Some thoughts on Netflix

August 5, 2009

After our class discussion regarding Netflix and its success, I became interested in learning more about Netflix business strategy. In this short analysis, I will discuss Netflix current status, how Netflix may respond to the challenges of Blockbuster’s reaction to its popularity, and how it is adapting to the growth in popularity of streaming video websites.

Netflix Summary

Netflix was created after Reed Hastings, the founder, had to pay $ 40 in Blockbuster late fees for Apollo 13. The company was launched in September 23, 1999 (Raman, 2009). In 2000, Netflix offered to sell a majority stake in the company for a US$ 50 million investment from Blockbuster. The Blockbuster executives rejected the offer, and instead signed a 20-year exclusive deal on video on demand with Enron (Harris, 2008).

In 2003, Netflix patent was granted and it began functioning on a new business model.  Chang (2008) explains that in the conventional model customers go to the store, select movies, take them home, and have to return them by a particular date or be charged a late fee. The Netflix model allows customers to pay a fixed monthly fee, create a queue, and order from the Internet.  According to the researchers Sunil Kumar, Achal Bassamboo, and Singh Randhawa, who studied this type of rental system through a mathematical model, Netflix became a great success because it didn’t create deadlines for the movies.  They also found out that the company needs to stock only a small quantity of the total demand for any video and offer a good service. The success of the model depends on the fact that Netflix customers cannot rent another movie if they don’t return one. The researchers also point out that the customers’ wish lists give the company real insight of the movies that the customers want.

In 2008, the company was worth US$ 1.9 billion while Blockbuster was valued at US$ 345 million (Harris, 2008). Presently its 10th year, Netfilx has delivered 2 billion movies and it has approximately 10 million subscribers. Besides the now traditional online rental and paid delivery, the company is also streaming videos on its website, through Xbox 360, TiVo, and Samsung Blu-ray disc players (Raman, 2009). According to the company’s website, Netflix has approximately 100,000 titles while a neighborhood video store has only 3,000.

Blockbuster after Netflix

As Netflix expanded, Blockbuster decided to drop late fees, but it had a tremendous impact on profitability because those fees accounted for 16% of its revenue (Harris, 2008). Blockbuster has a storefront business model, which requires the company to rent relatively expensive locations in strategic neighborhoods, while Netflix can utilize distribution centers in industrial areas. As competition became more intense Blockbuster had to close approximately 2,300 stores between 2005 and 2008.

In 2009, Blockbuster announced its plans to partner with 7-Eleven, the United States’ largest convenience store chain.  The goal of the partnership was to create “destinations”, where everybody could rent a DVD and even buy electronics gear, while at the same time Blockbuster.com begin featuring plenty of content to be downloaded or streamed. Staff at those destinations would also help customers learn how to download a movie or stream a video. What Blockbuster did was diversify sales to compete with Netflix (Nash, 2009).

In addition to the competition with Netflix, Blockbuster also has to worry with the growing trend of video on demand, file-sharing services, Wal-Mart, which is responsible for 37% of all U.S. DVD sales, and also cable companies that are promoting Personal Video Recorders.

Netflix and the future

In an article in Business Week, Albretch (2009) mentions that more people are watching streaming videos on Netflix during the American economic crisis. The CEO Reed Hastings affirmed that millions of subscribers are utilizing this service and renting fewer movies; they called it the “substitution effect.” Hastings emphasized that with streaming videos subscribers have instant gratification, and he was very positive about it.

We already know that there is a trend in favor streaming videos with the success of YouTube, Hulu, Vimeo and other streaming video websites. According to a study released by comScore in January 2009, US internet users viewed 12.7 billion online videos during November 2008 alone. Can the streaming video business ruin the perfect mail delivery business of Netflix, and what is Netflix doing to adapt its own business model?

