24 - Chapter 4 Textbook Notes Netflix PDF

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Chapter reading quiz notes and answers for Professor Finney's MIS 301 Class...

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Chapter 4 Textbook Notes: Netflix Introduction: -Netflix was known for its very good service -Netflix was met with troubles when it tried to transition to internet streaming rather than DVD shipping mainly because it struggled to communicate its repricing scheme and it failed its attempts to split the firms into two separate services -Reed Hastings (CEO) was correct in his decision to transition the firm though because he knew thats where the future of the industry and the technology was headed -The business of streaming is radically different from DVD by mail: content costs, content availability, revenue opportunities, rivals, and their motivation and more are all different -Netflix is on top rn, but whether they will stay there is threatened by the fact that competitors have wildly different sets of strengths (disney with content, apple with hardware customers, and amazon giving product away as a free perk) -Netflix uses tech to both craft and reinforce its competitive advantage, but more importantly it is a rare example of a firm that has continued to lead after having shifted its focus from one business model to the next Part 1: -Reed Hastings said his greatest strategic regret was taking his firm public too early because it meant he had to disclose the firms financial info and that attracted the competitors Walmart and Blockbuster Netflix’s 3 Critical and Reinforcing Resources 1. Brand - Brand is not to be confused with advertising - Brands are built through customer experience - Even though Walmart and Blockbuster had strong customer awareness they were unable to translate that awareness into advantage when competing with netflix because Netflix from the beginning realized that it was the providing of a good customer experience that would make consumers associate Netflix with DVD by mail. Everyone else has to spend big to try and compete with the brand Netflix already established early 2. Scale - The one asset that neither competitor had that netflix was able to leverage strategically was its network of 58 highly automated distribution centers that allowed it to distribute DVDs in the mail at next-day speeds, none of the competitors had an operation of this scale which hurt their customer experience and in turn their brand - Additionally, Netlfix’s vast selection of content compared to competitors also attracted customers (long tail) - Long Tail: refers to an extremely large selection of content or products, this is the phenomenon whereby firms can make money by offering a

near-limitless selction. Online firms have a massive advantage in this over offline ones because they can store inventory in ways that offline firms cant match and selection attracts customers - Finally, the size of the customer base of a firm is another key scale component. Economies of scale, like this one is, dictate that a firm with a larger customer base should be able to spread its investments across increasing units of production allowing them to have a better cost structure, profit prospects, and offer better pricing. - In summary, the combination of netflix’s threefold scale advantage (distribution centers, variety of content, and customer base) created what gave them a competitive advantage that was not able to be imitated at the time 3. Data Asset - The massive amounts of user data netlfix collects and feeds into its proprietary recommendation system Cinematch - Collaborative Filtering: software that monitors trends among customers and uses this data to personalize an individual customers experience - The effective use of collaborative filtering can actually incur a switching cost upon users. Switching to a competitors means all of their preference data will be lost and thus their user experience suffers - In fact, when Walmart and Blockbuster did release their copy-cat services, netflixs’ churn rate (rate at which customers leave a product or service) actually declined - Netflix also uses its Cinematch software to demand shape by also analyzing inventory and prioritizing recommendations of in stock inventory so customers are not frustrated by wait times - Finally, Cinematch was also leveraged by netflix to partner with studios in exchange for their content catalogs for a cut of netflix subscriber revenues each time a user requests a given DVD. -In summary, netflixs ability to MOVE FIRST in establishing its 3 resource advantages and using technology to compliment them allowed them to craft a very valuable and mutually reinforcing pool of assets. However, now even newer tech threatens Netflix. Part 2: - Netflix’s DVD by mail business is actually still profitable due to innovations like custom sorting machines that operate five times more efficiently than prior worker heavy efforts so the firm has no need to shut down that business as of right now, but that does not mean the service is not on its way to going away -However, the transition to video streaming does present entirely new set of business opportunities and challenges Qwikster Debacle

