Strategic AnalysisSGMT 6800 S - Group Project

Schulich School of Business

Kevin Andrews

Ebube Anizor

Nasir Gondal

John Selvakumar

2Appendices

CONTENTS

......................................................................................................Company Overview 3...................................................................................................Products & Services 3

...............................................................................................................Technology 4..........................................................................................................Current Strategy 7

......................................................................................................Business Strategy 7.................................................................................................Technology Strategy 8

.................................................................................................Innovation Strategy 10...............................................................................................Investment Priorities 12

................................................................................................................Summary 12..............................................................................................Environmental Analysis 14

.......................................................................................................Forces Analysis 14.........................................................................................................Opportunities 15

.............................................................................Licensing and Regulatory Issues 16.................................................................................................Competitive Analysis 19

............................................................................................................Competitors 19..........................................................................................................New Entrants 22

..................................................................................................Netflix Positioning 22..............................................................................................Competitive Advantage 23

................................................................................................Intellectual Property 23...........................................................................................Complementary Assets 24

........................................................................................................Industry Outlook 28.......................................................................................................Studio Revenue 28

.....................................................................................................Recommendations 31.............................................................Short and Medium term Recommendations 31

.................................................................................Long Term Recommendations 33...................................................................................................................The Bet 33

................................................................................................................Appendices 36...................................................................................Appendix A: Movie Releases 36

..............................................................................................Appendix B: Industry 37........................................................................................Appendix C: Competition 40

......................................................................................Appendix D: Technologies 43

Netflix

3Appendices

COMPANY OVERVIEWNetflix was founded in Scotts Valley, California, in August of 1997 by Reed

Hastings and Marc Randolph. The idea for the “DVD-by-Mail” business was

born out of Hastings’ own personal frustration from paying $40 in late fees for

a video he had forgotten to return to Blockbuster. Hastings’ was compelled to

figure out a better way for consumers to experience what was then the new

video format – DVDs - and began his quest to disrupt the traditional movie

rental market and create a new industry.

In just over a decade Netflix has developed into the world's leading DVD rent-

by-mail and video streaming company. With over 14 million subscribers in the

US and growing, more than 10% of US households currently subscribe to either

Netflix’s mail or streaming services. Netflix employs 1,700 staff and reported

revenues of US $1.67 billion in 2009. Projections for 2010 include revenues

nearing $2.5 billion and a subscriber base approaching 17 million.

PRODUCTS & SERVICES

Netflix’s DVD-by-Mail service straddles the end of one particular technology

cycle (traditional DVD rental service) and the beginning of another (on-line

streaming). Though Netflix’s early attempts at streaming technology (see

Streaming below) were met with failure their foresight and “big bet” into this

technology has led to their dominant status in the movie streaming market, and

Netflix

4Appendices

has provided them with significant power in the industry. Figure 1 depicts how

the mail and streaming services operate.

Figure 1: Neflix’s Mail and Streaming Offering

While plans for geographical expansion are underway Netflix currently only

operates in the United States; offering one of four subscription choices:

• 3 DVDs at-a-time/Unlimited Streaming - $17/month

• 2 DVDs at-a-time/Unlimited Streaming - $14/month

• 1 DVDs at-a-time/Unlimited Streaming - $9/month

• 2 DVDs /2 hours streaming - $5/month

TECHNOLOGY

Netflix’s attempts to move from a solely mail-based service faced challenges. In

2000, engineers developed a streaming service that took 16 hours to download

a two hour movie – needless to say the project the scrapped. Noticeable

improvements were made in 2003 when using a TV connected to Linux PC at a

Netflix

5Appendices

cost of $300 it took two hours to download a two hour film.1 However, the

technology was still not yet ready to be commercialized. Improvements in

broadband speeds and Netflix’s technology were required to make streaming a

viable offering. Progress in both regards will continue to affect growth in the

Internet delivered video (IDV) industry and Netflix’s fortunes.

Adoption

Netflix’s service offerings reside in distinct stages in the technology life cycle

(Figure 2).

Figure 2: Technology Adoption Curve

DVD-by-Mail

DVD-by-Mail lies somewhere between the “Early Majority” and “Late Majority”

stages. The service is still growing; however the entire model as a means of

distributing movie content is changing, foreshadowing the decline of the

model. Ultimately delivery will be replaced as streaming improves, optimization

Netflix1 “Netflix Inside” (Wired), October 2009

DVD-by-Mail

Streaming

6Appendices

of the delivery chain peaks and the cost of shipping DVDs becomes too high

relative to revenue in a competitive market.

Streaming

The “Streaming” model however, would have still be considered to be in the

“Early Adopters” stage, however that is being driven full steam ahead into the

“Early Majority” as an increasing number of devices support the Netflix

platform. Televisions, Blu-Ray players, gaming consoles, mobile phones,

tablets, PCs, and just about any device that can connect you to the internet are

all becoming “Netflix enabled” devices that will likely catapult the Netflix

streaming service into majority adoption.

