Netflix Entertainment Distribution Marketing Case Study Case Studies Case analyses should be approached as though you are a marketing manager whose respons

Netflix Entertainment Distribution Marketing Case Study Case Studies
Case analyses should be approached as though you are a marketing manager
whose responsibility it is to assess the situation and present three long-term
strategies to the board of directors. Based on your understanding of the case
and external research on the CURRENT situation, what are the three best
strategies to revitalize and/or improve public perception to the same target
market and/or alternative markets? Please do not limit yourself to the specifics of
the case when formulating your strategies. Think ‘BIG PICTURE’ (ethical
objectives, internal/external factors, complementary products/industries,
sustainability, alternative products/services, cultural assessment, pricing
changes, etc.).
Your strategic recommendations should be 1) measurable and 2) broad enough
to encompass the direction of the brand for at least 5 years. At the same time,
analyses should explain IN DETAIL the logic and process behind implementing
such initiatives. Please do not provide vague recommendations. Please use the
critical thinking rubric (on blackboard) as a guideline and checklist for your
submissions. For the exclusive use of M. Darrat, 2017.
W16761
NETFLIX INC.: THE SECOND ACT — MOVING INTO STREAMING1
Sayan Chatterjee, Wayne Barry, and Alexander Hopkins wrote this case solely to provide material for class discussion. The authors
do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain
names and other identifying information to protect confidentiality.
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights
organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western
University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com.
Copyright © 2016, Richard Ivey School of Business Foundation
Version: 2016-11-18
Netflix Inc. (Netflix), a subscription-based movie and television (TV) show rental service, offered content
to its subscribers either via DVDs delivered by mail or through Internet-based streaming. Netflix’s 2011
third-quarter financial reports confirmed some widely anticipated negative news. Netflix, which depended
on perpetually increasing its subscription base, had lost 800,000 customers.2 While this loss represented
only 3.4 per cent of its 24 million patrons, the company had never suffered a decrease in its customer base
(see Exhibit 1). Alarmingly, this contraction resulted in a near 9 per cent hit to the company’s earnings-pershare, which dropped to US$1.163 per share from $1.27 per share in the previous quarter.4
This situation was compounded by the fact that it was not caused by market trends or the slumping world
economy, but by Netflix itself. In July, just three months prior, Netflix had increased customers’
subscription fees by 60 per cent. Netflix was at a crossroad; the path it chose could affect its future. Should
it return to combining the two services or continue with two separate services and live with the
consequences?
While the price increase seemed extreme, Netflix faced rising costs, particularly in acquiring content.
Netflix’s second change, made several weeks earlier, in September, was to split its DVD mail-order service
(renamed Qwikster) and streaming video service (remaining as Netflix). Reed Hastings, Netflix’s chief
executive officer, stated, “Streaming and DVD by mail are becoming two quite different businesses, with
very different cost structures, [and] different benefits that needed to be marketed differently, and we needed
to let each grow and operate independently.”5 Netflix needed to differentiate the two services, ensuring that
each had the latitude to rightfully respond to customers’ changing desires.
1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Netflix Inc. or any of its employees.
2
New York Times, “Netflix Inc.,” The New York Times, October 25, 2011, accessed November 8, 2011,
http://topics.nytimes.com/top/news/business/companies/netflix-inc/index.html.
3
All currency amounts are in US$ unless otherwise specified.
4
New York Times, op. cit.
5
Rene Ritchie, “Reed Hastings Apologizes, Announces Netflix as Streaming Only, Rebrands DVD Business as Qwikster,”
Tipb.com, September 19, 2011, accessed November 16, 2011, www.tipb.com/2011/09/19/reed-hastings-apologizesannounces-netflix-streaming-rebrands-dvd-business-qwickster/.
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Irrespective of the company’s rationale, the aforementioned changes were met with public disdain and a mutiny
of sorts. Forced to pay exorbitantly more and to work twice as hard to manage their online profiles, many
Netflix customers, some once very loyal, cancelled their subscriptions. Netflix’s stock price plummeted by
nearly 77 per cent in four months,6 indicating widespread displeasure. Nearly every mass media outlet chastised
Netflix’s decisions, calling them outrageous. Full blame was placed on Hastings himself, whom many not only
defamed but also bludgeoned verbally. Once the darling of the business world for guiding Netflix’s ascension
to market domination, Hastings’s qualifications were now called into question. Both he, and the company he
had incepted, had incurred losses to their once-celebrated reputation.