-Product launch by Reed Hasting that was hailed as one of the worst of all time -Netflix tried to separate its now 2 distinct services into 2 separate brands and websites with Qwicktser now becoming the site customers would need to go to for DVD by mail and netflix becoming the streaming site -The two were unveiled with 2 separate subscription costs ($8 each rather than $10 for the service before) rather than being bundled into one and this caused lots of consumer backlash -The rebranding was also a failure because they failed to secure the twitter tag @qwikster and it was currently being used by an account that featured inappropriate content -Qwikster was abandoned but the price increase was not and this saw netflix lose 800,000 customers, its stock drop from 304 to 75 and its market value shed over $12 billion -Hastings later admitted that the transition was done too fast and that was his mistake so he later announced that the firm would be raising rates by $1 but only for new customers and for existing ones they would be given a 2 year grace period. This was met by the consumers in a much more calm manner without any outrage Digital Products and Marginal Cost - Often people argue that the marginal cost of producing digital goods is basically zero but that not necessarily true -These costs include: -payments to telecommunication providers -cost of running programs on the servers of other companies (Netlfix actually uses computers provided by the cloud computing servies of Amazon (Coopetition - situation where firms both compete and cooperate with each other) -License fees if content providers charge netflix a per unit basis for streamed content Content Acquisition: Escalating Costs, Limited Availability, and the “Long Enough Tail” -First Sale Doctrine: US supreme court ruling that made Netflix’s DVD by mail business possible. It states that an individual who knowingly purchases a copy of copyrighted material legally from the copyright holder now has the rights to sell, display, or otherwise dispose of the particular copy. Meaning that as long as a studio retails that content, netlfix can buy it at full price and then has the rights to redistribute it to others. HOWEVER, THIS ONLY APPLIES TO PHYSICAL DISCS AND NOT STREAMING AND THIS IS A BIG PROBLEM FOR NETFLIX BECAUSE IT MEANS THEY CANT OFFER INTERNET STREAMING WITHOUT SEPARATE STREAMING LICENSES -The number of firms offering high demand content is very limited (6 firms control over 90% of US media consumed) and because their products are perfectly differentiated they have very strong bargaining power -Previously if Netflix couldnt purchase discs from the original supplier of the content they could buy them from other firms who were selling them to the public. However, with streaming the only place you can get the content is from the original owners themselves. -Additionally, the number of competitors at the video streaming table has increased causing even higher prices due to rivalry -DVDs are owned for life once you purchase but licenses must be renewed and the cost of

renewing has increased dramatically (Starz network deal with netflix was $30 million but 3 years later they turned down netlifxs 300 million offer to renew) -Netlfix’s recent cost of acquiring streaming content rose to 43x the amount it spent just five years earlier -All of this variability in cost to acquire content makes planning long term cost estimates very hard for netflix -Windowing: making content available to a given distribution channel for a specified time window, usually under a different revenue model before a more accessible and cheaper way of offering that content is made available if it even is made available in another way at all (pay per view, movies in theaters before DVD) -This complicates Netflix even more because they dont want to undercut higher revenue early windows of offering content but also means that things like exclusive contracts could cause media to be pulled from other services until that pay-window period is up. Ultimately it means that you have to have a strong legal team in order to be a player in the streaming media business to make sure you are able to defend and enforce your streaming rights to content -Some firms also just flat out refuse to give Netflix rights to stream their content -Key Takeaway: the increased difficulty in acquiring content in the form of streamable bits as opposed to physical discs means that Netflix has had to take a more curated approach to content acquisition. It no longer has the “longest tail” but a “long enough tail” meaning it no longer has the biggest library of selection but it tries to ensure that there is always enough to interest customers consistently Suppliers and Atoms to Bits -Studios may be wary of granting NF increasing power over product distribution and this may motivate them to keep rivals around. If they rely too heavily on one distribution channel for a large portion of their deals then that partner has an upper hand in negotiations Exclusives and Original Content -Because of the threat of firms like disney who can offer lots of high demand exclusive content Netlfix realized that it could not rely on non-orginal content to keep the firm competitive because the price to acquire new in demand content was only going up -The solution was to become an original content creator and Netflix has been very successful in doing so creating both shows and movies with big stars. -Netflix now considers itself “television network” and its own titles represent about 80 percent of US viewing -Exclusive content production is NOT cheap however -In 2018 the cost of original content was between 7.5-8 billion $$ and 26 fold increase in five years -The benefits of original content include subscriber number growth and and increased customer engagement and decreased customer churn -The firm had 125 million subscribers reported in early 2018, for reference there is only 94 million subs in the entire US pay-tv market -NF does all this while other pay tv providers have been experiencing declines in customer numbers

