Information Systems:
A Manager’s Guide to Harnessing Technology
4-1
This work is licensed under the
Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported License.
To view a copy of this license,
visit http://creativecommons.org/licenses/by-nc-sa/3.0/or send a letter to
Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA
4-2
Chapter 4
Netflix: The Making of an E-commerce Giant and the
Uncertain Future of Atoms to Bits
4-3
Learning Objectives
•
Understand the basics of the Netflix business model
•
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
4-4
Learning Objectives
•
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
•
Understand the “long tail” concept, and how it relates to Netflix’s ability
to offer the customer a huge (the industry’s largest) selection of movies
•
Know what collaborative filtering is, how Netflix uses collaborative
filtering software to match movie titles with the customer’s taste, and in
what ways this software helps Netflix garner sustainable competitive
advantage
4-5
Learning Objectives
•
List and discuss the several technologies Netflix uses in its operations to
reduce costs and deliver customer satisfaction and enhance brand value
•
Understand the role that scale economies play in Netflix’s strategies and
how these scale economies pose an entry barrier to potential competitors
•
Understand the role that market entry timing has played in the firm’s
success
4-6
Learning Objectives
•
Understand the shift from atoms to bits and how this is impacting a wide
range of industries
•
Recognize the various key issues holding back streaming video models
•
Know the methods that Netflix is using to attempt to counteract these
challenges
4-7
Introduction
•
When Netflix went public, financial disclosure rules forced the firm to
reveal how profitable it was
•
Rivals such as Blockbuster and Wal-Mart showed up
•
Competitors underestimated Netflix because:
– It was an Internet pure play without a storefront
– It’s overall customer base was microscopic in comparison
4-8
Introduction
•
Newcomers mimicked Netflix with cheaper rival efforts forcing Netflix to
cut prices
•
Netflix survived big competitors, a price war, and spending on the rise
4-9
Why Study Netflix?
•
It gives us a chance to examine how technology helps firms craft and
reinforce a competitive advantage
4-10
Netflix CEO Reed Hastings
Source: http://money.cnn.com/2011/07/25/technology/netflix_earnings/index.htm
2-11
How Netflix Works
4-12
How Netflix Works
•
Netflix settled on a DVD-by-mail service model
– It charges a flat-rate monthly subscription
– Customers don’t pay mailing expenses and late fees
•
Videos arrive in Mylar envelopes containing:
– Prepaid postage
– Return address
•
After watching the video, consumers:
– Slip the DVD back into the envelope
– Drop the disc in the mail
4-13
2-14
2-15
How Netflix Works
•
Users make their video choices in their “request queue” at Netflix.com
•
Consumers use the Web site to:
– Rate videos
– Specify movie preferences
– Get video recommendations
– Check out DVD details
– Share their viewing habits and review
4-16
http://www.youtube.com/watch?v=o8HROe4t8S4&feature=player_embedded 2-17
Tech and Timing: Creating Killer Assets
•
•
•
Building a great brand online starts with offering exceptional value
Advertising builds awareness, but brands are built through customer
experience
Subscribers expectations from Netflix:
Search function
– Huge selection
–
–
–
–
Ability to find what they want
Timely arrival
Ease of use and convenience
Fair price
Technology drives all of these capabilities
Technology is at the center of the firm’s brand
building efforts
4-18
Selection: The Long Tail in Action
•
Netflix offers its customers a selection of over 100,000 DVD titles
•
Traditional retailers cannot offer this because of shelf space constraints
•
Traditional retailers can determine their breakeven point by considering:
– Number of customers that can reach a location
– Store size
– Store inventory
– Payback from inventory
– Cost to own and operate the store
4-19
Selection: The Long Tail in Action
•
Internet firms can have just a few highly automated warehouses
•
Long tail: A phenomenon whereby firms can make money by offering a
near-limitless selection
4-20
Figure 4.2 - The Long Tail
4-21
2-22
2-23
Selection: The Long Tail in Action
•
The long tail works because:
– Cost of production and distribution drop
– It gives the firm a selection advantage that traditional stores cannot match
– Geographic constraints go away and untapped markets open up
4-24
Selection: The Long Tail in Action
•
