CEO Reed Hastings says he started Netflix to fix a few problems he had with the video rental business. His epiphany came in 1997. He had just sold his software company, Pure Atria, to Rational Software, and after returning a late copy of "Apollo 13," he garnered a $40 fee. There had to be a better way.

"It was my fault in some sense. The movie was about three months late," he says. "But I realized immediately that it was a poor customer experience. It was also suboptimal for the companies -- the retailers and vendors."

Hastings figured that a subscription service, without late fees, would work better. It would be cheaper and easier for both the studios and consumers because, he says, "it would take out the selling costs around the individual content items. Without having to pay as much for promotional costs, the content owner gets more money and the consumer gets a better deal."

At the time, an entertainment subscription service was unheard of, so Hastings decided to postpone the idea and start with a more traditional model: individual DVD rentals, ordered online and sent through the mail. During the first year, Netflix even charged late fees.

"We were worried that it was too radical," Hastings says. "We thought, let's first implement a more simple mode for consumers so they can get used to us." The extra time let Netflix develop a simple sign-up system and envelopes that let users send back a DVD in the same package it had arrived in. Growth, however, only started to take off after the subscription model launched in late 1999. The company signed up 85,000 subscribers by January 2000; a year later, the subscriber rolls had swelled to 300,000."

Users say that Netflix stands out because the model gives them a high level of flexibility without much hassle. Subscribers can pick DVD titles whenever they're using the Net; they can watch the movies wherever they want, for as often as they want. And when they're done with one movie, they can rely on Netflix to handle new orders with speed and efficiency. The music industry should take note.

"It's the ease of use and the convenience that make it so compelling," Andrews says. "And it's at a price that, given how much I would spend for movies anyway, is affordable."

There's a psychological force at work, Hastings suggests. Users don't mind paying because they feel they're being given a great degree of freedom and control. "Consumers enjoy and are willing to pay for an unlimited model because it gives them freedom," he says. "Some months they watch a lot of DVDs; some months they don't. But regardless, they have the freedom to decide for themselves. It's the same reason why people get the unlimited mileage when they rent a car -- they don't want to feel nickel-and-dimed."

Netflix shows what economists have known for years: that consumers think beyond simplistic value propositions such as a flat monthly fee divided by number of movies watched. They consider flexibility a value that's worth paying for, says Jim Griffin, CEO of Cherry Lane Digital, a specialist in rights management for songwriters and movie studios. "They're paying a flat fee for the anarchistic use of the content," he says. "That's an important part of the system."

For decades, businesses have enjoyed this privilege, what Griffin calls pool (in contrast to per piece) economics. Restaurants, health clubs and other public venues can all pay the music industry a flat fee for the use of whatever songs they want. Netflix simply extends the buffet model to consumers.

"Disney CEO Michael Eisner keeps saying that if we can't control all the content, we won't let it out there," Griffin says. "But that's historically incorrect. It's the lie being used to shove digital-rights management down people's throats. The truth is that with radio, television, satellite TV and webcasting, we've always let content out. This is the future, and our past."

At least one music subscription company recognized the significance of Netflix early in its trajectory. EMusic has been watching Netflix and learning from its focus on convenience and freedom since 1999.

"We spent a lot of time understanding their service before we launched our subscription service in July 2000," says Steve Grady, an EMusic general manager. "There are differing dynamics between music and DVDs, but in terms of how you communicate with the customer, the services are very similar."

Specifically, EMusic mimicked Netflix's use of the free trial and tried to follow the overall flow of its Web site.

"Netflix does a very good job of obscuring the complications," Grady says. "They focus on the main benefits of the service, then start asking, What kind of customer are you? We decided to follow that idea because, like Netflix, we were offering a new kind of service."

EMusic also maintained a similar level of portability. Just as Netflix users could take their DVDs anywhere, and order from any Internet-connected computer, so can EMusic's 50,000 members play their music however they like. Because the company's catalog uses the MP3 format, songs can be burned to a CD, shared, or copied to a portable MP3 player.

"In essence, in a broad conceptual way, EMusic is doing the same thing as Netflix," Griffin says. "They're saying [to users], Look, you don't have to account for each play. You just cut us in on the money and we'll untether this stuff for you."

But in today's music environment, flexibility has its consequences. EMusic's focus on portability looks like kryptonite to the major labels -- the kind of thing that will kill the industry. And if EMusic is the audio stepchild of Netflix, it's practically an orphan.

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