-OTT: an industry term referring to media services that are provided over the Internet instead of through conventional broadcasting mechanisms like cable or TV broadcast. -Profitability is helped since subscriptions are booked right away, while the cost of producing titles can be spread out over several quarters. -Another benefit of purchasing ownership over licenses is that when you expand to new places you dont have to pay up for additional licensing. Additionally, complete ownership gives netflix the option to produce DVDs or even offer licenses to other streaming sources for additional sources of revenue

Streaming and the Data Asset -Netflix has a growing and exquisitely detailed treasure trove of data that is far stronger than what rivals can assemble -This data: -Helps the firm make more accurate recommendations -Improve UI design -And especially help determine the cost for acquiring new content and shape creative decisions regarding original program offerings -Previous DVD by mail data came from and relied on users rating what they viewed each time but this also could not keep track of other factors like whether you watched multiple times, whether you finished what you started etc -The streaming service can collect all this data and more and it feeds it into its collaborating filtering software to keep providing customers with recommendations they will enjoy -75 to 80% of whats watched on netflix comes from recommendation not user search -Its estimated that this data and software has saved the firm $1 billion dollars a year because the customer satisfaction it provides prevents customer churn -Data analysis is also used to tailor and improve user experience over time through the uses of tools such as the A/B test -A/B Test: A randomized group of experiments used to collect data and compare performance among two options studied (A and B). A/B testing is often used in refining the design of technology products, and A/B tests are particularly easy to run over the Internet on a firm’s website. Amazon, Google, and Facebook are among the firms that aggressively leverage hundreds of A/B tests a year in order to improve their product offerings. -Data also helps netflix make better content investments. Through the data it gathers netflix can establish a piece of contents value to Netflix as an asset. If the data shows that the content costs more than the value it adds to NF then the executives are likely to pass. This ultimately allows the firm to make more informed and confident decisions, although they are not always perfect ones. The same goes for decisions on which original content to produce. -Netflix shows have an 80% success rate vs 30 to 40 of traditional TV network shows bc they are based on data from Netflix’s data asset -Data is also used to offer tailored audience promotions. Multiple trailers may be filmed for content but the one that is shown to each user is determined based on data gathered previously

about the users viewing preferences. This data has even previously been used to influence casting decisions on shows such as Orange is the New Black Disintermediation, Digital Distribution, and Gathering Customer Data -Disintermediation: the removal of an organization from a firms distribution channel. Disintermediation collapses the path between supplier and customer -

Examples: recent purchase of NBC Universal by Comcast = both vertical integration and disintermediation, Netflix's move into original content creation Disintermediation in the video industry offers two potentially big benefits. First, studios don’t need to share revenue with third parties; they can keep all the money generated through new windows. Also critically important, if a studio goes directly to consumers, then studios get to collect and keep a potentially valuable data asset. If another firm sits between a supplier and its customers, the supplier loses out on a key resource for competitive advantage