Evolution

Several factors including technological improvements and customer behaviour

foretell the gradual dominance online delivery. That being said, Netflix

anticipates the continued growth of the DVD-by-Mail business into 2013 (see

Figure 3) driven by the growing closures of video stores and Netflix’s delivery

excellence. Clearly what is being witnessed is the saturation of the shipment

business as the streaming business emerges and approaches a breakthrough in

market acceptance. See Figure C4 is Appendix C for a

Netflix

7Appendices

Figure 3: DVD-by-Mail Shipments (Source: Netflix)

perspective on the attractiveness of service delivery models. While the

technology Netflix employs in delivering a movie via mail or via streaming can

be classified as key; providing Netflix with short term advantage, they are

imitable in the longer term. See Appendix D for details on Netflix’s technology

life cycle and evolution.

CURRENT STRATEGY

BUSINESS STRATEGY

The core business objective of Netflix is to grow a large subscription business

consisting of streaming and DVD-by-mail content. In order to achieve this

objective and differentiate itself in the marketplace, Netflix uses a customer

intimacy strategy heavily rooted in innovation to make it simple, fast and easy

for subscribers to access a wide selection of content on a wide selection of

devices. Subscribers are offered a choice of delivery method and platform that

Netflix

8Appendices

is most convenient to them, all at one low price. This strategy has proven to be

a highly effective strategy as it helps grow and entrench the company’s greatest

resource: its loyal subscriber base. Through its focus on customer service and

user experience, Netflix has built itself into one of the leading brands in home

entertainment.

TECHNOLOGY STRATEGY

At the genesis of Netflix in 1997, its founder Reed Hastings was said to have

envisioned a future for online streaming content – thus the name “Netflix” - but

knew the timing was not right. It was obviously too early in the technology

cycle (or “S-curve”) for online streaming content and the technology had not yet

reached its breakthrough point2. When the company sensed that the

incumbents in the traditional video rental business such as Blockbuster were

beginning to catch up and that streaming had become more pervasive, the

company quickly changed its business model to include streaming content

through its ‘watch now’ online streaming feature.3

Creating, Delivering and Capturing Value

Technology strategy and innovation are at the heart of Netflix’s ability to deliver

a compelling customer experience and its ability to sustain competitive

advantage. At the technology strategy level, Netflix operates as a leader by

Netflix

2 Wolf, Michael (2010, July 1, 2010). How Netflix Shaped Skype’s Platform Strategy. Message posted to Gigaom archived at http://www.gigaom.com

3 Bulik, Beth Snyder (2010). How Netflix Stays Ahead of Shifting Consumer Behaviour. Advertising Age, 81(8), 28

9Appendices

investing in new technologies to enhance the “subscriber experience” and

“operate efficiently”4.

• Netflix creates value by continuously adding to its extensive inventory of

content, by building a recommendation engine which allows the company

to maximize its library utilization and by leveraging its customer

database and online merchandising experience to digitize the

relationship with the customer5.

• The company delivers value to customers through its recommendation

and merchandising technology by providing a quick and personalized

way to enjoy and experience content and through its pricing strategy

which entails charging one price for quick delivery of DVDs through mail

or via online streaming.6

• Netflix then captures value through fees charged to its large installed

base of 14 million users. By charging a minimum fee of $8.99 per month

to its membership, In 2009 Netflix earned a $116 million profit on $1.67

billion in revenue.

Platform Strategy

In addition, the company’s platform agnostic approach to spread its software

across multiple platforms is proving to be a strong source of subscriber growth,

Netflix

4 Netflix Annual Report (2009) Retrieved from www.netflix.com

5 Bulik, Beth Snyder (2010). How Netflix Stays Ahead of Shifting Consumer Behaviour. Advertising Age, 81(8), 28

6 Netflix Annual Report (2009) Retrieved from www.netflix.com

10Appendices

guided by the company’s goal “to be ubiquitous on whatever device gets the

Internet to the TV”7. By attempting to establish its online streaming technology

as the standard service for getting internet content connected to electronic

devices, Netflix has positioned itself to benefit from network effects and

capture more value in the form of subscription fees and loyal customers. This

strategy also helps the company defend its position against other competing

technologies and services that are quickly emerging in the market.

INNOVATION STRATEGY

Disruptive innovation has been the hallmark of Netflix since its inception in

1997. It was one of the first companies to offer DVD by mail ordered over the

internet. This service provided a cheaper, more convenient way for customers

to enjoy DVD movies and television shows compared to the traditional brick

and mortar video rental store, with the added convenience of no late fees.

