Movie Rental Business Questions

1. How strong are the competitive forces?

The strength on the competitive forces in this industry varies based on their business
strategy. Online retailers who offer movies instantly as well as low costs are
overshadowing most of the other competitors. Video-on-demand and vending machines
with DVDs also offer superior convenience to consumers and are succeeding in the
market. Movie rental stores as well as DVD retailers are having a harder time matching
up with the other rivals because of their inability to offer instant access to movies and
there prices tend to be higher. Competitors that are the strongest in the market have been
able to keep up with technological changes which are currently shaping the industry.

2. What forces are driving changes in the Movie Rental industry and are the
combined impacts of these driving forces favorable or unfavorable in terms of
competitive intensity and future industry profitability?

Some of the industry’s major key driving forces are the competitor’s ability to adjust to
emerging internet technologies and changes in how consumers are purchasing and renting
movies. These technological advances are shaping the industry because they are
allowing distributors to provide customers with movies instantaneously. Competitors
that only offer in-store movie rentals are having a hard time keeping up with the
convenience factor that is offered from downloading movies online. These technological
changes are making things unfavorable for many in the competitive industry who once
held a strong market share. The future industry profitability depends on the customers’
continuous desire to watch and rent movies as well as competitors’ ability to keep up
with changes in internet and technological capabilities. Below is a more detailed list of
some of these forces that are driving changes in the industry.

1. Adjustments in long-term industry growth rate

2. Ability to provide low costs on movie rentals
3. Emerging internet technologies and product innovations
4. Increase in the number of buyers and users
5. Exit of major rivals
6. Changes in how consumers get products (shift from movie stores to online
rentals)
7. Marketing Improvements (online resources, VOD)
8. Innovations in cost and efficiency in retailing
9. Competition among rivals
10. Changes in the economy
3. What does your strategic map of this industry look like? Which company is best
positioned? Netflix or Blockbuster?

Movie Rental Industry Strategic Map

High
DVD
retail-
ers
Blockbuster

VOD
Price
Netflix

Redb
ox

Low
Low High

Convenience/Selection of Movie Rental

The strategic map we constructed puts two of the strongest driving forces of the Movie
Rental Industry on the x and y axis. According to our map, Netflix is positioned more
favorably because of their ability to provide superior convenience and offer low prices.
Blockbuster offers moderate prices and the level of convenience can vary depending on
your proximity to the nearest Blockbuster store. As we have it mapped out, it appears
that Netflix current has a stronger position in the market and an advantage over the other
competitors.

4. What key factors will determine a company’s success in the movie rental Industry
in the next 3-5 years?

Key factors of success that will determine a company’s success in the movie rental
industry in the next three to five years will be the ability to keep up with technology and
to deliver movies instantaneously and at a low price. The industry is currently being
changed by internet capabilities and rivals must be able to stay ahead of these changes
and offer their products through online means if they want to compete. Good marketing,
promotions and incentives are also very important in order to attract and maintain
customers. Offering competitively priced rentals is also a key to success because
customers will be drawn to companies with cheaper offerings.

5. What is Netflix strategy? Which of the five generic strategies most closely fit the
approach that Netflix is trying to achieve? What type of competitive advantage are
they trying to achieve?

Netflix had a six-pronged strategy; 1) Provide a comprehensive selection of DVDs, 2)

Make it easy to choose movies, 3) Fast delivery of selections, 4) No due dates or late
fees, 5) Convenient drop-in-mail return procedure, and 6) Aggressive marketing.
Netflix’s approach most closely fits the Cost Leadership Strategy. They have an industry
wide scope, are extremely efficient, and have proprietary software to make the
customer’s experience personalized and expedient. Their competitive advantage is being
first in online rental, having a proprietary method of selecting DVDs, and a customer-
centric, monthly based subscription service.