The demise of DVDs would soon give way to streaming technology. Netflix’s commitment to this new
reality was obvious: by 2011, it commanded a market share of 61 per cent in movies that were either
streamed over the Internet or offered on-demand through a cable or satellite TV service. Comcast was next
with 8 per cent, followed by other services, such as Direct TV and Apple TV, at 4 per cent or lower. Netflix
faced stiff competition from other entities that had both the desire and capability to capture a share of the
streaming market.
Additionally, the acquisition of content was becoming ever more difficult as the production companies were
employing licensing policies that were becoming more stringent and costly. This situation starkly contrasted
Netflix’s cost of acquiring DVDs, particularly movies that were not the most recent releases (see Exhibit
2), as was Netflix’s practice. These different economies had an impact on Netflix’s cash flow, which was
only around $356 million (cash on hand) in the final quarter of 2011, compared with more than $76 billion
for Apple. Effectively adapting to these and other stark contemporary realities was tantamount to Netflix’s
continued success. Unfortunately, the changes Netflix thought were necessary caused nothing but turmoil.
NETFLIX: EMERGENCE TO MARKET DOMINATION
Netflix delivered movie and TV shows via Internet streaming and U.S. mail (for DVDs) for a monthly
subscription. Starting at $7.99 per month, subscribers could instantly watch an unlimited number of TV
episodes and movies by streaming the shows over the Internet to their computer or TV. Customers could
connect with their Netflix account through their Nintendo Wii, Sony PlayStation 3, Xbox 360, iPad, iPhone,
and many other devices, to instantly watch programs and movies. Netflix also offered unlimited DVD
rentals and no fees of any kind. Netflix was the first company of its kind. Capitalizing on the white space,
Netflix had dominated the industry, with 23.6 million subscribers as of April 2011.
Netflix was founded in Los Gatos, California, in August 1997, by entrepreneurs Reed Hastings and Mark
Randolph. Hastings, a former high school math teacher and software developer, started the company with
$2.5 million after selling his software company. Randolph had founded the computer mail-order company,
MicroWarehouse, and his resulting expertise was valuable to Netflix. Randolph was also the vice-president
of marketing for Borland International.
The fast adoption of DVD players was fortuitous for Netflix. The lightweight DVDs made it possible to
use the U.S. Postal Service to deliver a DVD with a single first-class stamp. Netflix tested more than 200
mailing packages before discovering that it could effectively ship the product in a single package.
6
Greg Sandoval, “Netflix’s Lost Year: The Inside Story of the Price-Hike Train Wreck,” CNET, July 11, 2012, accessed
August 23, 2015, www.cnet.com/news/netflixs-lost-year-the-inside-story-of-the-price-hike-train-wreck/.
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Growth Progression
In December 1998, Netflix formed a partnership with Amazon.com Inc. The Netflix website directed
customers interested in buying DVDs to Amazon.com, which in turn promoted Netflix on its high-traffic
site. Despite Netflix’s popularity, in FY1999, the company reported losses of $29.8 million on revenues of
only $5 million.
In February 2000, Netflix developed CineMatch, a personalized recommendation system that compared
customers’ rental patterns, looked for similarities, then used this information to recommend titles to people
with similar profiles. (The algorithms driving CineMatch were continually updated. Recently, Netflix had
offered $1 million for the person who developed the best new algorithm for CineMatch, which led to a 10
per cent increase in CineMatch’s recommendation ability.) In its first few years, Netflix incurred substantial
losses, but its stated future goal was to move beyond DVD rentals to streaming video.
By February 2002, Netflix had reached its target of 500,000 subscriptions and initiated an initial public
offering in May 2002, at which it sold 5.5 million shares of common stock. In 2003, Netflix posted its first
profit of $6.5 million on revenues of $272 million. The company also enjoyed a rapid increase in its
subscriber base, from one million in the fourth quarter of 2002, to approximately 5.6 million in 2006, and
nearly 14 million in March 2010. Netflix had the advantages of an early start in its business, a strong
distribution system, customer loyalty, and patents for its software programs.7
Profit Model
Netflix’s profit model relied on a “virtuous cycle” — that is, the more subscribers it had, the more content
it could buy; and the more content it had, the more subscribers found the service attractive. Subscriber word
of mouth led to new subscribers. The following information was from the Netflix investor relations site:
Our primary competitive advantage is our large and growing subscriber base, which gives us
tremendous operating efficiencies and, which we believe, drives the following virtuous cycles:
?
