe trying to deliver as much as it can (with the streaming service),given the current limitations of the studios and technology."

Netflix offers more than 100,000 movies and TV shows on DVD, about 10 times the streaming service's selection.