Saturday, September 4, 2010

Netflix: What is Driving It Out of the Mail? reported that Netflix stated in a filing with the Postal Regulatory Commission that a decision in GameFly’s favor could “result in reduced DVD shipment growth from Netflix as well as accelerate the ultimate decline of DVD shipments as Netflix would shift more resource to the digital delivery of content”.   In addition, Netflix is concerned about the Postal Regulatory Commission requiring the Postal Service to release confidential research conducted by Netflix that the Postal Service has that “certain changes in DVD design, manufacturing, packing and handling would enable GameFly to avoid DVD breakage from automated letter processing."

Netflix's assertion raises a couple of interesting question that are independent of whether GameFly's complaint has merit.  
  • Does increased competition among entities providing a service using an old technology hasten the decline in the use of the old technology?  Currently only Blockbuster offers a competitive mail delivery movie service.   Netflix's other competitors are the remaining Blockbuster and other retail outlets, and kiosks operated by RedBox and Blockbuster.

    Competition from new technology is most likely to knock out the weakest competitors offering services using older technologies.   Blockbuster is likely to file for bankruptcy early this month which will allow it to jettison a significant number of its retail outlets.  The Los Angeles Times reports it plans to concentrate its business on its licensed arrangement for kiosks with NCR Corporation and developing an on-line operation. 

  • Do lower costs for delivering and selling software for devices that can be used to stream movies affect the shift away from old technology?  All three of the major video game consoles (i.e. Nintendo Wii, Microsoft XBox 360, and Sony Playstation 3) have Wi-Fi capabilities that allow a viewer to stream Netflix's online content using the console.  Currently, there are over 60 million of these consoles in use.   If GameFly's service makes these consoles more attractive for potential buyers then it is possible that it creates a larger market for the consoles that are used for video streaming.   However given as a September 30, 2009, GameFly had 330,000 subscribers, it would appear unlikely that it has much impact on increasing the share of homes that have Wi-Fi capable game consoles.

  • If the current Netflix Envelope permits Postal Service automation equipment to handle envelopes containing CD's and DVD's why did GameFly not reverse engineer or license the envelopes?  Unless Netflix holds a patent on the envelope  there would be nothing to prevent envelope manufacturers from reverse engineering the envelope Netflix uses and selling them to other firms that want to mail large quantities of CD's and DVD's by mail using the Postal Service's lowest cost processes. Similarly, GameFly could have paid for the reverse engineering themselves.   The proprietary study that GameFly wants would significantly cut the costs of this reverse engineering if it has not done this already.  

    Netflix holds a a patent on its envelope, patent #6,966,484.   The patent was issued in 2005 and and refrences versions of the envelope since 2001.  Netflix's patent has not prevented Blockbuster from having its own envelope as does GameFly.   However, it  is possible that the patented envelope design may allow the Postal Service to handle Netflix's discs more efficiently than the envelopes available to mailers who do not have access to the patent.  

    GameFly has two options in regards to the patent.  First, it could seek to license the patent.  However, Netflex may not want to relinquish any competitive advantages from its patent.  Second, it could reverse engineer the envelope with the goal of designing an envelope that that does not violate the Netflix patent  yet still can be handled on the Postal Service's automation equipment.   The proprietary study that GameFly wants would significantly cut the costs of this effort.
      (Thanks to Brian Sheenan of for the patent information.)

  • Why did the Postal Service not do the research on envelope design itself?  The Postal Service has always relied on private industry to design envelopes that meet its specifications.  Creative requirements of mailers often result in a cornucopia of designs designed to attract attention and increase the impact of mail.  In the case of Netflix, the Postal Service worked with Netflix's envelope designers to help design and test potential envelope designs that  Netflix developed that led to the envelope that was patented. movie by mail business.    

    An alternative approach may have developed if the Postal Service operated under a different business model and had more capital.  Under this model the Postal Service would have developed and patented the envelope itself and then licensed the design to all mailers that required an automation compatible self mailer with return envelope for CD's and DVD's.  This way the Postal Service could make money both on the patent and in the mail that uses the envelope. 

  • Does the envelope issue raise questions about how the Postal Service manages its customer relationships and how the regulatory process influences these relationships?  The public fight between GameFly and the Postal Service appears to also be a fight between two of its customers.   The regulatory process forces the Postal Service to choose sides in a public battle between two of its customers rather than trying to find a way to privately maximize its return from both customers.  UPS does not have to figure out the impact on Walmart if it proposes a certain discount structure to Amazon. Why does it make sense for the the Postal Service to do this in public or for the Postal Regulatory Commission to have to make an evaluation of how rates charged to one corporate customer affect the business of a second corporate customer? 