6. What does a SWOT analysis of Netflix reveal about the overall attractiveness of
its situation?

SWOT Netflix

Strengths Weaknesses
 First Mover Advantage  Lack of Control Over Return Time
 Strong Brand Recognition  DVDs Can Arrive Broken/Scratched
 Large Movie Selection  Stream Library Is Small
 Low Overhead  Occasional Renters May Not Subscribe
 Affordable Pricing
Opportunities Threats
 Video Game Expansion  Staying Power of DVDs
 Downloadable Movie Expansion  Contractual Restrictions On Streaming
 Advertisements In Envelopes Content
 Partnerships With Content/Technology  DVD and Streaming Competition
Providers

Netflix is a very attractive company. Their strengths are based on customer value. They
can maintain this with low overhead and still be profitable. They have many opportunities
for growth and their threats and weaknesses are within their power to overcome and
prevent. They have the resources and efficiency to stay on top of the market.
7. What is your appraisal of Netflix Operating and Financial performance? What
positives and negatives do you see?

Netflix Operating and Financial Performance (in millions) (US dollars)

Profitability 2008 2009 2010
Total Revenue 1364.7 1670.3 2162.6
Cost of Goods Sold 910.2 1079.3 1357.4
Gross Profit 454.4 591.0 805.3
Gross Profit Margin 33.3% 35.38% 37.24%
Net Income 83.0 115.9 160.9
Net Income Margin 6.1% 6.9% 7.4%
Operating Expenses 332.9 401.2 521.6
Operating Income 121.5 189.8 283.6

Liquidity 2008 2009 2010

Current Assets 358.9 411.0 641.0
Current Liabilities 216.0 227.4 388.6
Current Ratio 1.66 1.81 1.65
Cash or Equivalent 139.9 134.2 194.5
Cash Ratio .65 .59 .50

Leverage 2008 2009 2010

Total Liabilities 268.3 480.6 691.9
Total Assets 615.4 679.7 982.1
D/A Ratio .436 .707 .704
Total Equity 347.2 199.1 290.2
D/E Ratio .773 2.41 2.38

Netflix has increased both gross and net income margins for three consecutive years.
Their margins are also very healthy. Their Operating Income is very healthy and has also
increased for three consecutive years. This means that they are an extremely efficient
business and are achieving economies of scale. They are very solvent. They can cover
short term liabilities over 1.6 times. The only negatives are that they took a substantial
debt load during 2009 which makes them very highly levered, however, they do have
strong consistent cash flows to cover their expenses. This is likely due to keeping up with
technological demand in a low profit industry. Overall, Netflix is very healthy financially
and considered a good company to invest in.
8. What does a SWOT analysis of Blockbuster reveal about the overall
attractiveness of its situation?

SWOT Blockbuster

Strengths Weaknesses
 Well Recognized Brand  Significant Liabilities
 Global Presence  Too Many Brick and Mortar Stores
 Too Large To Adapt to Industry Shift to
Streaming and Mail Delivery
Opportunities Threats
 Kiosks are Growing Industry  They are in Bankruptcy
 Try to Maintain a Streaming and/or  Creditors
Mail Presence  Liquidation of Assets
 Video Game Market Growth  Netflix

Blockbuster is currently in bankruptcy and on the auction block for an estimated $250 -
$300 million dollars. Trading has been suspended and their stock and bonds are
worthless. They have significant debt and have lost billions of dollars over the past
several years. They are likely to be bought at pennies on the dollar and sold off and
liquidated. Most creditors will not see a dime of repayment. We rate Blockbuster as
extremely unattractive.
9.What is your appraisal of its performance.? What pluses and minuses do you see.
Use the financial ratios in the text appendix of the text as a guide in doing the
calculations needed to arrive at an analysis-based answer to your assessment of
Blockbuster’s recent performance.

