Information Systems: A
Manager’s Guide to Harnessing
Technology, version 2.0
John Gallaugher
© 2013, published by Flat World Knowledge
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Published by:
Flat World Knowledge, Inc.
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© 2013, published by Flat World Knowledge
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Chapter 4
Netflix in Two Acts: The Making of
an E-Commerce Giant and the
Uncertain Future of Atoms to Bits
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Learning Objectives
• Understand the basics of the two services operating
under the Netflix business model
• Recognize that the firm has experienced wild swings
in market perception and stock performance as it
attempts the difficult transition from relying on a
model that may soon be obsolete to one that may
hold promise for the firm’s long-term viability
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Introduction
• Netflix started as a DVD rental business
– Known for best-in-class service
• Netflix rightly surmised that digital streaming is the
future
• Firm was split into two
– Internet based streaming services
– Traditional DVD by mail services
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Introduction
• Transition from a DVD based service to Internet
based video streaming business resulted in:
– Drop in customer base
– Drastic fall of share prices
• To bring back profits, the firm:
– Aggressively expanded the firm’s customer base, both
domestically and internationally
– Sponsored the creation of critically acclaimed, original
content
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Learning Objectives
• Recognize the downside the firm may have
experienced from an early IPO
• Appreciate why other firms found Netflix’s market
attractive, and why many analysts incorrectly
suspected Netflix was doomed
• Understand how many firms have confused brand
and advertising, why branding is particularly
important for online firms, and the factors behind
Netflix’s exceptional brand strength
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Learning Objectives
• Understand the long tail concept, and how it relates
to Netflix’s ability to offer the customer a huge
selection of movies
• Know what collaborative filtering is and in what ways
this software helps Netflix garner sustainable
competitive advantage
• Describe the sources of Netflix’s size advantage in
the DVD-by-mail business, and how this large scale is
a difficult-to-create asset for any start-ups trying to
compete in DVD-by-mail
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Learning Objectives
• Understand the role that scale economies play in
Netflix’s strategies, and how these scale economies
pose an entry barrier to potential competitors
• Recognize how Netflix built a data asset and why this
asset was so valuable in the firm’s original business
model
• Understand the role that market entry timing has
played in the firm’s success
© 2013, published by Flat World Knowledge
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Netflix: Going Public
• By going public, Netflix had to disclose its financial
position
– Resulted in two big competitors entering the market
• Blockbuster and Walmart
• Netflix maintained its lead in the market having:
– Constant customer and revenue growth
– Record profits
– Rising stock price
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Brand Strength
• Brands are built through customer experience
– Walmart and Blockbuster could create brand
awareness but couldn’t translate that into an industry
advantage
• Netflix remained segment leader as it had:
– An early market entry
– Effective execution
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Scale from the Distribution Network
and Selection
• Netflix’s nationwide network of automated
distribution centers collectively delivered DVDs
overnight to a large percentage of the population
• Netflix’s advantage came from the scale of the firm’s
entertainment selection
• Long tail: Large selection of products or content
beneficial for Internet retailers
– Selection attracts customers
– Internet allows large-selection inventory efficiencies
that offline firms can’t match
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Figure 4.1 - The Long Tail
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Customer Base
• Scale economies can be attained by leveraging the
cost of an investment across increasing units of
production
• Having a bigger customer base enabled a firm to:
– Have better cost structure
– Have better profit prospects
– Offer better pricing
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Leveraging the Data Asset
• User data can be leveraged to provide better
customer experience and build brands
• Netflix uses a proprietary recommendation system
called Cinematch
– Cinematch - Software technology known
as collaborative filtering
• Collaborative filtering: Classification of software that
monitors trends among customers and uses this data to
personalize an individual customer’s experience
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Leveraging the Data Asset
• Data provided by Cinematch is a switching cost
– Churn rate: Rate at which customers leave a product
or service
• Advantages of Cinematch
– Netflix could tailor recommendations based on
availability of products
– Studios found an audience for their back catalog of
movies and television shows
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Learning Objectives
• Understand the shift from atoms to bits, and how
this is impacting a wide range of industries
• Identify how digital products differ from physical
products and specify how the streaming business is
