Manuel Villanueva realizes he has been getting a pretty good deal since he signed up for Netflix Inc.'s online DVD rental service 2 1/2 years ago, but he feels shortchanged.
That's because the $17.99 monthly fee he pays to rent up to three DVDs at a time would amount to an even bigger bargain if the company didn't penalize him for returning his movies so quickly.
Netflix typically sends about 13 movies per month to Villanueva's home in Warren, Mich. - down from the 18 to 22 DVDs he received before the company's automated system identified him as a heavy renter and began delaying his shipments to protect its profits.
The same Netflix formula also shoves Villanueva to the back of the line for the most-wanted DVDs, so the service can send those popular flicks to new subscribers and infrequent renters.
The little-known practice, called "throttling" by critics, means Netflix customers who pay the same price for the same service often are treated differently, depending on their rental patterns.
"I wouldn't have a problem with it if they didn't advertise "unlimited rentals,' " Villanueva said. "The fact is that they go out of their way to make sure you don't go over whatever secret limit they have set up for your account."
"In determining priority for shipping and inventory allocation, we give priority to those members who receive the fewest DVDs through our service," Netflix's revised policy reads. The statement specifically warns that heavy renters are more likely to encounter shipping delays and less likely to immediately be sent their top choices.
Few customers have complained about this "fairness algorithm," Netflix CEO Reed Hastings said.
"We have unbelievably high customer satisfaction ratings," Hastings said. "Most of our customers feel like Netflix is an incredible value."
The service's rapid growth supports his thesis. Netflix added nearly 1.6-million customers last year, giving it 4.2-million subscribers through December. During the final three months of 2005, 4 percent of its customers canceled the service, the lowest rate in the company's six-year history.
After collecting consumer opinions about the Web's 40 largest retailers last year, Ann Arbor, Mich., research firm ForeSeeResults rated Netflix as "the cream of the crop in customer satisfaction."
Once considered a passing fancy, Netflix has changed the way many households rent movies and spawned several copycats, including a mail service from Blockbuster Inc.
Netflix's most popular rental plan lets subscribers check out up to three DVDs at a time for $17.99 per month. After watching a movie, customers return the DVD in a postage-paid envelope. Netflix then sends out the next available DVD on the customer's online wish list.
Because everyone pays a flat fee, Netflix makes more money from customers who watch only four or five DVDs per month. Customers who quickly return their movies to get more erode the company's profit margin because each DVD sent out and returned costs 78 cents in postage.
Although Netflix consistently promoted its service as the DVD equivalent of an all-you-can eat smorgasbord, some heavy renters began to suspect they were being treated differently two or three years ago.
To prove the point, one customer even set up a Web site, www.dvd-rent-test.deamhost.com, to show the service listed different wait times for DVDs requested by subscribers living in the same household.
Netflix's throttling techniques have prompted incensed customers to share their outrage in online forums such as www.hackingnetflix.com.
Hastings said the company has no specified limit on rentals, but " "unlimited' doesn't mean you should expect to get 10,000 a month."
Management has previously acknowledged to analysts that it risks losing money on a relatively small percentage of frequent renters. The risk has increased since Netflix reduced the price of its most popular subscription plan by $4 per month in 2004 and the U.S. Postal Service recently raised first-class mailing costs by 2 cents.
Netflix's approach has paid off. The company has been profitable in each of the past three years, a trend its management expects to continue in 2006 with projected earnings of at least $29-million on revenue of $960-million. Netflix's stock price has more than tripled since its 2002 initial public offering.
A September 2004 lawsuit cast a spotlight on the throttling issue. The complaint, filed by Frank Chavez on behalf of Netflix subscribers before Jan. 15, 2005, said the company had developed a sophisticated formula to slow down DVD deliveries to frequent renters and ensure quicker shipments of the most popular movies to its infrequent, and most profitable, renters to keep them happy.
Without acknowledging wrongdoing, the company agreed to provide a one-month rental upgrade and pay Chavez's attorneys $2.5-million, but the settlement sparked protests that prompted the sides to reconsider. A hearing on a revised settlement proposal is scheduled for Wednesday in San Francisco Superior Court.