  • How is new competition from Apple, Amazon, Hulu and others affecting the pace that consumers are shifting from mailed to streamed video content?   Consumers now have the choice of a number of options for viewing video content streamed over the web including subscription, rental, and free services.    Both Apple and Amazon are offering streaming of offer streaming of individual TV shows and movies.  Both charge 99 cents for TV shows and 3.99 for movies.    Hulu also offers a large number of current television shows, a wide selection of older shows and many older movies free of charge with commercials  Hulu also offers the full season of shows on three broadcast networks for a $9.99 monthly fee.    CBS and Comedy Central currently have many of their current shows on line for free.  Many of the movies offered on-line by competitors for rent are not yet on Netflix's on demand service.

    Currently none of the services offering streaming content offer as easy an interface for selecting movies or as wide of  a selection of as the one Netflix has for viewing by mail.   Nor do they offer as wide a selection of movies for watching on line as Netflix.   In order for Netflix's on-line competitors to make a significant inroads into Netflix's business they will have to improve their interface, expand their selection, and reduce the risk that movies will be interrupted by network issues.  Given that these firms currently dominate sales of music mp3 files and sales of DVD's and CD's, they can be expected to make the neccessary changes to offer a competitive customer experience for selecting movies for streaming.
GameFly's complaint and the responses of Netflix and the Postal Service illustrate how the regulatory process perverts the process of negotiating rates between the Postal Service and its customers.  This complaint case and Netflix's response is similar to case filed before the Interstate Commerce Commission prior to trucking and rail deregulation where contracts had to be filed with the Commission and carriers were limited as to the number of contracts that they signed.   This prevented carriers from offering services that were price competitive and limited the growth of new and innovate ways to distribute goods in the United States.

I do not know whether GameFly's or Netflix's cases have merit.   I do know that both companies and the Postal Service would be better served if the companies were able to negotiate rates with the Postal Service without regulatory interference.  Shifting both companies to a negotiated contract model for rates would require the Postal Service to know nearly as much about GameFly's and Netflix's business and their distribution requirements as they know themselves.  The Postal Service would find it to be in its interest to try to find ways to use its assets to provide transportation and distribution services at a lower cost than these companies now do themselves.  

The potential benefits that exist for GameFly and Netflix are not unique.  All mailers would benefit from a Postal Service that had to know its customer's businesses as well as the customer in order to design its services and price its products.   However, the current regulatory process does not encourage this and instead creates the adversarial environment illustrated by the exigent rate case.   The future of the mailing industry, and the Postal Service itself requires this change.  The question is what would it take for Congress to recognize and act to make this change.


Anonymous said...

How about this - in many locations the postal service is giving Netflix preferential service.
Last year, in Retail Digest, retail locations were ordered to stop providing separate drops and special signage for Netflix envelopes. That is evidence that at some point special specific arrangements were in place. Currently there are periodic requests by Plant personnel for collection units to separate and segregate Netflix.
It isn't universal and there is no published policy but it goes on and it's likely that protocols exist at plant levels to provide "extra" service for Netflix.
An interesting FOIA request or discovery request would be for all internal e-mails generated at District or Plant level that mention "Netflix" - say for the last year.
The envelopes may be patented but they're simple enough. What prevents damage is when Netflix envelopes are given preferential handling. Perhaps it's just coincidence but in trays of non-DPS box mail all the Netflix pieces come together.

Anonymous said...

Netflix content shelf life competes more directly with the media archive some cable providers for free. Red Box media library is "B" movies with limited leader items. Neither offers gaming software. Gaming rentals aren't a one day/one time occurrence. Sony has created a real time movie social network but it has limited market penetration. NO ONE lines up for retail movie releases. Halo fans will wait a week outside Gamestop for latest release. NetFlix market niche always had a short life. Moving into direct competition with Amazon, AT&T,Verizon etc seems like a K-Mart "borrow money to put Wal-Mart out of business" move.

Alan Robinson said...

I have used the standard convention for making corrections to an article. I have crossed out the section that is incorrect and replaced it with the section in italics. If readers find this confusing, please tell me.

Anonymous said...

Letter carriers NEVER get Netflix in auto-sorted mail; it is always manually sorted. Just look at the flimsy envelopes.

Anonymous said...

Yep. Netflix is receiving preferential treatment. We're told to face our Netflix envelopes before placing them in plastic trays. No mention of Blockbuster or any other companies' DVDs, just Netflix.

Anonymous said...

