Strategic Report for Netflix, Inc. – Pomona College Economics

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Strategic Report for
Netflix, Inc.




                         Hillary Carroll
                       Alex Menenberg
                              Ian Kwok

                         April 20, 2009
Netflix, Inc.



Table of Contents
Executive Summary ..........................................................................................................................3
   History .............................................................................................................................................5
   Business Model .............................................................................................................................6
Competitive Analysis ........................................................................................................................7
   Overview ..........................................................................................................................................7
   Porter's Five Forces......................................................................................................................8
   Internal Rivalry ..............................................................................................................................8
   Entry and Exit ...............................................................................................................................8
SWOT .................................................................................................................................................11
Financial Analysis ...........................................................................................................................14
   Overview ........................................................................................................................................14
Strategic Recommendations ........................................................................................................20
End Notes .........................................................................................................................................27




April 2009                                                                                                                                    Page 2
Netflix, Inc.

Executive Summary
 
Following a year of continued growth and profitability, CEO Reed Hastings contracted
Oasis Consulting to strategically advise Netflix, Inc. Although Netflix's innovative business
model has led to the company's success, Netflix faces a transitional home entertainment
industry, in which volatile consumer preferences and intense competition prove a major
threat to Netflix's long-term viability. Oasis Consulting assigned the project to their
Entertainment Division, whose lead consultant, Hillary Carroll, has compiled a strategic
report with the assistance of her two colleagues, Alex Menenberg and Ian Kwok. The team
researched Netflix's brief history, business model, industry landscape, competitors, and
financials to provide Netflix with a thorough strategic analysis, which includes a competitive
analysis, SWOT analysis, financial analysis, and concludes with strategic recommendations
for Netflix, Inc. The following briefly introduces the key issues Netflix faces and summarizes
Oasis' findings and strategic recommendations:


Netflix, Inc. is the largest online movie rental service provider, with a subscription base of
over 10 million and an inventory of 100,000 DVD and Blu ray titles. Along with offering a
breadth of titles, Netflix also provides movie ratings, reviews, and a recommendation service
customized to each subscriber's preferences. In addition to its traditional DVD-by-mail
service, Netflix has recently expanded to include digital streaming of over 12,000 titles
instantly to subscribers' computers and television sets.


Netflix acquires distribution rights for its media content through the outright purchase of
video titles and through profit sharing agreements with studios, networks, and distributors.
Netflix has also entered into joint ventures with a handful of electronics companies to
develop television devices that are compatible with Netflix's streaming video content.


Upon first glance, it appears as though Netflix operates in a relatively uncompetitive video
rental industry dominated by a handful of large firms including Blockbuster and Movie
Gallery. Since Netflix's primary competitor, Blockbuster faces a grim financial outlook and
possible bankruptcy, the probability of Netflix gaining greater market share seems inevitable.
However, this forecast is deceiving because the traditional video rental industry landscape

April 2009                                                                               Page 3
Netflix, Inc.
has shifted and now competes directly with digitally distributed visual entertainment. A large
number of small, innovative, internet based firms, like Hulu and Boxee, have penetrated the
digital visual entertainment market and now prove to be Netflix's greatest threats.


Although traditional "brick-and-mortar" video rental outlets will continue to dominate the
video rental industry in the near future, the industry has begun to shift from physical video
formats like the DVD and Blu ray to digital content streamed over the internet and on to
home television sets. This transition will likely make physical DVDs obsolete in the distant
future. It is impossible to determine what technologies or innovations will define digital
distribution markets, but there are a number of firms already vying for market control.
Therefore, Netflix faces numerous competitors that are difficult to detect because they do
not have significant market share as of now, but may have a strategic edge on Netflix in the
long run.


This transitional market landscape proves a challenge to Netflix because not only must they
remain competitive with "brick-and mortar" competitors in the DVD dominated market of
today, but they must also position themselves to remain competitive in future digital
distribution markets. In light of this challenging industry landscape, Oasis has focused on
providing business strategies that will enable Netflix to maintain short-term and long-term
profitability.


In the short-term, Netflix's profitability depends entirely on subscription fees. Therefore, the
company must strive to increase their subscription base through marketing, competitive
pricing, customer service, and breadth of titles. Simultaneously, Netflix must maintain their
current subscription base by reducing churn, the percent of subscribers that cancel their
Neflix subscriptions each year. Netflix must also remain cognizant of and adapt to emerging
industry innovations and technologies, which could undercut Netflix's current business
model.


In the long-term, Netflix needs to position itself as the firm that will bridge the transition
from physical DVD content to digital content distribution. Currently, Oasis believes that
Netflix is the company best suited to fill this roll but we have provided strategies that will

April 2009                                                                               Page 4
Netflix, Inc.
ensure Netflix maintains their competitive advantage over new market entrants. These
strategies include increasing investments in expanding streaming title selection, investing in
more refined streaming technology, and most importantly establishing profit sharing
relationships with studios and networks for exclusive control of content. The final
recommendation will be especially important because both networks and studios will be
major forces in directing the trajectory of the home entertainment industry in the near and
distant future.

 
Company Overview

History
In 1997, Reed Hastings founded Netflix and by 1998 the company began full operations
renting and selling DVDs by mail. It quickly became apparent that the demand for DVD-by-
mail rentals outweighed demand for buying DVDs and Netflix decided to discontinue
DVDs sales and instead focus their business model on rentals. In 1999, Netflix made
another strategic move by phasing out single DVD rentals and introducing a multi-tiered
subscription-rental model that allowed customers to pay based on their demand for DVD
consumption. This pricing experiment proved successful and by 2000 Netflix had
completely abandoned single DVD rentals. Around this time Netflix supplemented its
promising business model by launching its CineMatch application, which generates
customized rental selections for subscribers based on his or her previous rentals and movie
rankings.


By 2002, Netflix's unique service gained enough momentum to pass the 500,000-subscriber
mark and complete an IPO, which allowed Netflix to pay down debt and open more
distribution and shipping centers to reduce time lags between DVD shipments. Throughout
the early 2000s, Netflix continued to increase both its subscription base and inventory of
DVD titles. By 2003 Netflix's subscribers had tripled to 1.5 million and had acquired rights
to over 15,000 titles. However, Netflix's obvious success quickly captured the attention of
in-home video entertainment competitors Blockbuster and Wal-Mart. Both companies soon
released online, DVD-by-mail products that mimicked Netflix's business model. However,


April 2009                                                                             Page 5
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