Netflix perfected the fulfillment of its DVD rental by mail business by investing

in technology and developing processes to make it fast and efficient for

customers to receive and easily return DVDs by mail.8 Faced with competition

from kiosks and other mail based rental companies, improving broadband

penetration, and increased customer acceptance of online video Netflix is

gradually shifting its innovation focus from DVD by mail to growing its library

Netflix

7 Anonymous. (2010, Jan 23). Netflix Announces Multiple Partners to Instantly Stream Movies and TV Episodes from Netflix to the TV [Electronic version]. Leisure & Travel Week, p. 34

8 http://www.inc.com/magazine/20071001/netflix-vs-blockbuster-what-would-you-do.html (July 4)

11Appendices

of online movie offering and from a technology perspective, perfecting its

online recommendation engine and expanding its presence across multiple

platforms.

Open Innovation

Netflix has taken an open innovation approach to improving its

recommendation technology and executing on its platform strategy to expand

across multiple platforms. In one of its most well known initiatives, Netflix

engaged the general public and open source community by offering $1 million

to the person(s) who could “use Netflix movie-ratings data to build a

recommendation engine 10% better than Netflix’s current tool”9. In another

example, open innovation supported its platform strategy as Netflix saw

hundreds of new apps built when it opened up its API including apps to queue

movies for a mobile phone. According to a November 2009 Forbes magazine

article, the $1 million competition illustrated how Moore’s law may not be

applicable to innovation in the software industry. As opposed to Moore’s law

which states that hardware power will double within approximately two years,

the author contends that the ‘Netflix law’ illustrated by this competition

suggests that you will only realize a 2-3% improvement rate and only for a

short period of time.10 In addition to cost and time savings, this example

Netflix

9 Klaassen, Abbey. (2009) Brands get boost by opening up APIs to outside developers. [digital version] Advertising Age. 80 (40), 17

10 Gomes, Lee. (2009) Netflix’s Law: The Future of Software. [electronic version] Forbes Magazine

12Appendices

highlights the rationale for Netflix utilizing an open approach to speed up

innovation and the challenges in terms of making further improvements to its

recommendation software given that it took approximately three years for a

winning team to emerge.

INVESTMENT PRIORITIES

In terms of investment priorities, Netflix has applied significant resources in

web based strategic technology assets (STAs) such as subscription account

signup and management, personalized movie merchandising, inventory

optimization and streaming software11. These investments were made to

optimize subscriber satisfaction and management of the company’s library of

content by promoting the right movies to customers and ensuring correct

inventory levels. The other important STAs in which Netflix invests is in

technology to manage the processing and distribution of DVDs and streaming

content, including third party delivery networks.12

SUMMARY

Overall Netflix has made well timed adjustments in strategy according to both

consumer behaviour readiness and technology maturity. Its technology

strategy has supported its business strategy of consumer intimacy. This

involves a well tuned DVD distribution system, excellent streaming technology

Netflix

11 Netflix Annual Report (2009) Retrieved from www.netflix.com

12 IBID

13Appendices

and effective recommendation engine. This “intimacy” is likely how Netflix will

differentiate itself in the broader and to-be-hotly contested IDV industry. See

Competitive Analysis on below.

Netflix

14Appendices

ENVIRONMENTAL ANALYSIS

In what is expected to be a US$80 billion dollar business, the subscription

segment of the IDV industry exhibits growing rivalry, the existence of many

substitutes and the threat of powerful entrants. Table 1 summarizes the Five

Forces analysis. Appendix B provides full details.

FORCES ANALYSIS

Force Strength Competitors Medium/High

• Market rapidly growing. Estimated at US$13B by 2011• Online based services lowers entrance costs

Suppliers High• Several distribution avenues• Threat of forward integration (i.e. providing Internet

delivery services)• Flexibility in licensing content

Buyers High• Demand < Supply• No switching costs

Substitutes Medium/High• IPTV, Download Services (e.g. iTunes)• Traditional Cable and Satellite TV

New Entrants Medium• Potential for M&A among Major Players• Strength could be high if content providers forward

integrate

Table 1: Forces Analysis Summary

The environmental analysis provided below examines the opportunities that can

be exploited by Netflix to grow and strengthen its market position, and the

regulatory issues that can weaken its competitive advantage.

Netflix

15Appendices

OPPORTUNITIES

Game Consoles

With a high speed connection, Netflix content can be streamed via a game

console. There are over 60 million game consoles in the US13; representing a

potential asset that Netflix can exploit to expand its customer base. In April

2010, the firm signed a contract with Nintendo whereby Netflix subscribers can

stream video on the Wii at no additional cost. At the end of first quarter of

2009, 55% of Netflix subscribers had watched at least 15 minutes of streaming

video; but this still accounts for only 30 percent of Netflix-enabled devices14.

Mobile Devices

As of June 2010, or 80 days after product launch, Apple has already sold 3

million iPads15. Netflix has launched an iPad app that allows existing

subscribers to stream for free. The increasing penetration and capabilities of

smartphones and tablet devices will enhance the complementary asset base for

Netflix and provide further incentive for the new customers to sign up and

reduce churn when competition escalates.

