ISOM 310 Netflix Case
Netflix 2013 Case: Online Video Matures
In the 1980s and 1990s, people joked about how difficult it was to program a VCR to record a
television program. Products like TiVo and other DVRs (digital video recorders) made it easy
for consumers to record broadcasted shows and movies. Today, consumers have a wide variety
of options in satisfying their desire to watch movies and TV shows. They can rent DVDs and
video games from traditional brick and mortar video stores, such as Blockbuster. Cable TV and
Satellite TV companies offer premium subscription channels (such as HBO) for a monthly fee,
as well as, video-on-demand services. There are other options for those with broadband Internet
connections, such as programs that store entertainment and redirection devices (like
Slingboxes1). Consumers also can rent or purchase DVDs, Blu-ray discs, and video games at
video rental stores, vending machines (like Redbox2), and also can purchase them at electronic
stores (such as Best Buy), discount stores (such as Target), or on the Internet (Amazon and
Apple, plus many others). In addition, there still is much illegal file sharing of copyrighted
digital content. Today, when consumers want to watch a particular movie at any particular time,
they have many options.
The U.S. movie "rental" industry has changed. Direct online distribution of content (whether by
real-time streaming or downloading for playback) has replaced physical media as the normal
method3. Even traditional DVD retail companies like Wal-mart and Target are getting into the
digital streaming business4. In addition, many laptops and almost all netbooks and ultrabooks
today are being shipped without an optical playback device (i.e., one that can play a CD, DVD
and/or Blu-Ray). Obviously, the same is true for smartphones and iPods. In addition to those
mentioned above, there also are additional options for receiving digital streaming entertainment,
including Internet-enabled TVs, set-top boxes (like Boxee5), game consoles, computers, and
readers like the Kindle or Nook. Nonetheless, as of 2010, eighty percent (92 million) of all U.S.
households still had at least one DVD or Blu-ray player, leading many to believe the DVD
business will retain demand and some profitability for several years to come.6
New Competitors and Content
Numerous companies now compete in the shrinking DVD and video game rental industry. Dish
Network purchased Blockbuster out of bankruptcy and, in early 2012, has closed 500 of the 1500
remaining stores. Blockbuster, the largest video rental chain in the United States, has launched a
variety of initiatives to provide online DVD and game rentals. Dish Network limited the
customer base of the current streaming service to pre-acquisition customers and Dish Network
subscribers. Recently, Samsung announced (February 20, 2012) a deal with Blockbuster to
stream thousands movies to the company's smartphones, tablets, ultrabooks, laptops, smart TVs,
1
www.slingmedia.com
www.redbox.com/
3
http://www.nytimes.com/2011/03/06/movies/homevideo/06dvds.html?pagewanted=all&_r=0
http://mashable.com/2012/04/20/streaming-video-dvd-infographic/
4
http://www.digitaltrends.com/home-theater/target-preps-digital-movie-rental-service-for-launch/
5
www.boxee.tv
6
www.homemediamagazine.com/research/physical-media-study
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ISOM 310 Netflix Case
and Blu-ray players. Wal-Mart, the world’s largest retailer, briefly offered its own DVD rental
service and now partners with Netflix. There is also Redbox, with its $1.20 per night rentals
(increased from $1 on 10/31/2011). In 2012, Redbox and Verizon announced a partnership for
providing a movie streaming business. The streaming video business is dynamic, with new
partnerships and companies continually emerging.
History of Netflix
Netflix Inc. was founded in 1997. According to founder Reed Hastings in 2001, “It probably
looks easy to imitate Netflix, but it's quite difficult to get all the details right that matter to a
consumer. We've put four years' effort into building our service.” Hastings, an experienced
entrepreneur with a successful track record of managing start-up companies, stated that his
experience in paying a hefty $40 fee for an overdue video led him to question why a video store
did not work like a health club, where members pay a fixed monthly fee. The term, “subscriber”
is the key to Netflix’s unique idea. Originally, movie and game aficionados subscribed to
Netflix service paying a monthly fee for the DVD delivery service. Although there were several
subscription plans available, the basic plan was $7.99 per month, giving customers access to
DVDs via snail mail, on a one-at-a-time basis with unlimited rentals per month.
Here’s how it worked. A subscriber of the Netflix DVD-in-the-mail service created a list of
DVDs that s/he wanted to rent from the Netflix library containing more than 40,000 titles. An
online recommendation engine assisted subscribers in making their selections. Then, Netflix
would send to the subscriber, his or her top three DVD choices by mail, eventually, depending
on which plan was subscribed and what was available. The subscriber could keep the DVDs as
long as s/he wanted without any late fees (but, the subscriber could not possess more than 3
Netflix DVDs at a time). Whenever the subscriber sent one back, s/he was eligible to receive
another. The subscriber returned the DVDs using pre-paid mailing envelopes provided by
Netflix. In exchange, Netflix mailed the next top choice(s) of DVDs on the subscriber’s list,
usually within 1 to 2 days of receiving the returned DVDs. The cost of shipping was included in
the subscription price. On average, the company shipped 1.9 million DVDs a day (in 2010).
