Pretty sure its a contractual/legal thing. I really doubt Netflix is the one limiting the quality of the titles unless they are concerned about their server load. I would imagine if I were Netflix I wouldn't waste my time encoding independent and B-list crap no one watches to instant download unless I needed to fill out my library because the major studios are hesitant to allow rights.
As far as Netflix is concerned an oscar winner takes as much space on a hard drive and takes as much encoding time as Bob and Doug's backyard horror flick. I would imagine all things being equal they would devote their time to the one somebody is going to watch.
If the Netflix business plan works and it becomes popular I would be horribly afraid if I were the studios. I mean as much as a collector I am I know of about two dozen less DVDs I would have bought if I had them available on Netflix instant download. Even if it was slightly less than DVD quality I wouldn't mind on some titles, especially the TV series. Besides, if Netflix sees this taking off they might invest more into improving the quality and infrastructure.
Its a win win for the consumers and Netflix if they can get the quality passable. A flat fee instant rental service combined with huge saving in postal costs for Netflix and less worry about inventory management
I bought the device and am excited to get it, I know the titles aren't great but they have a lot of the history channel shows I like to watch, I don't mind Modern Marvels being less than perfect quality because well... it looks horrible on cable anyway... I've watched a bunch of the old black and white shows on my pc and they seem to be pretty decent. Besides like i said, I'm willing to trade quality for convenience on some titles, You still have the option to wait for the DVD or Blu-Ray on the titles you really care about the presentation. But for Crappy B-List films, films you want to watch on a whim, Stand up Comedy, Some TV Shows, stuff you just want on while you do something else, this is a great tool.