Netflix Assignment Econ136 - Matthias Boehm PDF

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Matthias Boehm Professor Baden Econ 136 02/26/2018 Netflix Analysis

1. How strong are the competitive forces in the movie rental marketplace? Do a five-forces analysis to support your answer.

Competitive Rivalry The competitive environment of the instant streaming industry in the US between 2010 and 2012 is very tense. Because the market trends predict a vast shift away from DVD rentals and towards online streaming, this analysis will mainly focus on the online streaming industry. Since Netflix started shifting their focus to subscription-based streaming services, many competitors have entered to market to seek long-term profitability. Netflix’s main rivals who also offer instant streaming services for movies and TV shows are Hulu Plus and Amazon Prime Instant Video. Hulu Plus offers its subscribers unlimited streaming and a one-week free trial. The monthly fee is $7.99, which is $2 less than the price charged by netflix. Amazon Prime Instant Video subscribers automatically subscribe to Amazon Prime, a service that allows for 2-day shipping, a free Kindle book rental every month and other advantages. Amazon charges a yearly fee. On a monthly scale, the price comes out to be about $6.60 and therefore constitutes the lowest price of them all. Nonetheless, Netflix maintains the market lead and is the most convincing streaming platform due to its high customer convenience, enormous streaming content library and device availability. Supplier Power The Bargaining Power of Suppliers is fairly high. In this industry, suppliers are defined as entertainment video providers from whom the company has to license content that is then added to their online streaming library. The act of acquiring the right of offering movies on their website is crucial in their ability to attract more subscribers. Once the executive board at Netflix realized that the consumer demand is going to shift from physical DVDs to online streaming, it has exponentially increased their expenditures of licensing movies and TV shows. This is why they currently have an edge on the volume of offered film titles. All

abovementioned rivals have also adopted an exclusive right strategy that allows them to be the only platform to offer certain movies or TV shows. This vastly increases the bargaining power of suppliers. Buyer Power The Bargaining Power of Consumers is also very high. Starting with the switching cost, a viewer is not contracted to an annual accord, and the cost of signing up for service is minimal. Most video streaming service providers offer a free trial, which makes it easy for consumers to switch to other streaming providers. The costs of all three providers is $10 maximum, which is also not very high. Netflix keeps its churn rate low by providing an appealing, friendly and interactive user interface. Another factor that is quintessential to the consumer’s power is the availability of TV shows and movies. Consumers are hoping for their respective platform to add movies and TV shows that match their personal preferences. If Netflix can’t provide these titles, they could easily switch to Hulu Plus or Amazon Prime Instant Video who offer different and possibly more preferable titles.

Threat of Substitution The threat of substitution for the online streaming industry is low. The 60% of U.S. households that aren’t yet subscribed to any streaming platforms substitute Netflix’s streaming services by something else. The company, however, has no control over people’s leisure time. Other people simply prefer watching the news or sports channels instead of catching up on movies and TV shows. Threat of New Entry According to a Nielsen report published in 2014, Netflix serves about 36% of the U.S. households, Hulu Plus serves 6.5% and Amazon Prime Instant Video around 13%. This difference alone suggests that the threat of new entry is huge because seemingly small differences can have such big impacts on the market share of an instant streaming business. However, Hulu, Amazon and Netflix remain the most apparent competitors in the market as of now. Overall, the competitive intensity of the instant online streaming providers is high. From the diverse competitive factors listed above as well as Netflix’s historical development, we can infer that small changes or external factors can vastly affect the profitability and market share of any of these companies. 2. What forces are driving change in the movie rental industry? Are the combined

impacts of these driving forces likely to be favorable or unfavorable in terms of their effects on competitive intensity and future industry profitability? The biggest market trend that is currently occuring is caused by the consumer’s desire for a higher level of convenience. Customer shift from physical DVD rentals to online streaming services to bypass the act of leaving the house to rent a DVD or wait on the arrival of a mail shipment. Many providers saw the change from DVD rentals to online platforms coming and adjusted their business models accordingly. The buyer power has a big impact on the rental industry in that the switching cost is so low. All of the movie providers offer free trials which allows customers to switch platforms and increase competitiveness substantially. The future industry profitability is not impacted by the buyer’s bargaining power in terms of an individual company the competitive intensity is. 3. What does your strategic group map for this industry look like? How attractively is Netflix positioned on the map? Why?