On the positive side, Netflix subscribers need to pay at least the minimum subscription plan to be able to access the streaming videos catalogue. Besides, the transition to streaming video will be gradual. Even though the United States have a high percentage of Internet users – if I am not mistaken, it accounts for over 70% of the population, many people, including myself still have problems watching long streaming videos: the Internet connection may be too slow, ISPs don’t provide reliable service, and technical glitches and compatibility issues can be very irritating. There are some infrastructural problems that restrain the substitution of online videos for DVDs.

On the negative side, Netflix has built a very complex and efficient mailing system, as we discussed in class, with its perfect envelopes that costs the minimum postage price and made with a color that called people’s attention to minimize losses. By introducing and increasing the number of online titles, they are making their own primary business obsolete. One may argue that Netflix business would become obsolete anyway, as far as streaming video continues to grow.  However, Netflix is not fully adapting its business in a way it would allow it to maintain its profit if it transitions entirely to streaming videos. Netflix is allowing users that pay cheaper subscription plans to watch as much content as they want, making their tiered pricing model unworkable. Also, although Netflix is driving more and more people to its website, it does not make good use of the page views: there are no ads on the website or in the videos, and there is no access control – you could definitely give your username and password to your mom and she could watch videos without paying the subscription.

I believe that Netflix will continue to lead the video rental market until other streaming video sites, such as Hulu, become more compelling competitors. Although Blockbuster is launching several initiatives to attract more consumers to the “destination kiosks”, I don’t see how a physical fixed location can be more convenient than the Internet and why Netflix subscribers would switch to this model. I also think that people pay Netflix because of the convenience of the mailing system, no late fees, and because many titles are not available for free on websites that offer the service. If other websites are able to add more titles supported by ad revenues, people who seek instant gratification will definitely go there. Of course Netflix will have great opportunities to profit using the information it has been gathering on its queues and its customers’ habits, which is another advantage over Blockbuster. They could use that information to create more engagement on its website and earn revenue with ads, or add features to allow friends to watch the same movie simultaneously and share comments, they could perhaps create online movie sessions with more people, they could charge for these private online movie events, and of course they could guarantee satisfaction by having pretty much any title that people want to see.  I truly believe Netflix has been a tremendously innovative company, but I have not yet seen evidence that they are adapting to switch to streaming online content. It would be sad to see a company like Netflix become another lost website on the Internet.

References:

Albretch, C. (2009, February 6). Netflix: It Feels Like the First Time. Business Week. Retrieved from http://www.businessweek.com/technology/content/feb2009/tc2009025_446813.htm

Caddell, J. (2009, February 11). Frontiers of innovation – Netflix demolishes own business model. Message posted to http://caddellinsightgroup.com/blog2/2009/02/frontiers-of-innovation-netflix-demolishes-own-business-model/

Chang, H. (2008, April 16). Netflix Broke the Rules and Won According to Stanford Business School Research. Reuters. Retrieved August 3, 2009, from http://www.reuters.com/article/pressRelease/idUS218079+16-Apr-2008+BW20080416

Emarketer. (2009, January 15). Online Video Growth Continues. Retrieved August 3, 2009, from http://www.emarketer.com/Article.aspx?R=1006868

Harris, J. (2008, July 10). A Blockbuster no more. Backbone Magazine. Retrieved from http://www.backbonemag.com/Magazine/Big_Ideas_07100801.asp

Nash, K. (2009, February 11). How Blockbuster Plans to Beat Netflix. CIO News. Retrieved August 3, 2009, from http://www.cio.com/article/480474/How_Blockbuster_Plans_to_Beat_Netflix

Raman, R. (2009, April 2). Netflix Net Numbers: 10 Years, 2 Billion Movies. Message posted to http://myfunbox.wordpress.com/2009/04/02/netflix-net-numbers-10-years-2-billion-movies/

Rappa, M. (May 2008). Case Study: Netflix. Retrieved August 3, 2009, from http://digitalenterprise.org/cases/netflix.html

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