Netflix: A Case
Analysis
By Mercedez Lemieux
October 15th, 2012
An Overview of Netflix
Netflix offers a variety of product services to its customers. The company offers
traditional DVD rental by mail, instant streaming of DVD content through home PCS, and
streaming on Netflix-ready devices that could be hooked up to one’s TV. Netflix has a
subscription based model, which allows customers to utilize their products/services through a per
month fee rather than a pay as you go rate. Although the company offers eight different
subscription packages, it derives its largest revenues from its $8.99, $13.99, and $16.99
subscription plans that include unlimited DVDs per month, 1-3 titles out at one time, plus
unlimited streaming of online content.
The Netflix Strategy
Netflix’s strategy so far has been to focus on not just one or two aspects of their customer
base, but to focus themselves in a number of directions in order to build upon and capitalize on a
growing subscriber base. Their main strategy has been to build and maintain the most
comprehensive selection of DVD titles in the industry, and they have done so by creating
mutually beneficial relationships with a number of entertainment video providers. Their second
main strategy has been focused on product differentiation- not only how customers receive
content and consume it, but also how customers choose what to watch. Netflix’s number one
competitive advantage is their unique software that takes what a customer has seen or rated, and
based upon that information builds a list of suggested titles similar to ones they have just
watched. While other companies like Blockbuster had begun to leak into the rent-by-mail niche
category that Netflix had started, no other company had customer profiling software quite like
Netflix.
U.S. Movie, TV, & Video Game Rental Market (2006-2009)
Consumer Movie Rental
Market Revenue ($
million)
In-store Rentals
Vending Machine Rentals
By Mail Rentals
VOD (cable, digital, &
2006
2007
2008
2009
$7,030
$6,215
$5,674
$5,118
79
198
486
917
1,291
1,797
1,949
2,114
993
1,077
1,365
1,684
subscription)
Between 2006 and 2009, the film rental market underwent a major shift. The in-store
rental market declined by nearly $2 million, while vending machine rentals increased tenfold and
by-mail rentals nearly doubled. However, VOD services through cable, digital, and subscription
also saw major increases. All of these changes meant companies like Blockbuster and Movie
Gallery had to either reorganize and make a complete business model shift- or face bankruptcy.
Meanwhile, the increases in by-mail rentals and VOD subscription, two services that Netflix
offered, meant that the number of Netflix subscribers more than doubled in that same time frame.
Purchase decisions from customers were focused on convenient access, price, variety of DVD
offerings, ease of return/return fees. Therefore, the key success factors within the U.S. DVD
rental industry were quickly becoming:
1) A variety of distribution channels (mail, online streaming, streaming to TV, vending
machine, etc)
2) Superior video libraries (including new releases, classics, hard to find)
3) Little to no fees associated with renting or returning DVDs
4) Ease of use (in terms of returning)
5) A strong network of entertainment video providers, i.e. suppliers
Customers like variety; a video rental store that only stocks the newest releases will not appeal to
all markets. Increasingly, customers are becoming more nostalgic in their movie preferences,
searching for titles long past premiere. Customers have also become increasingly busy, often not
having the time to go to a store to pick out a movie or remembering to return their rentals on
time. We live in a world of instant gratification, where being able to click a few buttons and
watch the latest Jennifer Aniston rom-com or an old cult classic like Rocky Horror is extremely
important. Customers also do not like fees. More and more companies today are offering free
shipping/return shipping, and the same is true in the DVD rental industry.
Five Forces Analysis of the Industry
Rivalry among competing sellers: High. Buyer costs of switching brands is low and product
offerings are weakly differentiated. The number of competitors is growing and rivals have
diverse strategies for providing their services.
Competitive pressure from buyer bargaining power: Medium to high. The cost of switching to
competing products is low, as well as the level of convenience for switching. Products are for the
most part undifferentiated.
Competitive pressure from supplier bargaining power: Low to medium. There are a large number
of suppliers within the industry and a variety of ways in with to gain access to the needed
material. However, most sellers cannot self-manufacture these movie titles; whereas the
suppliers could easily begin offering these services themselves.
Competitive pressure from substitute products: Low. The cost per DVD to buy is greater than
that to rent or stream a movie. Buyer demand for purchasing DVDs is decreasing due to the lack
of disposable income created by the financial crisis, as well as the practicality of owning a vast
collection of physical DVDs.
Potential of new entrants: High. The market is growing at an ever increasing pace and barriers to
entry are low. Buyer demand continues to increase as well, and existing industry members are
looking to expand their market reach. (See Appendix 1 for a visual representation).
There are a number of drivers of change affecting the movie retail industry. As mentioned
previously, there has been a shift in consumer’s willingness to go out of their way for certain
products or services. The consumer climate has shifted to an instant gratification model, in which
if acquiring a movie to watch requires more effort than clicking a few buttons, then it is no
longer worth the consumer’s time. This force is somewhat unfavorable in terms of competitive
intensity because it will drives firms within the industry to compete in a never ending sprint to
offer the most titles in the shortest amount of time, which will eventually hit its peak and taper
off. However, this force will also positively impact future industry profitability since the more
streamlined the process becomes, the more users and more uses the industry will gain.
Another force driving change is the switch from buying physical DVDs and acquiring
movie collections to accessing them online as needed. This saves consumers valuable time and
money, and they no longer need to worry about keeping their DVDs in good condition. This
force will positively affect future industry profitability because it will reduce the number of
distribution plants needed to sustain video libraries, thus significantly reducing operating costs.
Not having to stock multiple copies of millions of DVDS will mean that companies will no
longer have to spend money on:

