ATENEO DE MANILA UNIVERSITY

Graduate School of Business

Netflix Case Analysis

Submitted to:

Prof. Hans Clifford Yao

Submitted by:

Sheila Mae P. Adaya

22 July 2019
1. What was Netflix’s original value proposition? And how did external/industry factors change this over
time?

Originally, Netflix’s value proposition which differentiates it from other home movie service providers is
offering its movie selection through an online store, with home delivery via postal service. In its online
store, customers accessed a search engine where they can easily sort through Netflix’s movie selection and
build a list of movies they wanted to receive from Netflix, called a queue. Movies are then shipped to the
customers via mail.

Over time, various external factors have led to the change in Netflix’s value proposition. First, there was a
rapid adoption rate of DVD players in the US. At that time, DVDs were beginning to be sold at large retailers
and were gradually replacing VHS cassettes. For Netflix, such change slowly eliminated the convenience
advantage that Netflix initially offered to DVD viewers.

Also a major external factor is the high cost of acquiring movies for rent especially for brand new releases,
coupled by strong customer awareness and demand for such movies. Due to the high cost, Netflix is
restrained to choose carefully when stocking new films and often resulted in fewer than the desired
number of copies being acquired. With this limitation, Netflix had to devise a way to stimulate demand on
older and lesser known movies that were already in their catalog and paid for.

2. What are some of the critical internal capabilities that Netflix had to develop as its strategy changed from
the original model to the current one? Analyze on the basis of the firm’s strength, weaknesses and ARC.

Netflix’s architecture, being a start-up company, is designed to easily adapt to technology as it strives early
on to create a Web portal rather than a subscription service. This is also exhibited though its efforts to
concentrate on early-technology adopters who had recently purchased DVD players. Furthermore, Netflix
leveraged the most successful internet retail models to identify the characteristics that would appeal to
customers. In terms of routine, the Company integrate customer feedback on their operations which also
speaks about the Company’s culture that focuses on customer satisfaction.

In line with this, the Company’s strengths include having flexible and innovative human resource, led by
its visionary founder Reed Hastings. Netflix also maintained high customer engagement in order to
continuously improve its services. Later on, Netflix has gradually built its reputation as the highest-quality
source of independent films.

On the other hand, the Company’s weaknesses include having limited movie library which often caused
customer dissatisfaction. Moreover, it only has a single distribution center which also led to slower delivery
times. Because of the slower delivery times, customers became reluctant to come back for repeat purchases
as they didn’t see any value from it.

Given these internal factors, Netflix has strategically developed its internal capabilities in order to be able
to adapt to its current model. With the high cost of acquiring movies for rent especially for brand new
releases, Netflix has only maintained a limited online library which eventually caused customer
dissatisfaction in renting new releases. To address this, Netflix, through its engineers, developed a
proprietary recommendation system that helped stimulate demand on older and lesser known movies that
were already in their catalog and paid for. Further, Netflix also maintained high customer engagement
through short surveys and movie ratings as well as brief survey from departing subscribers which allowed
them to better understand their customers and create tailored recommendations. As they developed their
proprietary recommendation system, Netflix gained a competitive advantage which engaged customer
preference and interest while at the same time, allowed the Company to promote smaller films.
 Netflix also further strengthened its management team by hiring a highly experienced individual (Ted
Sarandos) as chief content officer in order to manage content acquisition. Through Sarandos, Netflix was
able to transition to revenue sharing agreements wherein Netflix would now have to pay a lower up-front
price in return for a fee based on the title’s total number of rentals for a given period of time.

Also with the aid of Netflix’s proprietary system, the Company gained the ability to drive demand for lesser-
known movies. With this strength, the Company was able to manage its acquisition costs as well as to build
a reputation in the movie industry. It grew to become a distribution channel for many small and
independent film studios. Building on this reputation, Netflix then started to acquire distribution rights to
certain independent films.

In addition, Netflix decided to turn long delivery times into advantage by moving to a prepaid subscription
service. The Company adjusted its pricing mechanism to provide better value to customers and started
offering unlimited rentals with no late fees.

Finally, to further improve its efficiency, particularly in terms of delivery time, Netflix increased the
number of distribution centers across the country. As a result, subscriber numbers quickly responded to
the improved quality service. By early 2007, there were 44 distribution centers and 90% of subscribers
could be reached within one delivery day.

Overall, by continuously developing its internal capabilities, Netflix has gained the strength of having the
first mover advantage which allowed it to operate competitively in providing home movie services. Netflix
also optimized its content suggestion and established revenue sharing agreement which allowed the
Company to keep a lower overhead on content and thereby extend its online library.

3. What are some of the external risks that the emergence of VOD create for Netflix?

One of the external risks in the emergence of VOD is the technology required to operate the business. VOD
was perceived as limited until the hardware needed to connect a user’s computer to their television was
more widely available. The imperative to make content available across technology platforms and for
different operating systems increased, as various handheld devices proliferated in subsequent years. As a
result, Netflix invested about $40 million to develop its early streaming feature and involved content
formatting software that could be installed on a PC under a minute.