International Expansion

Netflix

13NPD sales figure analysis. Accessed from http://www.digital-digest.com/blog/DVDGuy/2010/07/02/game-consoles-may-2010-npd-sales-figure-analysis/

14 http://www.zdnet.com/blog/btl/netflix-55-percent-of-subscribers-now-streaming-movies/33415

15 http://www.apple.com/pr/library/2010/06/22ipad.html

16Appendices

Currently, Netflix streaming is available only in the United States. However, the

increasing penetration of broadband connection especially in developed

countries presents a significant opportunity for Netflix to expand its offering

beyond the US. According to research by Morgan Stanley16 there are 124 million

households in the top 10 countries that meet key criteria for Netflix such as

broadband usage rate, GDP, and affinity for Western culture. By gradually

expanding its services into these countries Netflix can further leverage its

digital content library and build on its brand recognition in the US to become a

firm with international scope and reach. Naturally obtaining the content

licensing for new markets will be a separate challenge.

LICENSING AND REGULATORY ISSUES

Content Licensing

New films are released by studios in a process called windowing whereby film is

first released at different times in different distribution channels. Thus a new

film is initially available only in theatres, then hospitality channels, followed by

release on DVD, and then pay-per-view TV (See Figure A1 in Appendix A). As a

result, streaming on Netflix and other players in the digital streaming is

controlled through licensing by film studios.

Netflix

16 Morgan Stanley (2010). NetFlix Inc. Accessed from http://research.thomsonib.com/gaportal/ga.asp

17Appendices

For Netflix, only 25% of the content represents new releases17. However, with

the focus of the company shifting to digital streaming, the company might have

to rely more on library or older content. Netflix’s reliance on an older catalogue

will be disadvantageous especially if its competitors obtain licensing deals that

allow for better access to new content. Content access will be a key challenge

going forward in light of a recent agreement Netflix has signed. Realizing that

the firm needed to improve its relationship with movie studios to gain access to

wider variety of new content, Netflix signed an agreement with Warner Brothers

Home Entertainment whereby Netflix will not sell new releases until 28 days

after they go on sale. In return, Netflix will be “able to extend the range of

choices available to be streamed to [its] members”18.

Net Neutrality and Managed Services

In 2009, the Federal Communication Commission (FCC) introduced its proposed

rule changes whereby certain “managed services” will be exempt from net

neutrality rule. Managed services are those services for which network carriers

can reserve certain bandwidth on priority basis so that network data is

transferred more quickly. Since many of the US network carriers are affiliated

with subscription TV or video content providers, these carriers might use

managed services rules to reserve high bandwidth for their affiliated content

providers. For example, Comcast (who recently acquired NBC) might provide

Netflix

17 Cannaccord (2010).” Netflix”. Accessed form http://research.thomsonib.com/gaportal/ga.asp

18 CNET (2010). “netflix, warner bros. Rejigger movie renting”. Accessed form http://news.cnet.com/8301-31001_3-10426792-261.html

18Appendices

priority access to bandwidth for its own content. Thus if subscription video

streaming becomes part of managed services, then companies like Netflix

which don’t have an affiliation with any network carrier may be at a competitive

disadvantage.

Netflix

19Appendices

COMPETITIVE ANALYSIS

When Netflix launched in 1998 it effectively disrupted the video store industry.

In exchange for the delayed gratification of receiving a DVD by mail instead of

heading to the store Netflix offered quick turnaround and no late fees. By 2007

the company soared to nearly a billion dollars in revenue. Naturally Blockbuster

fought back toying with no-late-fee schemes and launching its own cheaper

DVD mailing service (with the option of pick ups at one of its 5000 retail

locations). Blockbuster’s resurgence seemed effective – for a while – as Netflix

dropped prices to compete. 19 Today Blockbuster is flirting with bankruptcy; its

stock value has dropped 79% in 2010 to under 20 cents and is no longer listed

on the New York Stock Exchange. As Blockbuster struggles to transform itself

into a digital and mail-based operation; Netflix can by no means declare

victory. Netflix’s move into the IDV business has multiplied its challenges and

garnered it a new roster of wealthy and powerful competitors.

COMPETITORS

Outside of traditional video stores Netflix now competes with Kiosk/Vending

Machine services, Television Stations, Cable/Distribution Service Providers and

likely soon to be the content providers (primarily movie studios) themselves.

Currently the market for Internet delivered video consists of three segments:

Netflix19 http://www.inc.com/magazine/20071001/netflix-vs-blockbuster-what-would-you-do.html

20Appendices

video-on-demand (VOD), ad supported, and subscription. Table 2 details the

key competitive firms and their positioning.

Service Type/Area Key Firms Positioning/OfferingK i o s k s / V e n d i n g Machines

• Redbox • Last-minute movie renter’s best friend• cheap

Ad Supported Video • YouTube • User loaded video (not professional)• Channels for professional / studio

content• No movie distribution

Ad Supported Video

• Hulu• TV stations

• Content from TV stations• 24 hours after air date• Deep Archives

Pay-Per-View • Apple • Movies are downloaded. Purchased content is owned, rented content expires after 24 hours

Pay-Per-View

• Amazon on Demand

(Microsoft, Best Buy, Wal-mart)

• Wide variety of content is available for streaming

Set-Top Boxes / TV’s

• TiVo• DVR’s

• Current content – immediately available• HD video on large screens• Partnerships with Amazon and Netflix

Traditional Cable and Satellite Providers

• HBO• Showtime• Roger’s on

Demand etc.