?
?
More subscribers means more money to license content, which drives more subscriber growth.
More subscribers means more word of mouth from subscribers to those who are not yet
subscribers, which drives more subscriber growth.
[M]ore subscribers means we could increase R&D spend to improve our user experience, [which]
drives more subscriber growth.8
As long as Netflix continued to grow its subscription base, and negotiated the best possible flat-fee deals
for content (versus revenue sharing), the company would remain profitable. Customer churn and
subscription-based (per user) licensing fees represented the main threats to the profit engine.
Customer Intimacy
Through the shrewd utilization of technology, Netflix had cultivated tremendous intimacy with its
customers. The company had invested heavily in its operational backbone: its website technology. Invisible
7
The background on Netflix is based on “Netflix,” Ivey product # 9B09M093.
R. Hastings and D. Wells, Letter to Shareholders, Netflix, accessed November 16, 2011, http://ir.netflix.com/common/
download/download.cfm?companyid=NFLX&fileid=511277&filekey=85b155bc-69e8-4cb8-a2a3-22465e076d77&filename=
Investor%20Letter%20Q3%202011.pdf.
8
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to customers, a state-of-the-art system captured mass quantities of empirical data, amalgamated the given
data points, applied germane analytics, and predicted customers’ desires. This complex system enabled
Netflix to tailor its website for each subscriber to a “one-of-a-kind” experience that provided
recommendations, requested ratings, offered customer reviews, and created unique, customer-specific
genre names. The more information subscribers provided to Netflix, the more personalized their long-term
experience — and Netflix reaped tremendous benefit through customers who were motivated to remain
engaged. Moreover, Netflix’s information on customer preferences and purchasing trends enabled it to
better its service, and to leverage suppliers and advertisers. Finally, Netflix deliberately targeted movie
aficionados who saw value in the information provided by Netflix and by other like-minded subscribers in
the Netflix-facilitated chat rooms. The virtuous cycle resulted in subscriber loyalty, and Netflix cemented
this loyalty by making content available (often at lower costs than blockbuster movies).
New Customers
Many analysts wondered whether Netflix could leverage its data-mining capabilities to create the same
level of engagement with its streaming customers, many of whom had a latent demand for watching popular
TV serials in one go (i.e., TV “binging”), a formula successfully adopted by TV channels such as
Nickelodeon. Netflix’s primary goal had never been to offer the latest content, and it focused instead on
offbeat movies favoured by movie aficionados. Many felt Netflix was trying to adopt the same formula as
“rerun TV.”
A CHANGING WORLD BRINGS ABOUT NEW REALITIES
Technological Progression: Antiquating the DVD
All technologies were inevitably eventually antiquated by newer inventions. Just as the eight-track tape gave
way to the cassette tape, the cassette tape to the compact disc, and the compact disc to the MP3 player, DVDs
were losing out to streaming video. Advancements in data packaging and transfer led to the migration from the
old DVD technology to new streaming services. Streaming services had previously been prone to interruptions
and glitches, rendering them unreliable. Extremely large files, once too big to transfer virtually, needed to be
saved on physical media and shipped by mail. Now, those files could be easily transferred to a small portable
computing device such as a cellphone. Streaming data was more reliable than DVDs (it did not scratch or
break), could be played anywhere (via mobile devices), and was far more responsive (received in real time).
For all these reasons, writer Jan Ozer noted that
Streaming media usage had grown exponentially over the past few years, both for entertainment
purposes and as a vehicle for organizations to market, sell, and support their products and services,
as well as for internal communications and training. For many such organizations, streaming video
had transitioned from a “nice to have” curiosity to a mission critical technology.9
Hastings had known full well that streaming technology would eventually take flight and ultimately bring
about the demise of the DVD. In his company’s annual reports, he had bluntly stated that streaming was
invariably the future of the industry. Hastings knew that, as technology advanced, those qualities that once
set his company apart from its competition would become nothing more than new requirements for entry.
