Essay For Economics Studies

T

CASE

15

Netflix Fights to Stay

Ahead of a Rapidly

Changing Market*

Synopsis:

In the face of changing technology and shifting customer preferences with respect to

movie distribution, video rental giant Blockbuster fell to its competition. Meanwhile,

Netflix has grown to become the top rent–by–mail and video streaming company, while

other strong competitors have emerged to dominate movie distribution via kiosks

(Redbox) and online (Apple, Amazon, Hulu, and others). Looking to the future, Netflix’s

survival depends on its ability to adapt to and adopt new technology and marketing

practices—issues Blockbuster failed to navigate due to its reactive, rather than proactive,

stance toward a rapidly changing market. Netflix faces an uncertain future as the DVD

rental sector approaches the end of its life cycle. However, the company is poised to

dominate the video streaming sector for the foreseeable future. The problem is, the

future changes rapidly in this industry.

Themes:

Changing technology, changing consumer preferences, competition, competitive

advantage, product strategy, product life cycle, services marketing, pricing strategy,

distribution strategy, non-store retailing, customer relationships, value, implementation

echnology has played a leading role in the evolution of the movie and rental

industry. Several of the major movie production companies have now opted to

bypass the theatre experience and instead promote a selection of their movies

directly to the home viewing audience via on-demand services, broadband downloads,

or

online streaming. Through increasing disintermediation

(bypassing theaters and

rental

chains), movie studios stand to increase profit margins dramatically. Today there

are at

least 20 major competitors in the sales and rental industry that compete with

Netflix.

These include major retail firms such as Walmart, Target, Best Buy, Amazon,

and Time

Warner. In the rental sector, Netflix faces intense competition from Redbox, and a variety

of online-only services such as Apple, Amazon, Google, and Hulu.

Netflix’s History

CEO Reed Hastings told Fortune he got the idea for the DVD–by-mail service after pay–

ing a $40 late fee for Apollo

13 in

1997. Although VHS was the popular format at the

time,

Hastings heard that DVDs were on the way, and he knew there was a big market

waiting to

be tapped. At first he and fellow software executive Marc Randolph attempted

*Kelsey Reddick, Florida State University, Jacqueline Trent, University of New Mexico, and Jennifer Sawayda,

University of New Mexico, prepared this case under the direction of Michael Hartline and O.C. Ferrell. This case

is for classroom discussion, rather than to illustrate either effective or ineffective handling of an adminis–

trative situation.

Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

4 7 1

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472 Part 5: Cases

a rent-by–mail service that didn‘t require a subscription, but it was very unpopular. The

company launched the subscription service on September 23, 1999 with a free trial for

the

first month and found that 80 percent of customers renewed after the trial ended.

Netflix

turned its first profit in 2003 in the same quarter that it reached one million sub–

scribers. Hastings said the company was named Netflix because they saw the industry‘s

future moving from the DVD format to Internet streaming in the long run. Netflix intro–

duced streaming services in 2007 after reaching more than 6.3 million members.

Intense competition from Netflix was a main reason that Blockbuster dropped its

late-fee program in 2005 (a shift that led to a $400 million loss in revenue for Block–

buster). In 2006, Hastings set a goal of reaching 20 million subscribers by 2012—a goal they

would exceed. Their launch in Canada in September 2010 helped them reach the

20 million subscriber goal sooner than expected. Quarterly sales topped $320 million

in

late 2008, followed by $394 million during the first quarter of 2009. Even more

impressive, Netflix managed to increase sales at a time when the entire movie rental

industry experienced an

8 percent sales decline. Today, with more than

23 million

members, Netflix touts itself as the world’s largest online entertainment subscription

service, with operations in the United States, Canada, Ireland, the United Kingdom,

and

the Caribbean.

Early Strategy

Netflix built its success around online movie rentals with expedited delivery of DVDs.

DVDs were first introduced to the United States in March of 1996. In August of 1997,

few

American households owned DVD players as they cost more than $1,000 at the

time. In

addition, few movie titles were available on DVD. However, Hastings and Ran–

dolph successfully predicted that the format would quickly replace the comparatively low

quality, bulky, and cumbersome VHS format among American consumers. A key factor in

Netflix’s strategy was that the DVD’s compact size made the U.S. Postal Service a via–

ble delivery method. It experimented with 200 different mailing packages in order to per–

fect the packages for disc safety, shipping cost, and reliability. On April 14, 1998, Netflix

officially opened for business with 30 employees and 925 titles—the majority of DVDs in

print at the time. Initially, Netflix offered a seven-day rental for

$4 plus

$2 in

shipping, with per item prices decreasing with each additional title. They offered no–

hassle “time-extensions” rather than punitive and costly “late-fees,” which had been the

industry standard and a big revenue generator.

During the initial period, when demand was low, Netflix formed strategic relation–

ships that were important in expanding the DVD market and ensuring its early success. The

company forged cross-promotional agreements with DVD hardware manufacturers and

studios, offering free Netflix rentals with purchases of DVD players from manufac–

turers such as Toshiba, Hewlett-Packard, Pioneer, Sony, and Apple to help get DVD

players in American homes. It also teamed with studios to promote high profile films

and

with online movie information/review providers to funnel movie-interested Internet

traffic

directly to Netflix. The company also enjoyed significant positive publicity in 1998

when it

offered videos of President Bill Clinton’s grand jury testimony for 2 cents, plus $2 shipping

and handling.

In September of 1999, Hastings announced that Netflix had achieved economies of

scale and could now offer subscription services. A few months later in early 2000, it

dropped the pay-per-title model entirely and began to market itself as an unlimited sub–

scription service, completely free of due dates, late fees, shipping charges, and per–title

fees. At that time, Netflix charged $19.99 per month for 3 DVDs at a time and added

its

less expensive one- and two-DVD options a short time later.

Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Leaning reserves the right to remov e additional content at any time if subsequent rights restrictions require it

Case 15: Netflix Fights to Stay Ahead of a Rapidly Changing Market

473

Bob Pisano, a former MGM executive and sitting president of the Screen Actors

Guild, joined the Board of Directors of Netflix in April 2000. Pisano cultivated relation–

ships with the studios, and in December, Netflix signed revenue sharing agreements with

Warner Home Video and Columbia Tri-Star. This enabled Netflix to consistently and

more profitably fill the short-lived new release demand peak. Agreements with other stu-

dios would soon follow.

Optimizing Distribution

In February 2002, Netflix reached the milestone of 500,000 subscribers. It made its initial

public offering in March, raising $82.5 million on 5.5 million shares. On June 20, 2002,

Netflix announced the opening of ten additional warehouses throughout the country.

The

company situated its warehouses to supply as many customers as possible with over-

night first-class DVD delivery because its per-capita subscription rates were much higher

in

markets with overnight delivery. As competitors entered the market over the next

couple

of years, Netflix was already refining its processes and opening more distribution centers to

better serve its expanding subscriber base more profitably and quickly.

The location of these distribution centers has always remained a mystery. Netflix employ-

ees sign confidentiality agreements when hired, and the exterior of the warehouses them–

selves are non-descript and are designed expressly to camouflage the building’s function.

Although Netflix was concerned with trade secrets early on, former Vice President of Com-

munications Steve Swasey explained in 2009 that Netflix was already so ahead of the compe–

tition that it was not worried about industrial espionage. Rather, it is more worried about the

possible disruption of processes when customers show up and expect to be able to drop off the

DVDs directly at the warehouse, rather than through the U.S. Postal Service.

In February 2003, Netflix hit one million subscribers. Customers appreciated the low–