• HD video on large screens• Large install base• Complementary assets in online

distribution of traditional content

Free (with “cable” subscription)

• R o g e r s , C o m c a s t , T V Everywhere, etc.

• Existing subscribers have access to “home” channels on-line and on mobile devices

Table 2: Competitive Offerings

Competitive Factor: Access to Content

The key competitive factor is access to content or the film release windows (See

Figure A1 in Appendix A). This is the mechanism that rights holders use to lock

Netflix

21Appendices

in early profits from DVD releases (the most lucrative) and through other

distribution channels over time. This factor alone may be enough to keep

Blockbuster in business. Blockbuster is a place where consumers still

congregate to buy DVDs; and while rentals remain 75% of its business, sales of

DVDs are far more profitable for studios. Studios earn up to $18 on each DVD

sold compared to around $4 for a rental. In March 2010, Warner Bros. signed a

deal permitting Blockbuster to rent DVDs online and through mail order the

same day they are released for sale; Netflix and Redbox are held to 28 day wait

period.

Competitive Factor: Pricing / Ownership Model

This primary delivery model is a streaming service (with no ownership) as

employed by most firms. The other, less prevalent, model is a purchase

download model primarily deployed by Apple iTunes and Blockbuster. Netflix’s

“all you can eat” in a month model has brought it early success and has been

acceptable by studios for the DVD-based product because Netflix purchases the

DVD’s in cash up front. With the streaming model lucrative DVD sales are lost

and Netflix (because of its market strength) becomes increasingly more of a

threat than customer.

Competitive Factor: Existing Business

Cable companies, satellite providers and similar entities with established

businesses and customer bases have both an advantage and disadvantage in

Netflix

22Appendices

the emerging IDV industry. The existing customer base gives the companies

access to customers and eases the transition to complementary streaming

services. However these businesses also have existing revenue streams and

investments to protect. In the long term, IP based television and delivery may

threaten margins and protected revenue made on its traditional business (e.g.

hardware). Netflix, and the like, don’t have this conflict.

NEW ENTRANTS

Interestingly enough as online and on-demand video threatens to wither the

high margin DVD business that studio the biggest threat from new entrants to

Netflix are the studios themselves; should they choose to forward integrate –

either directly or via exclusive partnership agreements. As will be discussed in

the Industry Outlook section, the future success of the company will rely heavily

upon its agreements with movie studios and what part the studios themselves

want to play in the IDV value chain. As a whole the comparatively low margins

IDV earns mitigates against aggressive entry from large players.

NETFLIX POSITIONING

Netflix augments, rather than replaces, the standard video or television

package that consumers use. Its success is based on clearly defining where and

how it competes:

• Segment. Netflix defines its segment as consumer-paid streaming

subscription of movies and TV shows.

Netflix

23Appendices

• Content. Focus on extensive catalogue of archived and relatively new

content. Other content (user-generated, news, sports, music videos,

adult & instructional) is not in scope. Pay-per-View and DVD will likely

always offer better content.

• Revenue Model. Single, simple subscription based revenue model.

Difficult for existing providers to mimic because it cannibalizes existing

revenue streams.

COMPETITIVE ADVANTAGE

Netflix’s disruption of the traditional movie rental industry has not only

garnered the company financial success but several assets that can be

leveraged to also lead in the online streaming business.

INTELLECTUAL PROPERTY

Netflix use a combination of patent, trademark, copyright and trade secrets to

protect its intellectual property both in the U.S. and abroad. The company uses

patented in-house video streaming technology that uses an Adobe flash

interface (in addition to standard protocols) to be compatible with the majority

of desktop and mobile devices.

In 20006 Netflix was granted a patent describing its mailing DVD rental

business model20. Just hours after receiving the patent, Netflix filed a patent

Netflix

20 http://patft.uspto.gov/netacgi/nph-Parser?Sect1=PTO2&Sect2=HITOFF&p=1&u=/netahtml/search-bool.html&r=1&f=G&l=50&co1=AND&d=ptxt&s1=netflix&OS=netflix&RS=netflix

24Appendices

infringement lawsuit against Blockbuster seeking damages and the halting of

their online rental operation. The suit was settled in 2007 – with terms

undisclosed. Blockbuster did indicate that the settlement materially affected its

ability compete. While patents are an important element of Netflix’s business,

its operation is not materially dependent on any one or a combination of

patents21.

COMPLEMENTARY ASSETS

Installed Base

Netflix’s published subscriber count increased from 1 million in 2002, to just

under than 6 million at the end 2006, to 14 million by the spring of 201022. The

company’s large install base and high level of customer satisfaction is arguably

its most valuable complementary asset.