9
Jan Ozer, “What Is Streaming? A High-Level View of Streaming Media Technology, History, and the Online Video Market
Landscape,” Streamingmedia.com, February 26, 2011, accessed November 16, 2011, www.streamingmedia.com/Articles/
Editorial/What-Is-…/What-is-Streaming-74052.aspx.
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New Requirements for Entry
While not entirely different from what they once were, the technological progression and resulting shift
from a DVD- to a streaming-dominated market had changed the resources required to enter the
entertainment distribution market. Certain capabilities were required of any competitors on this new
battlefield.
Content
Whether viewing a movie in the theatre, opting for a premium channel on a cable service, or subscribing to
Netflix, customers sought content. To maintain allure, content provision services needed to keep their
catalogues fresh. Continuously stocking their libraries with new movies and shows was paramount now,
because of this content’s ubiquitous accessibility. Competitors needed to find success in three principle
elements: maintaining fresh content, offering a large variety of content, and ensuring their content was easy
to find. With one or two notable examples,10 all Netflix content was also available elsewhere.
Content Delivery to Television
Most American households viewed their media content on a TV set.11 Cable TV and/or direct satellite
systems tapped into almost every domicile. Remarkably, the average U.S. household watched eight hours
and 18 minutes of TV per day.12 For consumers to find value in a media provider’s service, content needed
to be delivered to their TV sets with relative ease.
Content Delivery to Mobile Devices
While content delivery to consumers’ TVs was essential, so too was the content’s universal availability.
The prevalence of smartphones, micro-computers, tablets, and other devices for data receiving and
processing, coupled with the near ubiquitous coverage of cellular and Wi-Fi services, had made it possible
for people to demand content just about anywhere. Viewers, once tethered to their DVD and Blu-ray
players, could now watch what they wanted with ease from wherever they might find themselves.
As streaming technologies improved, content delivery was becoming more a requirement than a
competitive advantage. Content distributors such as Netflix worked on improving two customer attributes:
stuttering, which meant the streaming might be interrupted as the data was buffered to avoid resolution
issues, and the resolution itself. High-definition streaming required much more bandwidth (which was one
reason Amazon did not offer it). In 2011, Netflix was working on a downloadable application that
subscribers could use to monitor their connection speed and thereby optimize resolution (less than high
definition) and minimize streaming interruptions. However, this application would not be ideal if the
10
Kyle Thibaut, “Netflix Gets into the Original Content Game, Buys an Upcoming Show for a Rumored $100M,” TechCrunch,
March 15, 2011, accessed November 16, 2011, http://techcrunch.com/2011/03/15/netflix-gets-into-the-original-contentgame-buys-upcoming-show-for-100m/.
11
A study from Horizon Media indicates that in first quarter of 2010, Americans spent an average of 158 hours and 25
minutes watching TV, and only three hours and 10 minutes watching video online. Source: Paul Bond, “As the Company
Plans to Spend $1.2 Billion in 2012, Some Express Relief That They Are Buying Content No One Else Wants Such as
‘Pushing Daisies,’” Hollywood Reporter, January 14, 2011, accessed November 16, 2011, www.hollywoodreporter.com/
news/hollywood-execs-privately-netflix-71957.
12
Alana Semuels, “Americans Now Watch More TV than Ever,” Los Angeles Times, November 24, 2008, accessed
November 14, 2011, http://latimesblogs.latimes.com/technology/2008/11/americans-now-w.html.
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requirement was high-definition video. In the long run, a provider that could guarantee high-definition
streaming would have an advantage. The differentiator would be bandwidth — any service that could
deliver more content using less bandwidth would be favoured — especially from a remote device on a data
plan.
Production companies had been quick to realize that the omnipresent nature of their material, and
customers’ ability to watch it anytime and anywhere, had exponentially increased the value of that content.
As discussed below, this reality had proven the antecedent to drastic hikes in content licensing fees.
User Interface and User Engagement
Much of Netflix’s success had been based on the intimacy it had cultivated with its subscribers.13 Through
technology, Netflix had developed a sense of customer engagement by combining thousands of data points
to create a “one-of-a-kind” experience for each subscriber and/or household. Recommendations were based
on customer feedback, both individually and in the aggregate, which provided a connection between th…
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