What Facebook means to Netflix

June 27, 2011, 1:36 PM UTC

Netflix CEO Reed Hastings joined Facebook's board. More to come?

FORTUNE — Netflix Chief Executive Reed Hastings made a strategically brilliant move for the business Friday when he announced plans to join Facebook’s board of directors. Since it was founded in 1997, Netflix (NFLX) has risen from a start-up that took down Blockbuster with its red-enveloped videos by mail to the dominant movie streaming site on the web, disrupting the entire $85 billion home entertainment industry and prompting Fortune to name Hastings business person of the year for 2010. (See: Reed Hastings: Leader of the Pack)

But competition is heating up for the future of your living room. As Netflix looks to keep its lead, it could gain a significant competitive advantage by nursing a deeper relationship with the world’s dominant social network.

As I wrote in January (“What the hell is going on with TV?”), web TV—the idea the largest screens in our homes will become operating systems like those that power our computers and we’ll watch our favorite shows on tablets as well as the big screen—is finally coming. New business models will make this happen. Netflix has grabbed a huge share of attention this year with more than 23 million subscribers (many of whom opt for streaming movies on the web in addition to the red envelopes), but competitors from the pay TV providers to tiny upstarts are trying to displace it.

To stay ahead, Netflix will have to differentiate even as other web video services gain popularity. Online TV site Hulu.com, a joint venture run by News Corp.(NWS), Walt Disney (DIS), NBC Universal parent Comcast (CMCSA) and Providence Equity, launched a subscription service last fall. Viewers can watch some shows for free on the web, but for a monthly fee, they can watch even more shows on and do so on an expanding list of devices like iPads and smartphones. Recently, Hulu has reportedly put itself up for sale as the large media companies that own it clash over how its business should work, and its not clear what the future holds for the site.

Pay TV providers pose the larger threat to Netflix. Anxious to keep and grow the subscribers who pay monthly fees for bundles of channels delivered to their homes, companies like Comcast and Time Warner (TWX) (parent company to Fortune publisher Time Inc.) are including digital streaming options with their pay services though the “TV Everywhere” initiatives. Sign up for Comcast, for example, and you can log in to XfinityTV.com to view much of the programming over the web on your laptop, tablet, or smartphone.

Ultimately, viewers will flock to the service that gives them the shows and movies they most want to see. Hastings will have to work hard to maintain and build the Netflix library of films in order to keep viewers coming back. Because Netflix’s user growth has come fast, it has signed contracts with large entertainment companies in which the terms are likely to shift dramatically as they come up for renewal. Recently Sony (SNE) titles including a batch of high-profile pictures like The Social Network and Salt disappeared from the Netflix instant streaming service after a contract struck between Netflix and Starz, which owned the online rights to Sony movies, was violated–reportedly more people than allowed under contract had viewed the films. Hastings has said publicly that it “wouldn’t be shocking” if Netflix paid more than $200 million per year to renew its deal with Starz, an amount more than six times what it is estimated to pay now.

So far, Netflix has succeeded by continuing to reinvent itself to stay ahead of competitors. However, social is one area it has yet to master. While the company has a sophisticated recommendation engine for suggesting films to viewers, it offers few tools like share buttons to help viewers share titles with each other on popular social networks, for example.

Enter Facebook. With more than 700 million people globally now maintaining accounts, the social network could have a big impact on how viewers find, share and watch movies and shows in the future. Already, last March, Warner Bros. launched an application that let users rent and watch movies directly on Facebook. By joining the company’s board, Hastings could open the door for a deeper integration between the companies.

Could Netflix begin distributing programming directly over Facebook? Stay tuned.