Multiple large plants

Staffing said plants with a large labor force

Operating said plants in terms of rent, utilities, etc

Postage (in terms of Netflix specifically)

DVD maintenance

Mailing and location software
One more force that is affecting the movie rental industry is the introduction and
proliferation of VOD services offered directly from cable networks and providers. Barriers to
entry for these already existing firms is extremely low, and if all networks chose to offer these
services, a large portion of profits would be cannibalized from outside companies such as Netflix
or Hulu. This force will negatively affect competitive intensity, but positively affect future
industry profitability. If the large supplier companies (cable networks & providers) all started
offering their own VOD, competition from smaller independent renting firms would disappear.
Yet profitability would increase due to the ease of access to entire network libraries.
Mapping the Movie Retail Industry
The competitive characteristics that differentiate firms within the movie retail industry
are as follows:

Use of distribution channels

Product line breadth

Price

Geographic coverage

Ease of access/use
In conducting my analysis of the strategic positioning of firms within this industry, I chose to
focus on price and use of distribution channels (See Appendix 2). Netflix and VOD providers
are positioned most favorably on the map because both offer moderately priced subscription
packages for access to a comprehensive list of movie and TV show offerings using a variety of
distribution channels. Netflix is positioned most favorably due to its relative low cost compared
to the variety of products it offers access to. Redbox is priced well, but it only offers one method
of distribution. Whereas Blockbuster is priced higher than average, but has begun to offer
streaming and mail rental options in addition to in store rentals.
A Financial Analysis of Netflix
Overall, Netflix has fared fairly well over the past several years, even surviving the
financial crisis. They continue to generate a profit, and their revenue has grown at a steady rate
indicative of the growth of the mail rental & online streaming movie retail market.
The company has been growing at an average rate of 20% over the last four years.
However, from 2007 to 2008, Netflix only grew at a rate of 13.22%. This noticeable fluctuation
in their growth rate can most likely be contributed to the financial crisis that swept the nation
during that year. Aside from that dip, Netflix can be expected to continue to grow at a rate
indicative of the continued growth of mail and digital movie rental industry.
Product costs for Netflix have remained relatively stable over the last four years at over
60% of revenue, fluctuating only by 4% or less. This is despite the fact that revenues for the
company have been steadily increasing. This clearly shows an inability to control manufacturing
& operating costs. As Netflix expands, so does its physical DVD inventory and size/number of
distribution plants. Although one of their strategies is transition subscribers to streaming delivery
as opposed to mail delivery, it is obvious that they have yet to be truly successful in that
endeavor.
Netflix’s ROA hit an all-time high of 17.05% in 2009, which is somewhat surprising
given that the company is deriving most of its revenues from a nubile market. The mail and
digital movie rental industry is still growing, so to have an ROA that high is quite an
accomplishment. It is clear that the company’s investments in new assets are succeeding in
generating returns.
(See Appendix 3 for a complete financial analysis of Netflix from 2006-2009).
SWOT Analysis of Netflix’s Standing within the Market
Strengths
 Netflix cornered the market on direct
mail renting before anyone else
offered it
 Has a wide geographic coverage and
the fastest turnaround rate
Opportunities
 The increasing demand for digital
streaming is clearly an opportunity
 The shift from by mail rental to digital
streaming gives Netflix an opportunity
to restructure its subscription packages
 Known for its 1 month free trials
and price them even more
 The brand has a following across a
competitively
wide variety of consumer segments
 Their strong relationship with a large
network of entertainment video
 The firm can look at joining forces
with some of the networks that are
beginning to offer VOD streaming
providers
 Top management realizes the
importance/emergence of the digital
environment and is trying to shift
subscriber use accordingly
 Netflix has developed unique and
comprehensive movie selection
software that customizes the consumer
experience by capitalizing on their
movie tastes and making accurate
