Small company manages to get the world's biggest retailer to drop out of competition in the online DVD rental business.

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SAN FRANCISCO — Wal-Mart is handing off its online DVD rental business to Netflix, signaling the world’s largest retailer couldn’t beat the Internet upstart at its own game.

Yesterday’s David-defeats-Goliath announcement boosted Netflix’s shares, which gained 63 cents, or 4.1 percent, to close at $16.13, soaring as high as $19.27 earlier in the day.

Wal-Mart is offering its existing online DVD rental customers the chance to continue their subscriptions with Netflix at their current price for the next year.

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Those who don’t sign up with Netflix by June 17 will lose their service. Wal-Mart plans to continue promoting the Netflix service on its Web site.

In return, Netflix will urge its 3 million subscribers to buy DVDs from Walmart.com.

The companies didn’t disclose how many customers Netflix will inherit or the financial terms of their partnership. About 70 percent of Wal-Mart’s DVD rental customers pay $12.97 per month for the right to check out up to two titles at a time. Most Netflix customers pay $17.99 per month for three titles at a time. Wal-Mart charges $17.36 per month for three titles.

In a bid to disrupt the new alliance, Blockbuster Entertainment — the other big player in online DVD rentals — offered two months of free service to all Netflix and Wal-Mart subscribers willing to defect.

After the first two months, the defectors will be allowed to keep their former subscription rates for the next year. Customers who switch to Blockbuster also will be able to pick a DVD of their choice to keep.

Netflix still expects to lose $5 million to $15 million this year as it tries to thwart Blockbuster’s aggressive push into online DVD rentals, but getting Wal-Mart to drop out of the competition represents a major victory for the tiny company.

In terms of total receipts, it takes Wal-Mart less than a day to surpass Netflix’s 2004 sales of $506 million.

“It’s a great endorsement,” Netflix CEO Reed Hastings said during an interview yesterday.

Despite its size and merchandising savvy, Wal-Mart couldn’t overcome Netflix’s head start in the rapidly expanding niche of online DVD rentals.

Wal-Mart concluded the service didn’t blend in well with its stores, said John Fleming, an executive vice president who oversees the company’s online operations.

Wal-Mart is thought to have fewer than 100,000 online DVD subscribers, said industry analyst Dennis McAlpine of McAlpine Associates. “This is a nice deal for Netflix, but it still doesn’t mean Netflix will win the game,” he said.

Besides gaining a potential influx of new customers, Netflix hopes to introduce its brand to a wider audience through the promotions on Wal-Mart’s Web site.

With 19.7 million visitors last month, Walmart.com attracts twice as much traffic as Netflix, which had 8.4 million visitors, according to comScore Media Metrix. Just 9 percent of the people who visited Walmart.com last month also spent time on Netflix’s Web site, comScore said.

Wal-Mart is abandoning the online DVD rental business as its management struggles to accelerate the company’s recently slowing sales growth, a factor that has contributed to a 10 percent decline in its stock price so far this year. Wal-Mart’s shares fell 7 cents to close at $47.51 on the New York Stock Exchange and lost another penny in after-hours trading.

Meanwhile, Netflix has shaken up the home-entertainment industry since it set out to establish a new way to rent DVDs six years ago.

“Netflix is a pioneer in this space and we have always admired what they have done,” Fleming said yesterday. “We think this (Netflix partnership) will be a big win for our customers.”

The Netflix service requires subscribers to create an online wish list from a library consisting of more than 40,000 titles and then delivers up the DVDs through the mail.

Netflix allows subscribers to keep the DVDs for an unlimited amount of time without late fees. Once a DVD is returned in a postage-paid envelope, Netflix sends out the next selection on the subscriber’s online list.

The concept caught fire as more households bought DVD players and surfed the Internet, inspiring Wal-Mart to introduce a copycat service two years ago.

After initially deriding Netflix as a passing fancy, Blockbuster is investing heavily in an online rental service that costs $3 per month less than Netflix and offers two free monthly rentals from the company’s stores.

Blockbuster plans to spend $120 million on its online expansion this year and underscored its resolve to win back customers by dropping the late fees that inspired Netflix to launch its approach.

Eliminating the late fees reduced Blockbuster’s first-quarter revenue by $145 million.

With about 750,000 subscribers currently, Blockbuster expects to boost that total to 2 million during the next 10 months.

Meanwhile, Netflix is aiming to add an additional 1 million subscribers by the end of the year.

The cutthroat competition has battered Netflix’s stock, which has plunged from a high of $39.77 reached early last year.