Should You Hit Play or Pause on Netflix?

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Times are rocky for Netflix (NAS: NFLX) , folks.

I wrote this week about the impact the United States Postal Service's troubles will have on businesses that rely on it as an integral part of their business model. I included Netflix in that list, front and center, and expected that any change or cancellation of delivery service would have an immediate and negative impact on the red-enveloped company. But Netflix is facing a bigger, more immediate problem: Its customers are leaving in droves.

Rewind
The video rental star announced in June that it would split its streaming and DVD-by-mail service in two. In the wake of that shift, the company reported this week that it expects to lose some 600,000 customers, instead of adding a projected 400,000. That net swing of 1 million customers results from the new pricing plan, which requires customers to pay nearly double for the same services.

As a Netflix customer myself, I was paying $9.99 for unlimited streaming and one DVD at a time. I could watch as many DVDs as I wanted per month, limited only by how frequently I could sit down to view them, and how quickly the USPS would get my selection to a Netflix distribution center and back. 

This $9.99 rate had already been hiked from $8.99 less than a year ago; the same plan will now cost $15.99 per month. Adding insult to injury, my last eight discs have been scratched or unplayable, always at the best bits, and I've had several issues with streaming episodes being out of order or having playback issues.

Play
Luckily for customers, but sadly for Netflix, its service is no longer the only streaming game in town. Many television channels offer their episodes online, although quality of streaming, episode availability, and player sophistication vary wildly.

Amazon.com (NAS: AMZN) could benefit from Netflix's folly. The online retailer offers a wide array of streaming movies and television shows, unlimited and commercial-free, to members of its Amazon Prime shipping club. While the selection isn't nearly as vast as Netflix's, anger and spite will drive a lot of customers to do crazy things. Furthermore, Prime gives members the added benefit of two-day shipping on all their orders, at no extra cost. So if you buy often from Amazon, membership in the club might save you enough to shrug off Netflix's increased rates. My Foolish colleague Rick Munarriz thinks Amazon might be the new Netflix.

In addition to Amazon, a challenger that Netflix once defeated might end up with the last laugh. Remember the days when Blockbuster was a household name? Thanks to Netflix, and a series of lawsuits about excessive late fees, the onetime video rental giant declared bankruptcy in September, and was scooped up by DISH Network (NAS: DISH) at auction in April. The deal gives DISH access to all the streaming rights Blockbuster held, and it seems as though DISH aims to put those rights to use.  Industry rumor suggests that the satellite service will unveil a streaming option in October.

Special features
Furthermore, Fools shouldn't overlook Hulu, owned by Comcast's (NAS: CMCSA) NBC, News Corp.'s (NAS: NWS) Fox channel, Walt Disney's (NYSE: DIS) ABC, a private equity firm, and the Hulu team itself. The site offers a wide array of ad-supported on-air shows for free, alongside Hulu Plus, a subscription-based option that increases video quality and offers full television seasons, as well as the Criterion Collection's library of classic and arthouse films. Hulu put a planned IPO on hold while the company focused on building the Hulu Plus subscription model.

Now the company has become a hotly rumored buyout target, with potential bidders valuing Hulu at anywhere from $500 million to $2 billion. The company's Q2 results, posted in July, claim 875,000 subscribers, well on track to meet the company's goal of 1 million by the end of the year as promised. In addition, 25 million devices are now Hulu Plus-enabled. Perhaps an equally important indicator: "Do you Hulu?" has invaded the lexicon in much the way "Google it" did.

If Hulu ever IPOs, I'll be first in line. Until then, I'll be keeping an eye on a potential sale. 

Fast forward
Netflix's moat is shrinking. Customer loyalty is eroding, and that dissatisfaction is spreading. Alternatives are easily accessible and reasonably priced, and a lack of switching costs mean that you can close your Netflix account as easily as you open an email. If Blockbuster can launch a successful streaming service without the issues that faced their in-store rental business, they'll be a serious contender. Hulu already is, and Amazon Prime is a perfectly adequate substitute for those who don't watch much television.

Netflix needs to adapt, and fast, before its customers turn it off for good.

Wondering which one company will profit the most from the broadband Internet expansion? Check out The Motley Fool's Top Stock for 2011. Enjoy a copy on us; it's free for Fools.

At the time this article was published Fool contributor Molly McCluskey does, in fact, Hulu, but doesn't own shares in any of the companies mentioned.Motley Fool newsletter serviceshave recommended buying shares of Netflix, Amazon.com, and Walt Disney, and buying puts in Netflix. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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