Distribution

When Netflix first launched the business didn't seem to require cutting-edge

technical know-how. All the company needed to do is “stick discs in mailers

and get those mailers to customers”23. But keeping customer high did in fact

require some heavyweight technology. Netflix has sped up mailing times by

building a network of 15 distribution centers across the country. The objective

has always been building enough centers so that most Netflix subscribers

Netflix

21 Netflix company 2009 annual report < http://ir.netflix.com/secfiling.cfm?filingID=1193125-10-36181>

22 http://ir.netflix.com/

23 PC Magazine website 2003 <http://www.pcmag.com/article2/0,2817,894278,00.asp>

25Appendices

receive their movies within a day of shipping. The centers also give Netflix a

competitive advantage over Wal-Mart and Blockbuster, each of which sends out

discs from only one warehouse24.

Customer Service

Now that Netflix has settled into the leader in DVD rentals, they have decided to

focus on another aspect of business, customer service. One might find this odd

due to the fact they do not have a physical store and are online only business,

but they have eliminated e-mail based customer service inquiries, thus forcing

all complaints, questions, and suggestions to their call center. Unlike other

companies where it sometimes feels impossible to locate a telephone number

to contact customer service, they have made it very simple and easy to find on

their main page. And unlike the increasing trend of many other companies, they

have chosen not to outsource their call center. Their call center is located in

Oregon and along with being local is open 24 hours a day.25

License Agreements

The company has license agreement with large content providers such as

Warner Bros. and various studios and distributors granting Netflix the right to

provide its subscribers with movies and TV shows on DVDs and Blue-ray discs.

On the other hand, streaming content over the Internet involves the licensing of

rights which are separate from and independent of the rights that the company

Netflix

24 PC Magazine website 2003 <http://www.pcmag.com/article2/0,2817,894278,00.asp>

25 Netflix, Victory for Voices Over Keystrokes http://www.socialtext.net/ism4300/index.cgi?netflix_strategic_advantage

26Appendices

acquires when obtaining DVD content26. Unlike DVD, streaming content is not

subject to the First Sale Doctrine (Netflix’s right to do whatever it desires with a

physical disc). As such, Netflix is completely dependent on the studios, content

providers and distributor providing the company with additional licenses in

order to access and stream content. Nonetheless, having strong relationship

with those studios and content providers, Netflix is in a very strong position in

to acquire the most popular movies and TV shows available for streaming over

the net27.

Netflix Ready Devices

Roughly 50 percent of Netflix members are now instantly watching movies and

TV episodes without commercial interruption, on computers, televisions, and

via game consoles, Blu-ray disc players and other devices that have been on the

market since 200828. The viewing experience is enabled by Netflix controlled

software that can run on a variety of consumer electronics devices (“Netflix

Ready Devices”). These Netflix Ready Devices currently include Blu-ray disc

players manufactured by LG, Panasonic, Philips, Samsung, Sony and may more.

Also customers can stream the content via Internet-connected TVs, digital

video players and game consoles such as Xbox 360, Nintendo Wii, PlayStation

3. Even Home Theatre systems that are “Netflix Ready” enable users to have

Netflix

26 Netflix company 2009 annual report < http://ir.netflix.com/secfiling.cfm?filingID=1193125-10-36181>

27 Netflix company 2009 annual report < http://ir.netflix.com/secfiling.cfm?filingID=1193125-10-36181>

28 http://blog.netflix.com/2010/03/friends-update.html

27Appendices

access to the streaming content only if they have internet feed available 29.

Thus, users do not need to acquire any hardware as long as they have one the

mentioned devices. Netflix elegantly offers convenient and practicality for any

type of customer who may be comfortable using only one of those devices.

Netflix29 http://www.netflix.com/NetflixReadyDevices

28Appendices

INDUSTRY OUTLOOK

The now infamous failure of the music industry to adapt to the digitization and

online distribution of music – and eventual dominance of Apple’s iTunes has

many in the movie business contemplating their future in light of the success of

Netflix. The aforementioned “28 day agreement” that studios have negotiated

with Netflix can only be interpreted as an offensive move to protect future

revenues. While the measures that studios put in place to not commoditize its

business is key to industry outlook, activity in other areas will also shape the

outcome.

STUDIO REVENUE

Historically, studio revenue comes from the distribution of their movies through

a chain of different channels and the importance and value of second rights

(see Figure A2 in Appendix A) has grown over time to produce the kind of

revenues and splits seen in Figure 4 below. Consequently studios will tread

lightly in addressing IDV given the revenues other competing channels provide

to the industry.

Netflix

29Appendices

Figure 4: US Movie Revenues (2009)

The movie industry has been wrestling with where online fits into the

distribution window. Online could follow theatre releases, or alongside DVDs, or

even after TV. With all traditional providers of services for each of these

windows capable of offering online, many models are possible and have been

tried. Placement is key to not only maximizing revenues from the new format

but to minimizing losses from existing ones.30 For example VOD, with its pay-

per-view model and revenue share for studios, makes a far more appealing

proposition for studios than Netflix subscription model and therefore VOD

services are getting access to movie releases earlier. 