An “on-demand” service was added in 2007 allowing the customers to view movies immediately
on their PCs or Macs. In 2008, this service was enhanced to allow subscribers to instantly
stream movies and TV shows on their TV though Netflix-ready devices, such as Internet-enabled
Blu-ray players or Microsoft’s Xbox 360. As of 2010, Netflix streaming became very popular,
in part because the service was bundled in the flat-rate monthly subscription charge. Netflix’
streaming choices were ever growing, with over 17,000 items available in Netflix’s “Watch
Instantly” library (in 2010). Netflix-ready devices (both set-top boxes and Internet-ready TVs)
also have expanded, covering the market with multiple streaming-ready gadgets. As of 2010,
Netflix offered 12 million subscribers over 100,000 movie choices (in contrast, a typical video
rental store offers an average of 500 DVD titles and many fewer in a Redbox). This was Netflix’
mode of business until the middle of 2011.
In mid-2011, Netflix changed its marketing and pricing strategy. First, Netflix divided the
company into two business units and renamed DVD-by-mail service to Qwikster. Customer
outrage made them reverse this naming decision but not the new pricing. Now, there is a
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ISOM 310 Netflix Case
separate monthly fee for each service (DVDs by mail or streaming). Second, Netflix changed
their focus from DVD-by- mail to streaming. The default free trial memberships and new
memberships are for streaming only. DVD-in-the-mail service can be added for $7.99 and, for
an additional $2.00 per month, Blu-ray discs are included. As of the end of 2011, the number of
streaming subscribers was double that of the DVD-in-the mail subscribers. Netflix is set to
continue to expand its streaming business, while the number of DVD subscribers will continue to
decrease. The future is about streaming. As mentioned earlier, many are forecasting the demise
of the DVDs and Blu-Ray disks.7 Nevertheless, how to evolve remains uncertain. Netflix’s new
strategy was devastating to market share (see chart). They had to reverse their decision
ultimately.
Figure 1 Netflix Share Price 2003-2013
Netflix Current Strategy
Netflix currently operates in the United States, Canada, and Latin America. In 2012, it began
services in the United Kingdom and Ireland with plans for more international expansion.
International expansion requires new content such as non-English movies, international
television shows, and providing movie subtitles in more languages.
The company has contracts with nearly 100 movie studios and distributors to supply the
company with content titles. Netflix receives a digital file of a movie and is licensed to produce
the physical DVDs and/or to deliver by streaming. As of 2010, Netflix has purchased
approximately $100 million worth of titles from these suppliers, placing Netflix as one of the
studios’ largest customers. Netflix needs constantly to license new content from its owners (i.e.,
movie studios, HBO, etc.). Unfortunately, this strategy is risky. Some famous failures include
Netflix’s loss of the Starz content in May 20138.
Unique to Netflix is its extraordinary recommendation system, Cinematch. Cinematch is an
algorithm built into the servers that uses customer data to personalize a subscriber’s movie
7
See http://www.kwch.com/kwch-tech-talk-blog-netflixs-je-ne-sais-quoi-20120125,0,6520302.story and
http://www.kwch.com/kwch-tech-talk-are-dvds-really-dying-netflix-says-yes-redbox-says-no20120207,0,6188610.story.
8
http://www.dailymail.co.uk/news/article-2317467/Netflix-losing-nearly-2-000-movies-streaming-serviceWednesday-including-James-Bond-Woody-Allen-titles.html
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ISOM 310 Netflix Case
rental/viewing experience to a degree previously not possible. This personalized service
observes what people watch and browse through online logs. It also asks the customers to rate
movies using a 5-point rating scale with ratings of hated it to loved it. Netflix’s Cinematch
recommendation system displays other titles that the subscribers might enjoy based on statistics
calculated in the background. Recommendations drive about 60% of all selections (2008)9.
Netflix has accumulated over 300 million ratings in a database (2010), with more than 1 million
ratings added each day, more than any other competitor. This database provides Netflix with
deep insights into subscriber preferences for movies. In 2006, Netflix started a contest to
improve their movie rating and recommendation system. The grand prize of one million dollars
was captured in 2009 by "BellKor's Pragmatic Chaos", who improved Cinematch's results by
10.6%. A follow-up contest was started and promptly cancelled due to lawsuits. From the
customers’ perspective, this system could perhaps be improved with a better user interface and
by providing more or different information.
