Netflix: From movies in the mail to movies on demand?

Birds circle and scream overhead as winds howl through the wreckage of burned-out buildings. Waves crash against the rocky shores in the gathering dark, while dock hands work to berth our wildly bucking boat. No doubt about it, Alcatraz Island, or "The Rock," is long on the kind of atmospherics moviemakers love. Ever since it stopped being a prison (and before that, a fort), Hollywood has been making the trek across the San Francisco Bay to cash in on all these natural special effects.

Tonight, it's Netflix's turn. This is the online DVD-rental company that is spooking all of Hollywood with its unexpected success in getting consumers (5 million and counting) to change their movie-watching ways. The company has brought a group of 125 lucky film buffs to tour the island and then watch Clint Eastwood's "Escape from Alcatraz."

The total audience for tonight is small (and cold). But as all of Hollywood warms up for what everyone agrees is the next big thing – digital delivery of home entertainment – ironically, the little Los Gatos Internet upstart that relies on the first-class postage stamp to deliver its discs has become the player to beat. It now finances films. It scours independent festivals to procure movies that the studios miss. It's even begun exploring video on demand.

"We want to find unique ways to bring film to the people," says Leslie Kilgore, chief marketing officer for Netflix, explaining how tonight's festivities fit in with the overall Netflix vision. This event, held in the damp chill of the former inmates' chapel, is the final stop in the summer-long "Rolling Road Show." The company has also screened classics such as "Jaws" and "Field of Dreams" where they were made (Martha's Vineyard, Mass., and an Iowa cornfield, respectively).

"The company is a game-changer," says branding expert Morris Reid. Getting people to alter their behavior is the holy grail of modern business, he says, and when a company succeeds, everyone pays attention. "They've changed the model, not just by making [renting movies] more convenient, but it shifted the ground around them so that now everyone else has to react to what they're doing."

No late fees, (mostly) overnight delivery, and, most important, a deep catalog of more than 65,000 titles linked to a sophisticated, proprietary searching software that allows customers to find obscure films and introduces them to new ones, have been the keys to the company's success. In the past two years, Netflix executives have begun to find new ways to expand their reach. They have inked distribution deals for small, independent films such as "Embedded Live," "The Girl from Monday," and "Assisted Living." In July, they signed a deal with NBC to distribute new TV shows, including Aaron Sorkin's "Studio 60 on the Sunset Strip," even before some have aired.

The jewel in the Netflix crown, however, says Ted Sarandos, Netflix chief content officer, is the answer it has found to Hollywood's most persistent bugaboo: how to tell what people will pay to watch. With its online communities of people who provide reviews and feedback, the company can identify potential fans for new films.

"By helping to find markets for hard-to-market films, there are a couple of hundred films already that would never have been seen without Netflix," says Mr. Sarandos.

Many media watchers are bullish on the company, even going so far as to call it revolutionary. "What Netflix has done and continues to do is broaden the viewership for movies, because it allows viewers to focus on niches that are of interest and see movies they might not otherwise see," says Michael Sherman, chair of the entertainment law group at Jeffer, Mangels, Butler & Marmaro in Los Angeles. The company is credited with single-handedly building audiences for such quirky films as "Capturing the Friedmans," a documentary about a family racked by sexual abuse.

But in Hollywood, where success is recalculated in every day's trade papers and imitation is the only sure thing, media watchers say the company faces many challengers. Blockbuster has a virtual replica of the Netflix service while every movie and television studio in town is scrambling to find new ways to deliver content to consumers, from iTunes to Movielink, not to mention deals with every major cable provider.

Some observers say Netflix may have already begun to lose its edge, beyond the recent swoon of the company's stock after failing to meet analyst's projections. "The biggest challenge for Netflix is distraction," says Mr. Reid, the branding expert. A content-delivery firm should not be in the business of picking and choosing winners through financing films, he adds. The company would be better off sponsoring film festivals or concerts, he says, and the jaunt to Alcatraz may have been unique, but it is a "waste of time and money."

Some analysts suggest that Netflix may have peaked with its core audience for obscure films. There is a limited viewership for small films seen at home, says critic Christopher Sharrett, adding, "most people still want the experience of going to the movie theater."

Indeed, not every movie fan is a Netflix fan, as demonstrated back at The Rock, where a select core of 25 diehards have also signed up to spend the night in a cell. John and Diana Lafleur have come in from La Mirada for the privilege. As they stamp their feet on the cold concrete floor of the makeshift screening room, they consider the relationship between their night in jail and their normal life. They do not subscribe to Netflix, says husband John. Will their stint in the pokey turn them into subscribers once they return home?

"Possibly," says John, who says he has little free time and likes to get out of the house when he does. "This just seemed like fun," he says. "I don't know if I would want to start getting committed to movies coming in through my mailbox every week."