Case 1 - NETFLIX
MGMT 601 –Monday - Spring 2011
Group 6- Amit Deshpande,
Blockbuster (pre 2004) was operating mainly using the physical stores throughout the country. In 2006,
Blockbuster had 5194 stores through the country. 70% of the population was considered to be less than 10
minute of drive from a blockbuster store. Blockbuster charged about $3-$4 per rental for a fixed amount
of time. The customer needed to pay late fees if the title was returned in the stipulated amount of time.
More than 10% of blockbuster revenue represented the “late fees”. Only the high demand (majority of
which comprised of newer tittles) were stocked. It was hard to find old, unpopular or independent films at
the store. The economics of offering less popular films was not favorable. Blockbuster’s growth strategy
was based on opening new locations to expand geographic coverage and increase market share.
Increasing competition from Netflix, Redbox, Amazon on demand and other VOD services resulted in
declining revenues for blockbuster. The company filed for bankruptcy on September 23, 2010 wiping out
more than $1B of debt. Some 54.8% of voters in our weekly poll said creditors shouldn't lend the
company any more money, while 45.2% are still hopeful that Blockbuster will be able to rebound with
more cash [1]. Recently the deadline to file a bankruptcy and restructuring plan was extended till March
21, 2011. Blockbuster planned to close 72 stores by the end of 2010 and another 110 stores in the first
quarter of 2011 [3].
On the contrary, Netflix offered an online DVD rental service with no physical store location. Launched
in 1998, the company focused on early adopters and offered only the DVD format even though the VHS
cassette was prevalent at time of period. The widespread acceptance of DVD format was a presumption
and risk for Netflix business model. Users could search through the collection and select the required title.
The DVD was mailed to the customer using the USPS service. Earlier Netflix used the per rental charge
model as other companies plus the shipping charges. However Netflix soon realized that it was spending
$100 to $200 for a customer to make one $4 rental. As a solution Netflix started the prepaid subscription
based model. The new model allowed greater customer retention, turned the long delivery time to
advantage and most importantly allowed Netflix to offer “unlimited” DVDs per month. The new “all you
can eat” model was an attractive alternative to the traditional per-day fee structure with late fees. A
diagram of this system can be seen in Exhibit 1.
The next hurdle Netflix faced was high demand for hit and new movies and the user frustration with the
movie unavailability. The recommendation system developed suggested the user movies which are
available and might be of interest based on preference and history. The success of the recommendation
system decreased the demand for newer releases to 20% of the total demand compared to the 70% for the
traditional video rentals. A positive “network effect” was generated from the large customer-generated
rating system. As a start-up company, Netflix did not have any business relationship with major studios.
Netflix mainly acquired titles from smaller studios at a minimal discount. Sarandos who had excellent
relationships with the studios and was veteran in the DVD rental industry was successful in forming
revenue-sharing agreements with the major studios. The average wait time when there was just one
warehouse in Sunnyvale was about 1 week. The one day delivery model was very useful. Today Netflix
has 44 distribution centers across the country which can deliver to more than 90% of 6.6 million
subscribers within a single business day. Using optimized processes, Netflix’s employees could open and
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re-stuff an average of 800 DVDs per hour, allowing the entire distribution center network to ship over 1.6
million DVDs per day. In addition, Netflix collaborated with USPS, to further reduce the turnover time
and cost. Netflix received a standard discount for presorting the mail by zip code. As Netflix became
known as the de facto source for independent and foreign movies, the smaller studios were interested in
partnering with Netflix to market the movies. In 2006, Netflix started to acquire rights for some
independent movies through its Red Envelope Entertainment subsidiary. Another growing concern was
the high attrition rate (churn rate) which grew from 3.6% in 2002 to 6.3% in 2006.
Although Blockbuster and Netflix compete in the same video rental market they really do different jobs
for consumers. Blockbuster has made its core business the idea of a “movie night”. They assumed that
most movie rentals were impulse decisions for people who want to watch a movie right now. These are
usually new releases and so this is a majority of what Blockbuster stocks. Netflix on the other hand has
evolved to view movie watching as a regular part of daily entertainment. They appeal to the customers
who do not see “movie night” as an event but instead as an ordinary form of entertainment like watching
television. The ability to hold movies longer and the convenience of receiving/returning through mail is
perfect for this type of consumer. So, Blockbuster and Netflix cater to two different types of movie
renter. A Blockbuster customer would probably watch fewer movies but the ones they do watch would be
new releases rented impulsively. A Netflix customer would watch movies more frequently. They would
also be more interested in lesser known films and would plan out their rentals in advance.
Blockbuster and Netflix have differing business models and their operations strategies reflect this. As
stated above, Blockbuster focuses on the “movie night” crowd who want a new release movie right away.
So, they operate in a brick and mortar way where customers come into the store and leave with a movie.