The company’s highly sophisticated and integrated purchasing, merchandising and logistics
software supports all aspects of its operations. For example, Netflix optimizes its licensing of
content by using demand forecasts based on analysis of subscriber preferences. To manage
inventories and logistics, Netflix has 30 (up to 58 in 2009 through 2011)10 regional shipping
centers located throughout the U.S.; 80% of subscribers are able to receive their DVDs in 1 to 2
days (after Netflix gets a returned DVD). Netflix can handle more than 2.5 million shipments
per week – more than almost any other e-commerce company (2010). Subscriber feedback in
2003 suggested that occasional system glitches result in delayed or wrong deliveries for some
customers. Additionally, analysts reported (when) that customers’ complaints sometimes went
unanswered or not handled in a timely manner.
Netflix is not without critics. It turns out that the service “rewards” customers with the fewest
monthly rentals, in terms of popular movie availability and promptness of shipping, and
“punishes” those with the most turnover. This policy is spelled out in the company’s terms of
service, published on the Netflix Website. In 2004, the policy caused a “frequent” Netflix
customer to sue the company in a class-action lawsuit titled Chavez v. Netflix, Inc.11 The
plaintiff in the case, Frank Chavez, claimed that Netflix’s claims that a subscriber could rent
“unlimited” DVDs each month and receive them “in a day’s time” were false. Although Netflix
denied any wrongdoing, they settled the suit in 2005. Chavez received $2,000, and his lawyers
got over $2.5 million.
The most valuable recent innovation at Netflix is the addition of their own production studios to
create their own TV shows, such as House of Cards, which won an Emmy award in September
2013, causing some analysts to believe the fundamentals of TV production and distribution are
now in question12. The rebound of Netflix’s stock following their Quickster mistake is largely
explained by the emergence of this new TV domain. With their own content, there is no risk of a
Starz contract collapse happening again. One might wonder how Netflix knows which TV shows
to produce in house. Interestingly, reports suggest that they follow online pirates to understand
9
See http://www.nytimes.com/2008/11/23/magazine/23Netflix-t.html?pagewanted=all
http://www.hackingnetflix.com/2009/05/netflix-opening-new-central-operations-center-in-grove-city-ohio.html
11
http://arstechnica.com/old/content/2006/01/5951.ars
12
http://online.wsj.com/article/SB10001424052702303759604579092061505560526.html
10
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ISOM 310 Netflix Case
which discontinued shows have loyal followings13. So far, this approach has led to a large
increase in subscriptions.
Netflix Future
Netflix added 1080p high definition and 5.1-channel surround sound to their streaming video
content.14 In 2010, analysts predicted that by mid-2011, two thirds of subscribers would be
watching Netflix content through online streaming. This prediction proved correct. Netflix is
already expanding internationally and increasing its TV show production and catalogs. Their
movie rental business is stable. But, investors demand increasing growth and promising new
strategies. Think about what sorts of innovations are coming in consumer preferences and
capabilities as well as information and online technologies. What’s next for Netflix?
Assignment
This assignment has you practice and demonstrate a critical analytical and communications skill required
of business analysts and consultants related to the emergence of new technology and information systems
opportunities. The basic concept is that you are expected to analyze Netflix in terms of future possibilities
and prioritize key recommendations to include in a short memo to Reed Hastings, the CEO. That memo
needs to justify your recommendations based on clear logic and evidence. To aid you in completing this
activity, you may want to search online and read articles about the film and TV industries as well as
emerging consumer preferences and technology for entertainment. Think about Netflix’s core capabilities.
Can they be repurposed into other domains as profitable products or services?
Instructions
Complete this assignment individually. You must submit this
assignment in Blackboard. Your job is to write a business
memorandum (“memo”) to the Netflix strategic planning
committee. (Memos are a standard business format you need to
know and learn. Templates are available in MS Word. See the
Writing Center to learn more about this format and how to
structure it.)
In your memo recommend a future direction for Netflix. In this description, be sure to address:
1. Identify at most two key forces among Porter’s Competitive Five Forces model that Netflix needs
to focus on. Analyze the market situation in relation to this/these force(s) to illustrate clearly why
this/these force(s) are important right now.
2. Next, identify one or more key strategic information technology innovations Netflix should adopt.
Explain how Netflix could use your recommended innovation(s) to counter their competitive
force/forces identified in (1) and create strategic advantages.
This double spaced memo should be no more than 550 words. You will be graded on the content, as well
as, the quality and clarity of your recommendations. Format, grammar, spelling, and punctuation should
be professional.
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14
http://torrentfreak.com/netflix-uses-pirate-sites-to-determine-what-shows-to-buy-130914/
http://www.cepro.com/article/netflix_1080p_timeline_when_will_it_come_to_ce_devices/
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