On my strategic group map, Netflix is positioned further away from Amazon and Hulu due to its enormous content library volume. This could be a relevant reason why they the company currently enjoys a much larger market share. Netflix is also positioned a little higher than its two rivals because they charge a slightly higher monthly fee. In sum, Netflix’s position is highly favorable because the

increased title count in their content library will reach more viewers with a diverse range of preferences. 4. What key factors will determine a company’s success in the movie rental industry in the next 3-5 years? I believe that all three streaming providers have to pursue a differentiation strategy on factors that they’re able to differentiate. These factors may include the composition of movie and TV show titles, advanced features that come with their streaming services, the user-friendliness and the price at which a subscription offered. Higher marketing expenses and exclusive rights to titles or private-label movies will also play a factor of this industry’s trajectory. 5. What is Netflix’s strategy? Which of the five generic competitive strategies discussed in Chapter 5 most closely fit the competitive approach that Netflix is taking? What type of competitive advantage is Netflix trying to achieve? Netflix’s core strategy in 2012 was to increase its streaming subscriptions for its online platform domestically and internationally. The executive board of the company decides to pursue three major factors to continuously grow their customer base. First, they want to continue to grow the content library to reach the preference of more customers. Second, they want increase their collaborations with electronics partners to increase the number of Netflixcompatible devices that can be used for streaming. And last, they want to put in an effort to continuously work on the functionality and convenience of their website. Given their current market position, I believe that Netflix is pursuing a broad differentiation strategy. Their strategy is not to provide streaming services at a lower cost, but to design their services so that it is most appealing to a broad spectrum of customers. Their competitive advantage is their brand name, enhanced user convenience, more appealing interface and frankly more titles. 6. What does a SWOT analysis of Netflix reveal about the overall attractiveness of its situation? Strengths Netflix’s strength is their reach to their customers. They not only offer a wide range of recent and popular movies that are particularly appealing to viewers, but

they also come out with exclusive Netflix movies and shows that they have produced and which they can offer exclusively. The quality and reputation of these private-label titles outperforms the attempts of Hulu and Amazon who try to do the same. Besides that, Netflix offers a friendly user interface and has established an interactive rating system that predicts users’ film preferences. Weaknesses Netflix has previously failed to pursue the decisions that they have made. For example, three weeks after announcing the separate company Qwikster which was supposed to take over the DVD-by-mail services, this proposal was dropped again. Furthermore, the company’s operations in international markets has yet to become profitable. Although revenues are growing these segments are not obtaining positive segment margins. Opportunities Although also a current weakness, pursuing an international expansion strategy might become the most important strategy of the company. The international market is not yet saturated with local streaming providers. Therefore, Netflix could have some kind of first mover advantage in european, australian and asian countries. The exclusive content Netflix has been publishing also constitutes a big opportunity for their long-term growth. When eagerly pursued, this could be a means of decreasing the churn rate of the company and to retain more subscribers. Threats Online entertainment services in general are increasing. This could be considered a threat of substitution because people might start to find it more entertaining to watch unrelated videos on Youtube or other video platforms. HBOGO and the CBS Network also offer a more diversified range of entertainment programs. Perhaps an online stream provider merges with a cable channel providers; they could potentially become influential enough to overcome a company such as Netflix. I believe that Netflix is currently in a good position because they are in the process of becoming a more established provider internationally. Their domestic base is already profitable and can stem the temporary costs of segment losses

abroad. As long as Netflix follows a flexible but decisive strategy in the future, they will continue to make profits and serve a lot more consumers. 7. What is your appraisal of Netflix’s operating and financial performance based on the data in case Exhibits 2, 3, 5, and 6? What positives and negatives do you see in Netflix’s performance? Use the financial ratios in Table 4.1 of Chapter 4 as a guide in doing the calculations needed to arrive at an analysis-based answer to your assessment of Netflix’s recent financial performance. We can see significant developments in Netflix’s financial performs between the years 2000 and 2011. While the bottom line in the year 2000 was still negative, Netflix has experienced a net income of $226.1 million in 2011. Their current ratio in 2011 approximately 1.5 which speaks for a rather good financial situation. However, the current ratio between 2005 and 2010 depicted an even higher value. The current value in 2005 was 1.77, for example. This suggests that, in recent years, the company has taken out more loans in order to invest in major projects such as their international expansion. Between 2010 and 2011 Netflix increased their current assets by 65.2% to a total volume of $1,830.9 million. Their current liabilities increased accordingly. On exhibit 5 we can see that the subscriber count has been vastly increasing between 2000 and 2011. When taking a close look at the year 2011 break-up, we can see that the subscriber count suffered a slight decrease in the third and fourth quarter of 2011 while in the 1st and 2nd quarter Netflix still experienced an increase of 5.1 million subscribers. This sudden change in growth is most likely due to the structural price change the company has introduced in July of 2011. Exhibit 5 also shows that due to the mostly exponential increases in paying customers, the average subscriber acquisition cost has decreased from $50 to approximately $15 per subscriber between 2000 and 2011. Exhibit 6 provides important information on the three segments Netflix is divided into. As discussed in the article Netflix in 2012: Can it Recover from Its Strategy Missteps? the international segments Netflix has expanded to has yet to become profitable. In fact, exhibit 6 shows that between the third quarter of 2011 and the end of first quarter of 2012 the international segment has suffered from increasingly large contribution losses. This is not due to a decrease in revenue but due to a vast increase in the marketing efforts that Netflix has induced. Within three quarters, Exhibit 6 shows that the marketing expenses combined with other costs of revenues have increased from $46 million to $146 million. Revenues