Another external risk is content availability. There has been a growing concern on pirated downloads and
a lack of urgency to supplant their profitable DVD sales made studios reluctant to offer much content to
VOD websites.

Moreover, competition in the VOD space has heated up with new entrants coming from production studios,
technology giants and traditional pay TV networks. Cable providers has viewed Netflix as a clear threat
being an aggregator of diverse content. As such, cable providers have launched their own web streaming
services in direct competition to Netflix. An example is HBO Go who has expanded its service to rival
Netflix’s breadth of selection in streaming and owned exclusive content that could not be viewed on Netflix.

4. Between Netflix and Blockbuster in its original business model, name 3 critical success factors and explain
why they are critical business success.

(1) Extensive movie library

Customers like variety. While a large number of customers would eagerly want to have the latest movies,
a video rental store that only stocks the newest releases will not appeal to all markets. Customer
 preference in terms of movie selection widely differ, and as such, it is very important that video rental
stores keep an extensive movie library.

(2) Strong network of distribution channel

Watching a movie is a form of leisure, hence, customers would look for accessibility and convenience when
looking for a video rental store. The importance of a strong network of distribution channel is highly valued
by Blockbuster who based its growth strategy on opening new locations with the objective of expanding
geographical coverage and increasing penetration in existing markets. Meanwhile, Netflix initially had a
single distribution center which compromised its delivery time, leading to customer dissatisfaction.

(3) Price

Customers are price-sensitive. Between to video rental stores within the same vicinity and offering the
same movie, price becomes the differentiating factor. For customers, the price does not only include the
price of renting the video per se, but also considers late fees to be charged. Customer’s sensitivity to price
is reflected on Blockbuster’s response to Netflix who decreased its subscription twice which resulted to
increase in traffic and rental volumes, although insufficient to offset revenue loss.

5. For Netflix in the VOD industry, name 2 main competitors, discuss 3 critical success factors, and explain
why they are critical to the success of the business.

Based on the case, Netflix considers HBO Go as one of its main competitors. HBO Go was launched by HBO
(one of the large cable providers in US) which, since its launch in February 2010, has expanded its service
to rival Netflix’s breadth of selection in streaming and owned exclusive content that could not be viewed
on Netflix. Another strong competitor is Amazon Instant Video whose streaming service is bundled with
Amazon Prime subscription. Like Netflix, Amazon Instant Video also offers DVD-by-mail.

(1) Movie and TV content availability

Customers would generally not subscribe to any VOD service if such service does not offer the movie or TV
show that the customer prefers. Netflix prides itself as the definitive provider of online entertainment for
its subscribers, offering deep catalog with diverse content. Meanwhile, Amazon Instant Video holds more
than 40,000 DVD movie titles available for rent while its streaming services offer 2,500 movie title and
4,000 TV show episodes. On the other hand, HBO Go still offers limited content given more than 200 movie
titles and over 1,400 TV show episodes. Nonetheless, HBO Go holds exclusive rights on popular shows
produced by HBO.

(2) Value for money

Given a low-switching cost, customers remain price-sensitive in choosing a VOD provider. Such customer
behavior is exemplified by the response received by Netflix from its subscribers when it announced the
dramatic change in its product strategy wherein they shall have unbundled pricing for its online streaming
and DVD-by-mail services. As a result, many users have expressed their dismay and promised to cancel
their subscriptions and switch to other service providers. Based on the case, Netflix charges the highest
price given the monthly subscription fee of $7.99 while Amazon Instant Video and HBO Go are free for their
respective subscribers for Amazon prime and HBO.

(3) Ease of access

Customers, nowadays, look for “instant gratification”. As such, customers would prefer VOD providers that
are easily accessible. Ease of access may be reflected as to whether the services can be accessed through
multiple devices since users would want to choose and watch video content whenever and wherever they
 wanted to. It also includes friendliness of user-interface and comfort while watching (i.e., little to no lag
time, clear quality, etc.). This factor is largely impacted by the company’s technological capacity. Notably,
services of the three companies are accessible in multiple devices such as PC and mobile device.

6. Using Porter’s 5 forces, discuss the attractiveness of the VOD industry for Netflix.

A. Threat of New Entrants (MODERATE)

Entry into the industry is unregulated, but constrained by the cost of getting distribution rights from
studios. Further, entering into the VOD space requires capital investment, supplier contracts and
networking in the industry which can be difficult to follow by a new entrant. Nonetheless, the level of threat
is moderated due to the evolving technology and changes that emerge as a result of technology
development. Further, with the aid of Internet, the delivery of video and television content may gradually
decrease the cost of operating the business.