According to Telco 2.0, an initiative designed to catalyze change in the

Telecoms-Media-Technology sector, “the problem for studios though is that

once they release a film for rental, any purchaser of a licensed rental copy can

rent it out for whatever price they choose and the same goes for online. Studios

Netflix30 Telco 2.0 http://www.telco2research.com/articles/AN_Netflix-v-Hollywood-telcos-help_Summary

30Appendices

have no control over pricing, just license conditions, such as time, geography

and revenue share.”31

So what can studios do? Should they try and starve Netflix and the likes of

content, compete directly with them by setting up their own online distribution

channels? Needless to say the answers to these questions are of keen interest

to Netflix.

Netflix31 Ibid

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RECOMMENDATIONS

The biggest strategic challenge facing Netflix will be the content agreements

put in place. They key for Netflix will be to reduce the “blackout period” from

when they can release new titles. This is currently difficult given the desire for

the studios to generate revenue from DVD and Blu-Ray disc media sales for

several weeks before releasing their titles to Netflix. However as Netflix’s

subscriber base expands as more customers are exposed to streaming media

from an increasing amount of technology “touchpoints” (TVs, Blu-Ray Players,

laptops, netbooks, tablets, etc), the pressure for the studios to fairly negotiate

will mount. Due to Netflix’s first mover advantage, library, user experience,

wide install base and existing relationships, Netflix is positioned well to

maintain transition from gorilla status in DVDs to the same in the streaming.

SHORT AND MEDIUM TERM RECOMMENDATIONS

Focus on Negotiated Favourable Long Term Content Agreements

• Some acceptance of less desirable terms will likely be required. Because

the content providers could start their own offerings and have several

firms willing to take Netflix’s place, this will be a challenge. Acquisition

or partnership with studios is an option if access to attractive content

grows more difficult.

Netflix

32Appendices

Become Compatible with as Many Devices as Possible

• Large install base (e.g. Windows) can be an effective barrier to entry and

spur retention

• This does increase Netflix risk as it becomes more reliant on partners to

deliver the Netflix experience. This can be a challenge and have brand

image consequences if experience degrades.

Geographic Expansion

• Use current strength to move ahead in new markets leveraging existing

model. Building physical distribution in other markets may be cost

prohibitive – so focus should be on online streaming. Local partners (i.e.

joint ventures) may be a route to market entry if regulations or other

barriers prohibit expansion.

Expand Complementary Assets

• Develop further features / reasons to make leaving Netflix for other

service providers more challenging. Apple has accomplished this through

proprietary file formats for its iPod, iPhone and iPad. Netflix can

accomplish this through existing mechanisms like rental histories,

reviews, recommendations – but may need something more compelling.

Leverage DVD/Streaming Hybrid model in USA

• Mailing current comprise 25% of operating costs this is likely to increase

as shipping fees get more expensive. With margins on content Netflix

33Appendices

squeezed, phasing out some distribution (perhaps in exchange for longer

delivery times) may be necessary as more users get access to films via

streaming. This will have to be timed properly. Speed of delivery is a

differentiator for Netflix so changes should be considered carefully.

Other competitors cannot imitate delivery efficiency – so Netflix should

not exit the business too soon.

LONG TERM RECOMMENDATIONS

Key to long term growth when subscription growth flattens will be leveraging

the installed based – both in terms of subscriber population and devices - to

enter other business. This strategy may provide attractive growth prospects for

Netflix. Netflix’s core-competencies and complementary assets may provide

the path for extension into other physical / digital mediums that may work on a

subscription basis; the most notable being video games, books and even music.

THE BET

In the 5 years heading into 2010 Netflix has experienced great growth with

subscribers tripling, revenues up 20% on a compounded annual basis, profit

23% and a market cap of US$6.2 billion32. Even those that invested in the

company as recent as January 2010 would have doubled their money by July

2010. So what room is left future investors? Netflix’s prospects for growth are

high for the following reasons:

Netflix32 On July 12, 2010

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• They have not expanded geographically (Canada, Europe, Brazil, Russia,

India, China)

• Smartphone and tablet sales projected to increase as legitimate platforms

for consumption of video

• Mobile network speeds improving for mobile devices (4G networks, etc)

• Increased number of Netflix-enabled devices being released by various

device manufacturers

• Entry into complementary business (books, video games) a possibility

Investment

The recommendation is a “medium” size investment in Netflix with funds ideally

distributed as depicted in Figure 5. Because of the high number of competing

firms and potential content challenges in the IDV industry a “large” investment

cannot be recommended.