Streaming Changes Viewing Habits and Frees Creative Constraints - WWW = the ability to view what you when, when you want it, on whatever screen is available - The ability to binge watch increases customer retention for a show rather than having to wait whole weeks between episodes - Not having to allocate primetime viewership like a traditional tv network does, streaming platforms can more prudently support new shows and nurture them over time as they grow their user base - Additionally, the dropping of the 22 minute commercial television show duration means shows have more creative freedom and can tell more complex stories Customer Experience, Complexity, Pricing, and Brand Strength - Netflix is unique in its choice to offer all of its content and screen number for a single monthly sub fee - This is in contrast to firms like Apple, Google, Amazon, Hulu, and cable operators, who all offer a mix of pricing schemes that might include buying content, pay-per-view, commercially supported content, and subscription for additional premium offerings. Streaming and Scale Advantages - Studios are more likely to accept a 200 million dollar exclusive check from NF than 3 50 million dollar checks from smaller studios, so once again advantage goes to the biggest player - Scale advantages come from both the size of the streaming library and the scale of the customer base which gives them the ability to pay for that library - Larger more profitable firms also gain pricing advantages being able to offer lower prices than most competitors for their service The March to Global Dominance

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Netflix has expanded to become the biggest global player by far but does face some regional competition from powerful regional players Expanding internationally incurs large up front costs for things like marketing and local content licenses Also complications with different laws arise and issues with countries that have censorship But Netflix global bet is now paying off. For the first time, Netflix’s international segment turned an annual profit in 2017, and international subscribers now make up more than half the firm’s user base

It’s a Multiscreen World: Getting to Netflix Everywhere - Instead of trying to put netflix on television screens by developing a hardware cable box that consumers would have to buy, Netflix developed a software platform and made it available to manufacturers seeking to include netflix access in their devices - Today, Netflix streaming is available either as an app or baked directly into over a thousand consumer electronics products, including televisions, DVD players, video game consoles, phones, and tablets. And that internally developed Netflix set-top box? The group was spun out to form Roku, an independent firm that launched their own lowcost Netflix streamer, and which today is a publicly traded firm with the largest share among television streaming devices. - Netflix has found trouble trying to be offered through the cable provider set-top box since the cable providers are leery of streaming services that don’t require their networks So What’s it Take to Run this Thing? - The bulk of the Netflix computing infrastructure runs on Amazon’s servers. But using Amazon Web Services has enabled Netflix to grow its services by millions of customers without adding any data center capacity since 2008. - Netflix is the biggest AWS customer, drawing “many tens of thousands” of servers at a time - Netflix’s storage appetite is voracious. The master copies of all the shows and movies that the firm streams, plus all the additional data cataloged and used for personalization and machine learning collectively amount to upwards of 12 PB of data per day routed through an Amazon S3 data warehouse that itself contains 100 PB of highly compressed chunk of Amazon cloud storage - Netflix also uses so-called complexity-based encoding, which shrinks files based on the type of content being streamed. - As the pioneer in the field, Netflix has been forced to build most of the software it needs from scratch. - Also surprising—Netflix gives away a huge portion of software that its team has developed. DOES NOT GIVE AWAY SOURCES OF COMPETITIVE ADVANTAGE SUCH AS THEIR COLLABORATIVE FILTERING ALGORITHM Crowdsourcing and Code Contests: The Netflix Prize and Beyond - While Netflix is widely considered to have a best-in-class collaborative filtering engine in

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Cinematch, the firm also realizes that it has no monopoly on math. So the firm previously ran a competition, known as the Netflix Prize, ponying up $1 million to the first team that could improve Cinematch scores by 10 percent. The Netflix Prize is an example of crowdsourcing, a technique in which a firm states a problem it would like solved, the reward it will provide, and then makes this available to a broader community in the form of an open call

A Crowded Field of Rivals and Other Challenges - Rivals with deep pockets who are willing and able to take losses while they chip away at netflix’s market share such as Amazon and Apple could spoil the netflix party - Breakdowns in infrastructure can also lead to huge customer loss but nearly every firm in the space is faced with this problem - Then...