The postal service looses money on every Netflix it handles. Originally Netflix was supposed to be sorted on automatic sorting machines but there was so much damage, the post office now sorts them by hand which has deminished the potential profit from the post office.

Anonymous said...

The outbound to customer envelope is the only one that actually goes through the Postal Service's automated equipment. The return envelope back to Netflix is manually separated from the mail stream. This manual separation begins at the stations and branches, and continues throughout the plants. On a given Monday my plant may return 50,000 Netflix envelopes all manually prepared that bypass any and all automation equipment.

Anonymous said...

AS a carrier of 28 yrs. I can vouch that no mail recieves such special treatment from pickup to delivery as netflix.
I have no Idea what you pay, but they are handled separatly and picked up with special collection methods. I do not even know who your competitor is.
You should sink your bar code with our scanners though and recieve faster data on sneding procedure.

Anonymous said...

Not sure but i think all Netflix return locations are in the same zip code as the mail plant serving that area. I know on Long Island NY all netflix returns go to Melville, same zip as our plant. it would make sense for netflix to set up their system this way so they could pickup and dropoff their mailings at the plants. in the past our electric and telephone companies had the same arrangement. our plant was in Hicksville NY as were the addresses for both utilities payment locations. they would come and pickup their mail as they had a unique zip code and their mail was pulled out of the mailstream automatically by LSM's (remember them?). we are told to tray up our outgoing mail on return to office and separate all dvd's. supervisor goes through all outgoing mail brought back by carriers and pulls dvd's out and puts them in separate tubs or trays. i have to admit their are very few blockbuster or gamefly dvd's but they are pulled out too. they must not be machinable beacause i un derstand upper management wants all outgoing mail to be sent to the machines to keep them busy. even local mail from within the same zip code that is dropped at the post office to the in-town mailbox makes the trip to the plant and back. that seems like more of a waste then pulling out dvd's and also increases the risk of a locally mailed letter to not reach it's destination in the same town by the next delivery day due to dps error.

Anonymous said...

Netflix is currently paying $700 Million dollars a year to the Postal Service. They are paying the full first class postage rate on each piece and we do not have to run their returns through the machines. This gives them faster service and we use less resources on the machines. With the amount of returns, there is no reason to send all of that to a machine that will push the disks out into one bin on the machine. We avoid extra handling and I am extremely thankful that we have a customer such as Netflix to help us with our finances. Blockbuster and Gamefly do not have anywhere near the same volume. Netflix has worked very closely with the Postal Service to get the best service they can, what is preventing Gamefly and Blockbuster from doing the same thing?

JVDeLong said...

One interesting dimension of this dispute is its connection to the current battle over Internet "Net Neutrality." See

uncommon sense said...

Welcome to the upside down world of the USPS.

Blockbuster, Gamefly, and Netflix envelopes will all run on most USPS automation equipment. The Blockbuster and Gamefly envelopes are actually far better designs and have significantly less problems on automation equipment than the Netflix envelopes. So why are less Netflix DVDs broken?
Nearly all Netflix mailings from the warehouse come to the USPS in trays presorted to the 5 digit destination zip. They only have to make it through the delivery point or carrier route automation sorting operations. This is between 1 and 3 fewer trips through a machine than a Gamefly envelope must make to be sorted to its final destination.
While all automation breaks an occasional DVD, the only mail processing equipment that tends to break DVDs at a very high rate is the canceling equipment that faces and cancels raw mail brought in from collections.
Netflix return envelopes are flimsy enough that they seldom make it through this equipment without jamming, breaking DVDs, and stopping production. There is a culling operation prior to the raw mail hitting these machines. Because of the fact that they are abundant, easily identifiable, and will stop the machine, Netflix DVDs are all pulled in the culling operation that feeds this equipment. If they weren’t pulled the equipment would be down all night and none of the mail would make it out the door. (Having a drop point exclusively for Netflix was probably someone’s idea on a way to reduce this culling operations workload).
Blockbuster and Gamefly envelopes usually make it through the facer canceling operation without jamming the machine. There aren’t as many of them and they aren’t as easily identifiable so they don’t all get culled and consequently have a greater incidence of broken disks.
The “genius” of the Netflix envelope design is that it is good enough to meet the USPS standards for automation mail but not quite good enough to be run on the automation equipment most likely to damage it.
Avoiding automation would seem to be inefficient for the USPS but because there are so many of them and they are all headed to the same destination pulling Netflix return envelopes in the initial culling operation avoids downstream handlings of this mail and reduces overall processing costs. It would cost the USPS more not to give Netflix return envelopes special handling than it costs to give them special handling.