Netflix has used the long tail to create close ties with film studios
– Studios earn a percentage of the subscription revenue
– Netflix gets DVDs at a very low cost
– Studios do not spend on additional marketing (after box office and DVD releases)
4-25
Cinematch: Technology Creates a Data Asset
that Delivers Profits
•
Netflix uses a proprietary recommendation system called Cinematch
•
Each time a DVD is returned, Cinematch asks the customer to rate it
•
Collaborative filtering: A classification of software that monitors trends
among customers and uses this data to personalize an individual
customer’s experience
– It can be mimicked by competitors
4-26
Cinematch: Technology Creates a Data Asset
that Delivers Profits
•
The data provided by Cinematch is a switching cost
•
To see how strong switching costs are is to examine Netflix’s churn rate
– Churn rate: The rate at which customers leave a product or service
– In mid-2008, churn rates for Netflix’s most active regions were below 3 percent
•
Netflix’s marketing costs benefit from satisfied customers, as referrals are
a better choice than advertisements
•
Netflix launched a crowdsourcing effort known as The Netflix Prize
4-27
A Look at Operations
•
Technology lies at the heart of Netflix’s warehouse operations
– Netflix has a network of fifty-eight ultrahigh-tech distribution centers
– Distribution centers are all located close to U.S.P.S. facilities
– Trucks collect DVD shipments from these U.S.P.S. hubs and return the DVDs to
the nearest Netflix center
– Scanners pick out incoming titles
– Netflix presorts outgoing mail before dropping it off at the U.S.P.S. facilities
– All DVDs are hand-inspected for cracks and smudges
– Warehouse processes are linked to Cinematch
4-28
A Look at Operations
•
Staff members are expected to focus on improving the firm’s processes
•
Quality management features are built into systems
•
Netflix can monitor and record the circumstances surrounding any failures
4-29
Killer Asset Recap: Understanding Scale
•
Netflix’s size gives it a huge scale advantage
•
Scale economies allow firms to:
– Lower prices
– Spend more on customer acquisition, new features, or other efforts
•
Smaller rivals have an uphill fight
•
Established firms end up straddling markets
4-30
Killer Asset Recap: Understanding Scale
•
By moving first, Netflix gained scale advantages
– Largest network of distribution centers
– Largest customer base
– The firm’s industry-leading strength in brand and data assets
4-31
From Atoms to Bits: Opportunity or Threat?
•
Many media products are created as bits (digital files)
•
When we buy a CD, DVD, book, or newspaper, we’re buying physical atoms
that are a container for the bits
Atoms to Bits
The idea that many media products are sold in containers (physical
products, or atoms) for bits (the ones and zeros that make up a video file,
song, or layout of a book). As the Internet offers fast wireless delivery to
TVs, music players, book readers, and other devices, the “atoms” of the
container aren’t necessary. Physical inventory is eliminated, offering great
cost savings.
4-32
Access to Content
•
When Netflix launched its streaming video option, only 17,000 videos were
offered
•
Legal issues involved in securing the digital distribution rights
•
Windowing restricts the number of titles available
•
Wal-Mart uses its bargaining power to encourage studios to:
– Hold content from competing windows
– Limit offering titles at competitive pricing during the new release period
4-33
https://www.netflix.com/
2-34
But how does it Get to the TV?
•
Netflix initially developed a prototype set top box
•
It then developed a software platform that allowed firms to build Netflix
access into their devices
•
Advantages of the atoms to bits model
– Netflix will eliminate a huge chunk of its shipping and handling costs
– Bandwidth costs are minimal
Hulu.com & Hulu Plus
4-35
But how does it Get to the TV?
•
Disadvantages of the atoms to bits model
– Wrangling licensing costs is a challenge
– The switch to Blu-ray DVDs means that Netflix will be forced to carry two sets
of video inventory
• Standard
• High-definition
4-36
From Atoms to Bits
•
•
•
•
The shift from atoms to bits is realigning nearly every media industry.
Newspapers struggle as readership migrates online and once-lucrative
classified ads and job listings shift to the bits-based businesses of Craigslist,
Monster.com, and LinkedIn.
Apple dominates music sales, selling not a single “atom” of physical CDs,
while most of the atom-selling “record store” chains of a decade ago are
bankrupt.