from the international segment are expected to offset these costs in the future. Also worth mentioning is the decrease in contribution margin of the domestic DVDs-by-mail segment. This decrease was previously projected by the executive board of Netflix, with the reasoning being the demand shift of customers to instant streaming services. The consolidated income statement for the same three quarters shows that the international operations have resulted in a net loss of $4.6 million in the first quarter of 2012, suggesting that the net loss of the international segment has resulted in an overall net loss of the company. 8. How does Netflix’s competitive strength compare against that of Blockbuster and Amazon? Do a weighted competitive strength assessment using the methodology presented in Table 4.4 in Chapter 4 to support your answer. Based on your assessment and calculations, does Netflix have a net competitive advantage over Blockbuster and/or Amazon?

As we can see on the competitive strength assessment, Netflix wins the comparison with a score of 8.55. The selection of titles is weighted heavily, giving Netflix a slight competitive advantage over its biggest rival Amazon. Blockbuster comes in last, not being able to keep up with Netflix and Amazon’s good reputation and convenience. 9. What 3-4 top priority issues does Netflix management need to address? Priority issues that Netflix management need to address include exclusive titles, international expansion and mobile data deals. Exclusive titles can be classified into exclusively licensed titles and original content. This distinction calls for an in-depth analysis of the differences and opportunities.

The international expansion project is not yet profitable and needs much attention, especially in the beginning stage of implementation. Mobile data deals have already been implemented by music streaming provider Spotify. This is a big opportunity for Netflix to increase their customer base. 10. What recommendations would you make to Netflix CEO Reed Hastings? At a minimum, your recommendations should cover what to do about each of the top priority issues identified in question 9. I suggest Mr. Hastlings to maintain a strategy that includes a high volume of marketing expenses. I believe that the brand name and reputation is a key factor that boosts market share. I consider a strong domestic market share to be essential to the international expansion Netflix is currently pursuing. The company has to hire employees who are familiar with respective foreign regulations and policies to efficiently tackle the issue of foreign licensing. In terms of exclusive titles, Netflix should not stagnate in terms of the performance of their Netflix Originals series. With the TV show House of Cards, Netflix has faced outstanding responses but nonetheless, most of its exclusive titles are offered through a long-term license and do not represent Netflix’s own original content. This, however, could be the next step - backward vertical integration into the movie business. Netflix would have to evaluate the costbenefit margin of creating its own movies but not having to deal with the costly and time-consuming act of pursuing title licenses does sound very appealing in the long-run. And it would potentially attract even more subscribers as it would put more value to the streaming platform. My last suggestions is to increased the extent to which mobile data deals are offered for the usage of Netflix on smartphones. Netflix has already teamed up with a few internet providers to allow users to not use up any data when streaming Netflix on their mobile phones.This is a great technique to reach more potential subscribers who are no able to afford a higher data plan but could potentially afford the Netflix subscription. Music streaming company Spotify has already successfully implemented this feature in many countries and so should Netflix. Advertising with this feature internationally would not only allow Netflix to grasp this portion of potential customers but also gain the company valuable international brand awareness. Such marketing techniques should convey that Netflix intends to pursue the needs of niche customers on an international level.

References

Arthur A. Thompson. “Netflix in 2012: Can it Recover from Its Strategy Missteps?” The University of Alabama. McGrawhill Connect, 2012, pp. 128147....