Blockbuster Operating and Financial Performance (in millions) (US dollars)

Profitability 2008 2009 2010

Total Revenue 5289.0 5065.4 4062.4
Cost of Goods Sold 2540.3 2435.1 1884.2
Gross Profit 2748.7 2630.3 2178.2
Gross Profit Margin 51.9% 51.9% 53.6%
Net Income -73.8 -374.1 -558.2
Net Income Margin -1.4% -7.4% -13.74%
Operating Expenses 2788.6 2486.2 2141.0
Operating Income -39.9 144.1 37.2

Liquidity 2008 2009 2010

Current Assets 1319.2 1258.6 1060.0
Current Liabilities 1288.5 1253.4 934.8
Current Ratio 1.02 1.00 1.13
Cash or Equivalent 184.6 154.9 188.7
Cash Ratio .143 .123 .178

Leverage 2008 2009 2010

Total Liabilities 2077.9 1940.2 1852.6
Total Assets 2733.6 2154.5 1538.3
D/A Ratio .760 .901 1.20
Total Equity 655.7 214.3 -314.3
D/E Ratio 3.17 9.05 Incalculably Bad

From an Operating and Performance standpoint it doesn’t get much worse than this.
There is absolutely nothing positive about this analysis. Blockbuster is in way too much
debt to rebound. Their revenue has decreased for three consecutive years. Net Income
Margin has decreased at an increasing rate. Blockbuster is insolvent and the Debt Ratios
show why they are in bankruptcy. The 2010 Debt to Equity Ratio cannot be calculated as
the denominator is negative. There is nothing attractive about Blockbuster at this point.
10. How does Netflix’s competitive strength compare against that of Blockbuster?
Do a competitive strength analysis to support your answer.
Does Netflix have a sustainable competitive advantage?

To examine the competitive forces of Netflix and Blockbuster, we constructed a

competitive strengths model which can be seen below.

Strengths: Netflix Blockbuster

Relative Cost 9 5
Brand Image 10 9
Distribution 9 7
Differentiation 9 7
Convenience 10 6
Total: 47 34

Based on our analysis, it appears that Netflix is significantly stronger than Blockbuster.
Netflix has positioned itself as one of the industry leaders by offering a relatively low
cost and convenience that Blockbuster and other rivals are having a hard time matching.
Blockbuster and other movie rental stores as well as DVD retailers are having a harder
time matching up with the other rivals because of their inability to offer instant access to
movies and there prices are higher. Netflix’s online strategy has given them a sustainable
competitive advantage because they are taking advantage of technological changes by
using them to offer movies instantly to buyers.

11. What 2-3 top priority issues does Netflix management need to address?

In order to maintain their position as the leading provider of movie rentals online, Netflix
management needs address their ability to continue to grow as a DVD subscription
business that delivers movies at a fast speed, to keep up with the latest technology, and to
increase marketing campaigns to attract new customers. Their subscription business
attracts buyers because they are able to offer all of the benefits of an in-store movie rental
place, but allows consumers not to leave the comfort of their homes. Management needs
to ensure that they will continue to offer these perks of convenience at a low price which
should keep them as an industry leader.

12.What recommendations would you make to Netflix CEO James Reed Hastings
At a minimum you’re your suggestions should cover the priority issues identified.
Mr. Hastings has done a top notch job thus far. Netflix now sits alone at the top of the
movie rental industry. No company can match them for streaming content. The closest
challenger on the DVD side is Blockbuster and RedBox, however, Blockbuster is now
bankrupt and RedBox is kiosk only rentals. We would suggest that Netflix continue to
add value to their product by continuing to be efficient and keeping costs low. This is
where Blockbuster failed. Counting on $250 - $300 million of late fees for part of your
revenue stream is neither efficient or consumer friendly. As long as Netflix continues to
adapt and not become comfortable with their profits they will be successful.

13. What recommendations would you make

to Blockbuster CEO James Keyes?

To Mr. Keyes credit, he did make major changes after coming on board as CEO in 1997.
He saw opportunities in video gaming, online rentals, monthly subscriptions, and kiosks.
Unfortunately for him, Blockbuster was extended beyond sustainable proportions when
the market shifted to online and streaming rentals. There were too many brick and mortar
stores, too much reliance on late fees as a revenue source, and most importantly they just
became a bloated company unable to adapt to the changing market. We now recommend
Mr. Keyes enjoy his retirement package somewhere warm and sunny.

At a minimum recommendations should cover the identifies priority issues.

Please include all you analyses to support your answers.