Amazon has even begun delivering digital books, developing the Kindle digital
reader.
NYTimes for iPad: Enjoy our Top News section for free, or subscribe and
unlock all the sections in the app and get unlimited access to NYTimes.com on
any device
2-37
http://money.cnn.com/video/news/2011/06/21/n_comcast_ceo_netflix.fortune/?iid=HP_River
2-38
•
•
•
•
•
•
Subscription movie rental service Netflix (NFLX) is launching new, unlimited DVDonly plans in the U.S. -- but as a part of that move, it's scrapping unlimited plans
that include both physical DVDs and online streaming.
Netflix said that the changes are meant to "better reflect the costs" of each option.
The changes cut prices slightly for customers who only want DVDs, but streaming
video will now cost extra. Customers who want both options will essentially have to
pay for two plans, raising their overall bill.
Netflix's unlimited streaming-only plan will remain at $7.99 a month, while its "1
DVD at a time" plan will also cost $7.99. That means customers who want both
streaming and DVDs will have to shell out at least $15.98 a month.
That's a big jump from the $9.99 a month customers currently pay for a plan that
offers unlimited streaming plus 1 DVD at a time.
The move comes as Netflix continues to shift its focus toward online streaming
video -- an option that, while popular, costs Netflix loads of cash
Netflix first introduced streaming plans in 2007. Since then, the service's
membership has climbed from 6 million to 23 million in the U.S.
2-39
A Threat to Netflix: The Rising Licensing Fees
Netflix relies on licensing deals to stock its on-demand offerings -- and the
cost of those deals is about to skyrocket.
2-40
Update
• Netflix has more than 23 million subscribers. The company has a
very popular online streaming program that's available on dozens of
electronic devices, including computers, video-game systems,
television set-top boxes, smartphones and tablets.
• In Canada, Netflix offers only the streaming service, not the DVD
mailings.
• However, the streaming program's convenience and ubiquity is
sometimes overshadowed by its dearth of quality movies available
for streaming, relative to those contained in Netflix's extensive DVD
catalog.
2-41
•
Unlimited streaming will cost $7.99 per month, as will taking out one DVD
at a time. The combined cost is $15.98 per month, a huge price increase
for those who currently pay $9.99 for a combined streaming-plus-one-DVD
plan. --- August 2011
2-42
•
•
Netflix in August 2011 announced that it would separate the pricing for
online video streaming and DVDs, resulting in a hike of up to 60% for
people who utilize both options. A number of customers were outraged,
and last week Netflix disclosed that it is on track to lose 600,000
subscribers in the current quarter, after previously telling investors to
expect that it would add 400,000.
As a result, Netflix stock fell 26% in two days, equating to a loss of $2.6
billion in market value.
2-43
•
For only $7.99 a month, you get unlimited movies & TV episodes instantly
over the Internet to your TV or computer. There are no commercials, and
you can pause, rewind, fast forward or rewatch as often as you like. It's
really that easy!
•
During sign up, you can add unlimited DVDs (1 DVD out-at-a-time plan) for
only $7.99 more a month. With DVDs by mail, you'll get an even broader
selection of movies & TV episodes. You can exchange each DVD as often as
you want with no due dates or late fees — ever! You can add access to Bluray discs to your account at any time for an additional $2 a month.
2-44
Copyright Laws
•
This is because copyright law applies very differently to Netflix's DVDs and
streaming videos. With DVDs, Netflix can rent whatever it wants thanks to
the First Sale Doctrine. Once Netflix owns a DVD, it has the rights to rent
it to whomever it wants, at whatever price it wants to charge.
Unfortunately, that's not the case with streaming video. There, the rights
stay with the owner of the content, and those owners are charging more
in licensing fees, and might be charging way more very soon. They also
decide which videos can and cannot be streamed. DVD rentals, despite
the relative inconvenience of rental by mail, might look like a bargain by
comparison for many customers.
2-45
Additional References
•
•
•
•
•
Netflix addresses customers 'upset' with price hike
Netflix's vanished Sony films are an ominous sign
Why Hulu is so hot right now
Why corporate America needs more Reed Hastings
Netflix hikes prices for DVDs + streaming
2-46