B. Bargaining Power of Buyers (HIGH)

The low switching cost allows the customers with option to cancel their subscription and pursue other
media providers which increase the business threat to the company. In addition, customers can subscribe
to many providers at the same and, therefore, can easily compare between providers. Due to this pressure,
companies can’t charge high prices from the customers and need to keep the pricing strategy according to
the demand of the customers, with minimal price increase. Moreover, high bargaining power from
customers results in maintaining service quality that is in accordance to the customer needs and
preferences. Also, technological development and preferences in video consumption are continually
changing, which causes consequences such as unstable buyers’ preferences, thereby further strengthening
the bargaining power of buyers.

C. Bargaining Power of Suppliers (HIGH)

The process of acquiring movies and other audiovisual programs is controlled all the way through revenue
sharing, licensing and direct purchases. These agreements allow companies to stream video content which
are predominantly acquired from studios, networks and distributors. Obtaining a contract and acquiring
the license to distribute the content involves negotiation on pricing, where suppliers have an edge. While
smaller and independent content providers may exhibit low bargaining power, in general, suppliers hold
high bargaining power. Suppliers such as networks, studios, and distributors usually have full control of
prices that the internet streaming companies must pay for the video content.

D. Threat of Substitute Products (MODERATE)

The substitute products pose moderate level of risk. Netflix faces threat from substitute service which are
offering similar products through rental DVDs and online streaming. In addition, the traditional media
content providers constitute another example of substitute product. Since these are relatively similar
products and the cost of switching is usually minimal, trivial fluctuations in prices can initiate consumers
to cancel that particular viewing format and replace it with alternative, usually very similar, one. In
addition, customers can also engage in other sources of entertainment and leisure activities than online
streaming and watching media content.

E. Competitive Rivalry

Netflix is facing strong competition from traditional broadcasters and rival companies providing videos on
demand. VOD involves a broad range of technologies and channels of distribution. Rivalry includes not only
internet streaming companies, but satellite enterprises’ VOD services, cable networks who air movies on
television and websites running video.
Netflix had just recently entered the content production business, with the company now producing and
releasing original TV series and movies. What do you call this strategy? Is this the right strategy that has
been formulated by the company? Analyze briefly by an external and internal analysis, and by defining the
strategic framework (where, what, how, why).

Goal: WHERE?

At the onset, Netflix envisioned itself as the ultimate online destination for movie enthusiasts. This vision
is being supported by offering a recommendation list to any user, whether they were active customers or
not. As part of its early strategy, Netflix was trying to create a Web portal rather than a subscription service.

Scope: WHAT?

In its early beginnings, much of Netflix’s activities are focused on asset deployment. They utilized their
human resource and customer insights in creating its proprietary recommendation system which later on
became its competitive advantage not only to its customers, but as well as to its suppliers.

But as it recently entered the content production business, the scope of the activities are now focused on
asset acquisition considering this is a different line of business within which Netflix is originally operating.
As such, Netflix would need to acquire additional resources, not only physical equipment and software, but
as well as the necessary skills and expertise.

Competitive advantage: HOW?

In order to achieve its long-term goals, Netflix is now doing a BACKWARD INTEGRATION wherein they are
now doing the activities which its suppliers, who are the content creators and aggregators, are doing, With
the high cost of acquiring content, Netflix can save on cost when they produce their own content and
thereby re-allocate the cost savings in further developing its services for its customers. In addition, this
may also be a strategic response the the stiff competition in the VOD industry as cable providers are
forwards integrating and launching their own streaming services. Just as HBO Go is offering exclusive
access to certain shows produced by HBO, Netflix can also offer the same exclusivity to the shows that it
creates.

Logic: WHY?

Netflix can succeed in this strategy given its strong reputation as the world’s leading internet subscription
services, boasting of a large subscriber base at over 20 million subscribers. It has grown to become the
definitive provider of online entertainment for its subscribers. Further, their large subscriber base can
translate to deep customer insight to which they can utilize in understanding what type of content do
subscribers prefer. Through data analytics, Netflix can better understand what genre is more in demand as
well as artists who are popular among subscribers. Such analysis is useful in determining what content to
produce. Finally, their proprietary recommendation system can also aid Netflix in promoting the content
that they produce.

In general, backward integration may be a viable strategy to Netflix given the external factors that are
affecting its current business and the internal capabilities and competitive advantages that is possess,
However, while Netflix can save on the cost paid to content providers as they backward integrate, Netflix
may have to incur additional investments to obtain the needed resources in content production. Notably,
according to the case, Netflix had the opportunity and cash to bypass content providers by creating its own
proprietary content, but Netflix may not have the necessary skills required in content production business.
Alternatively, Netflix can explore the possibility of building strategic alliances (through a joint venture)
wherein Netflix can partner with smaller content creators who have the resources (such as equipment and
skills) in content production. In the long-run, once Netflix has acquired the necessary expertise in content
production, the Company may later on full-integrate content production in its business.