suggestions
 Netflix offers the most detailed movie
information including customer
reviews, critic reviews, etc
Weaknesses
Threats
 Netflix is a market leader in by mail
 Changing subscriber preference
rental, which has now capped off and
towards online streaming will affect
started to become a declining category
Netflix’s current portfolio mix
 The company’s comprehensive DVD
 The increasing intensity of
libraries and distribution centers are
competition from other companies,
eating up a large chunk of their
such as Hulu with their Hulu Plus
revenues
program will eat into Netflix’s
 Unlike other movie rental/streaming
companies, Netflix does not offer
access to newly released films
consumer base
 Increasing number of networks that are
beginning to offer free streaming of
content on their websites
For the moment, Netflix’s overall situation is fairly attractive. Being the first company to
introduce a new niche in a market is a huge asset. A company cannot simply ‘buy’ cornering the
market on a good or service. Since Netflix already offers unlimited direct streaming, that puts it
ahead of some of its competitors. However, Netflix will need to restructure and reevaluate the
profitability of its by mail rental service in the near future.
Competitive Strength Assessment of the Movie Rental Industry
Netflix
Blockbuster
VOD Providers
10
3
6
8
5
6
# of Products
9
6
8
Ease of Use
10
6
10
9
7
8
Price/Fees
Distribution
Channels
Strong Network of
Suppliers
46
27
38
Compared with Blockbuster and VOD Providers, Netflix has the highest level of competitive
strength at 46 points. Netflix by far has the most comprehensive number of products and
distribution channels, given that consumers can either rent DVDs by mail or stream them on their
PC or TV. The number of distribution channels factors into the company’s ease of use, as does
the fact that their DVDs come with prepaid return envelopes. VOD Providers are a similar ease
of use to Netflix given that consumers can just click a few buttons on the TV and instantly be
watching their chosen film. Blockbuster is ranked lowest in terms of price & fees because their
prices are based on a per DVD cost, and when sales began to decrease, the company increased its
prices. Not to mention that there are late fees associated with renting, whereas with Netflix you
can keep a DVD for as long as you like without incurring fees. Blockbuster also scores lower in
terms of the number of products because their library is limited by store space, whereas Netflix
and VOD Providers can have a virtually unlimited library of titles spanning the entire duration of
the movie industry.
Performance Concerns
Overall, Netflix’s performance is quite satisfactory. The company persevered through the
financial crisis and has managed to hold on to market majority despite growing competition from
rival firms.
a) My main concern for Netflix is the amount of revenue that is currently being eaten up by
product costs. Despite steadily increasing revenues, Netflix’s COGS continues to take up
more than 60% of said revenue. In the coming years when the market shifts entirely to
direct streaming, Netflix will be left with millions of DVDs and operating costs
associated with the large distribution centers required to house these DVDs. If the
company takes too long to phase out this aspect of its product/service portfolio, it could
lose out on major profits and potentially wind up in debt.
b) A second issue I see for Netflix is that more and more companies are beginning to offer
streaming of their own content either for free to the public, or free to subscribers of
certain cable companies. Since Netflix has a cost associated with it, its customer base
could be cannibalized by these new entrants.
Recommendations
a) Given that by mail renting is on the decline, Netflix should work quickly to phase out this
service from its current offerings. Right now there are still companies out there willing to
take on extensive DVD libraries- five or so years from now, that may not be the case and
Netflix will have lost out on an opportunity to avoid a significant loss.
b) Netflix needs to look at restructuring and re-pricing their current subscription packages.
The number of packages and their prices that the company offers are no longer relevant
to demand. With more and more entrants into the market, Netflix is losing its competitive
pricing advantage.
In sum, in order to remain competitive Netflix needs to restructure both its product offerings
and pricing strategy. The company should be looking ahead to see what the next big thing in
movie rental/streaming will be and capitalize on that, while other firms are still entering the
market and developing what Netflix already has.