Figure 5: Distribution of Investment Funds

Netflix

35Appendices

Netflix

36Appendices

APPENDICES

APPENDIX A: MOVIE RELEASES

Figure A1: Film Release Windows (Source: www.flatworldknowledge.com/pub/gallaugher/

41141)

Figure A2: Film Release Model (Source: Telco 2.0)

Netflix

37Appendices

APPENDIX B: INDUSTRY

Figure B1: US Subscription Home Entertainment Market Size (Source: PWC 2009)

Porters – Video on Demand

Buyer Power – In this case, the buyer would be the end-user utilizing the

Netflix service (either the “DVD by Mail” model or “Streaming model”). The

buyer does have a significant amount of power in this relationship, as there are

many other digital alternatives for them to consume the same media that

Netflix provides, meaning there are very low switching costs for the end

consumer to try “other” DVD rental services (i.e. Blockbuster, or another

streaming service, i.e. Blockbuster Online, Amazon Online, Vudu, etc).

Threat of Substitutes – The threat of substitutes is increasingly growing, as

more and more people are realizing the future of broadband media. While the

Netflix

38Appendices

“DVD by mail” business model that served as the foundation of Netflix in the

early years slowly fades, Netflix has successfully transitioned into the streaming

media model, and by doing so first has established a first-mover advantage

that makes it difficult for pure substitutes to compete. Technically speaking,

many substitutes exist to both their business models. In Canada, Zip.ca

replicates Netflix’s “DVD by Mail” model to Canadian consumers. In terms of

media streaming, many companies in the US are also offering streaming media

services similar to Netflix, making anyone of them a substitute threat for

Netflix.

Supplier Power – In this case, the suppliers for Netflix would be the movie

studios granting them the rights to stream their content via their service. Of

course, there is the imminent fear from these studios that by providing their

content to Netflix, they are cannibalizing their own DVD/Blu-Ray title sales

through regular distribution channels. This would lead one to believe that the

Hollywood studios do carry much of the power in this relationship, which is true

to some extent. Don’t forget that the “DVD by Mail” business is profitable for

the studios as well, so even while the model is transitioning, there are still

positive relationships between Netflix and many of the Hollywood movie

studios. Overall, this “upper hand” that the movie studios perceive to have is

slowly eroding and shifting into the hands of Netflix for the following two

reasons:

Netflix

39Appendices

1. Lessons learned from the “Apple iTunes model” – whether the studios like it or not, movie and television content is being consumed online in a big way, growing more and more as each day passes. Some could say that they days of fixed disc content like DVD, and even Blu-Ray are numbered. After seeing the challenges that their big music label neighbours fell victim to in the music industry, many Hollywood movie houses like Warner Brothers are much more willing to get ahead of this inevitable trend and work with Netflix on this streaming service. Just as iTunes proved to the world that there was a market for legally downloadable music for a fair price, Netflix seems to feel the same way for streaming TV & movie content, and so far their business growth is proving them right.

2. The Gorilla That is Netflix – At some point, even those movie studios that first resisted the “streaming” model cannot ignore the impact and power that Netflix has in the video streaming market. By the nature of sheer “industry peer pressure” combined with not wanting to be the few that have not joined Netflix’s streaming vision, the transition of “Buyer Power” is slowly but surely transitioning for the big movie studios and into the hands of Netflix as a pure result of their “Gorilla” status in the “DVD by mail” and “Streaming” markets.

Threat of New Entrants – As the streaming video market heats up, it will

inevitably draw a crowd of competitors. The big competitors to date in the

streaming business have been Blockbuster, Vudu (which is now owned by Wal-

Mart), Cinema Now, Hulu and Hulu+, and Amazon.com. While this list of

competitors is formidable in both brand reputation and size, none of the

competitors combined end-user base matches the total number of end-users

(12.3 million) that Netflix currently has on record. (Netflix, 2010). Netflix’s first

move advantage, combined with their proprietary streaming technology, wide

platform base, and user-friendly interface have all created a substantial

competitive advantage that has served to suppress its nearest competitors..

Netflix

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They currently offer over 15,000 titles for the rent-by-mail side of the

business, and over 30,000 titles available for their streaming business.

APPENDIX C: COMPETITION

Figure C1: Video-on-demand Competitive Map (Source: Netflix 2.0, Slideshare)

Netflix

41Appendices

Figure C2: Video-on-demand Product Comparison (Source: Netflix 2.0, Slideshare)

Figure C3: Netflix video-on-demand offering (Source: Netflix 2.0, Slideshare)

Netflix

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Figure C4: Product Portfolio / BCG Matrix (Source: Netflix 2.0, Slideshare)

Netflix

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APPENDIX D: TECHNOLOGIES

Technology Life Cycle

Stage NotesEmerging/Pacing N/AKey • Streaming technology (e.g. codecs)

• Recommendation and merchandising algorithms

Base • High Speed InternetTable D1: Technology Life Cycle

Evolution and Adoption

Figure D1: Technology Evolution (“S” Curves”) and Adoption

Netflix Product Evolution

Figure D2: Netflix Product Evolution (“Bowling Alley”)

Netflix