Their business model is to allow consumers to make an impulse decision to rent a movie and get it right
away. To accomplish this they have an operations strategy of actual stores located heavily across the
United States and stocked with mostly mainstream titles. Netflix on the other hand has created a business
model around the idea that consumers want convenience and selection more than they want to be able to
make an impulse decision. They then created an operations strategy to accomplish this. Monthly fees
instead of rentals, mail delivery instead of pickup, and a wide choice of movies instead of just new
releases are all a part of their operations strategy. It certainly appears that Netflix’s business model will
win out in the end as shown by the stock price of the two companies in Exhibit 2 and 3.
Also discuss the business model for VOD. Would you have been long or short Netflix stock at the time of
the case? Why?
With the rise in availability of broadband internet and internet connectible devices, the video on demand
business model has gained prominence. VOD is a pay per view ability to access any multimedia content
to an individual Web browser or TV set based on user requests. VOD systems either stream content
through a set-top box, a computer or other device, allowing viewing in real time, or download it to a
device such as a computer, digital video recorder or portable media player for viewing at any time [5].
I will bet short on Netflix unless, it starts VOD for “all” of its titles available. Netflix offers “some”
select few titles for online viewing but this will not be enough in the future. Allowing users to watch any
movie they want right away would be an enormous strategic advantage for Netflix. This would obviously
take some negotiating with the other entities in the movie business. The DVD makers would be strictly
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opposed to this but if the price was right a deal could surely be made. In addition to expanding their
selection of VOD titles, allowing playback easily on televisions will also be important. If a consumer
owns a 50” HD television they are not going to want to watch a movie on their computer, even if it is
being watched “on demand”. So, giving playback on televisions either through gaming consoles, DVD
players, set top boxes, or direct connection to a computer is going to be an important step towards
winning the VOD battle. Another Netflix disadvantage is the limited TV programming available to watch
online. Services like HULU Plus offer a huge collection of high definition TV programming. Also the
Hulu (free service) is available to view limited TV programming. While it may be hard to work out deals
with the movie studios, working on deals for television shows (both past and present) seems extremely
possible. Also, a customer would be more willing to sit and watch a 30 minute television episode at their
computer where as they might not be willing to do the same with a 2 hour movie. This eliminates the
struggle to get VOD onto televisions and is another reason that focusing on “on demand” television show
viewing could be arranged rather soon.
Even though they are currently struggling, Blockbuster, has started the “Total Access” service. The Total
Access service allows the customers to order and return titles via mail, second, order and return the title at
participating physical store, third, rent or purchase movies online on-demand. In addition to the movies,
Blockbuster also offers access to Playstation 3, Xbox 360 and Nintendo Wii games at no extra charge.
According to PwC, the video game industry will grow at 6.7% compound annually for the five-year
period to $12.5 billion. It has already surpassed the music spending from the consumer spending point of
view. Therefore, the offering the video game with movie DVD and blu ray disk can be vital factor for
success.
Blockbuster has also started to set-up vending machines at local grocery stores and gas stations. For
newer titles Red Box has been the preferred service in the recent times. Red box vending machines can be
found in the everyday grocery stores like Kroger, Wal-Mart, Biggs etc.. , pharmacies and even local
markets. Red box offers convenience of reserving a movie through internet (iPhone app is also available)
to avoid the inconvenience of not finding the movie required. As of April, 2007, kiosks had averaged 49.1
rentals per day and $37,457 a year in revenue [4]. Redbox is the cheapest movie rental which charges
$1.00 for a DVD and $1.50 for a blue ray disk for one night. Redbox allows the customer to return the
rental disk at any location. In addition to the rental business, customers also have the option to purchase
the disks from the Red box vending machines. Other VOD providers like Qriocity have exclusive
connectivity with Sony which is a major player in the HD TV market. In short, the Netflix has some stiff
competition in the days ahead.
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Exhibit 1
Exhibit 2
Exhibit 3
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References
1. Blockbuster Creditors Should Call It Quits, Poll Says, TheStreet, 30 Jan 2011. http://t.co/TcSPlun
2. Blockbuster wins 3-month restructuring extension, Reuters, 20 Jan 2011. http://t.co/iZPsUi5
3. Blockbuster wins 3-month restructuring extension, Reuters, 20 Jan 2011. http://t.co/iZPsUi5
4. Redbox, Wikipedia, Accessed: 31-Jan-2011, http://en.wikipedia.org/wiki/Redbox
5. Video On Demand, Wikipedia, Accessed: 31-Jan-2011,
http://en.wikipedia.org/wiki/Video_on_demand
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Did Netflix do the same jobs for consumers that Blockbuster did? How did this evolve
over time? Why?
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Compare Blockbuster's and Netflix's business model and competitiveness. How might the
differences affect the respective company's operations strategies?
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As you examine each major shift in Netflix's operations strategy, find what caused them
to make each shift? What were the uncertainties about each shift? How did they manage
to reduce risks?
–
Also discuss the business model for VOD. Would you have been long or short Netflix
stock at the time of the case? Why?
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