substantially different from the DVD-by-mail business
• Know the methods that Netflix is using to attempt to
address these differences
• Understand how the “First Sale Doctrine” applies to
physical versus virtual products
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Learning Objectives
• Understand key terms such as windowing, fixed
versus marginal costs, and bandwidth caps
• Discuss how Netflix is attempting to create
competitive advantage through catalog offerings
despite not being able to secure a longest tail
• Identify opportunities for Netflix to further
strengthen and leverage its data asset, and detail
how the asset can offer the firm competitive
advantage
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Learning Objectives
• Understand that while scale in DVD-by-mail differs
from scale in streaming, some scale advantages may
be achievable
• Recognize how Netflix made streaming widely
available on products offered by many different
consumer electronics firms and why the Netflix
approach offers advantages over offerings from
Apple or other consumer-electronics firms
© 2013, published by Flat World Knowledge
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Learning Objectives
• Identify the major issues driving what is widely
considered to be a disastrous rollout and recall of the
Qwikster service, and intelligently discuss options
that may have limited the fallout in transitioning the
firm’s business
• Describe crowdsourcing and discuss the positive
benefits from code contests that Netflix has
conducted
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Atoms to Bits
• Idea that many media products are sold in containers
for bits
• Shift from DVD-by-mail to the streaming business
poses new challenges for Netflix
–
–
–
–
–
Content availability
Content acquisition costs
Potential opportunities for revenue and expansion
Potential partners
Competitors and their motivation
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Content Acquisition
• First sale doctrine - Ruling that states that a firm can
distribute physical copies of legally acquired
copyright-protected products
– Allows firms to lend or rent products
– Applicable only to the atoms of the physical product
and not to the bits needed in streaming
• Windowing - Content is available to a given
distribution channel for a specified time window
– Under a different revenue model
© 2013, published by Flat World Knowledge
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Figure 4.3 - Film Release Windows
© 2013, published by Flat World Knowledge
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Original Content
• Netflix is combating rivals with exclusive content by
offering exclusive content of its own
– Acquiring or developing original content is an
expensive proposition
– It can give a firm exclusive first-window streaming
rights
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Streaming and the Data Asset
• User data is used to:
– Make accurate recommendations
– Improve user interface design
– Help the firm determine the appropriate cost for
acquiring content
– Shape creative decisions in original program offerings
– Make better content investments
– Inform the original content investments that Netflix is
making
– Create ultra-tailored audience promotions
© 2013, published by Flat World Knowledge
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Figure 4.4 - Top 100 Most Popular Movies and Television Shows
on Netflix and Their Availability on Major Streaming Competitors
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Getting Netflix Everywhere
• Netflix wanted its content to be available on
television
– Set top box was developed, but wasn’t practical
enough
• Software platform was developed and made
available to manufacturers
– Made it easier to build apps
– Allows it to be baked directly into consumer
electronics products
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Risks Involved With Streaming
• Streaming based business needs a robust and
reliable infrastructure
• Internet service providers (ISP) are placing
bandwidth caps
– Bandwidth cap: Limit imposed by the ISP on the total
amount of traffic that a subscriber can consume
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Future of Netflix
• Shift from atoms to bits is a hybrid transition taking
place over several years
– Quick shift - Loss of customers
– Slow shift - Rivals move into the market
• Options to stay afloat
– Grab compelling content at manageable costs
– Broaden distribution options
– Grow its customer base
• Lock them in with the switching costs created by
Cinematch
© 2013, published by Flat World Knowledge
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Netflix DVD-by-Mail versus Streaming
Netflix DVD-byMail
Netflix Streaming
Content acquisition
costs
Fixed
Variable and increasing
Competitors
Mostly vanquished
Many with different
models
Competitor motivation
Market has little appeal
for new entrants
Maturing tech firms
see
It as a growth market
Plans
Fixed price per month
Unlimited monthly
subscription
Innovation
Very limited
Opportunities for new
content and revenue
models
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Netflix DVD-by-Mail versus Streaming
Availability
Netflix DVD-byMail
Netflix Streaming
Any DVD that can be
purchased
Limited to what studios
license
Delivery infrastructure Tough to duplicate
Currently uses public
cloud
Delivery to
Any device with a
DVD player
Any network-connected
screen with a Netflix
client
Global expansion
Expensive to replicate
infrastructure
Can be served from the
cloud
Market outlook/
challenges
Mature and likely to
decrease
Growing but highly
unpredictable
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