Instead of attracting customers to a retail location, Netflix offered home delivery of DVDs through the mail. Why only DVDs? In 1998, most available movies were in VHS cassette format but Netflix concentrated on using only DVDs because its marketing strategy was to develop cross promotional programs with the manufacturers and sellers of DVD players, providing a source of content for the customers. Also, there was no competition in that niche market and DVDs were small and light which made them perfect for mail delivery. Netflix had several sources of competitive advantage.
For starters, Netflix’s website included a search engine that allowed customers to easily sort through its selection by title, actor, etc. Using these search engine customers could easily and quickly find a movie that they would like instead of looking on shelves of a retail store. Netflix was using the US Postal Service to deliver DVDs directly to a customer’s home. It was more convenient for customers. They used similar pricing to that offered by traditional video stores in the beginning but what gave them the competitive advantage was moving to a subscription prepaid service.
And, soon afterwards they offered unlimited rentals to customers because they were targeting another group of customers – ones that wanted the convenience of watching a movie at any time and change them unlimited during a month. Netflix’s engineers developed a proprietary recommendation system. They have done so because mostly the new movies were being rented and they wanted to balance customers demand. How did this system work? Upon signing into a new account for the first time, customers took a survey to identify their favorite movie genres, as well as rate specific movie titles.
This survey gave enough data to Netflix’s engineers to build a base and understand better customer’s preferences. Also, Netflix’s size and growth rate generated a positive ”network effect” from its large customer - generated rating system. Because it had the largest collection of movie ratings in the world, customers recognized that they were more likely to have their tastes and preferences accurately reflected from Netflix’s site. The key to success in Netflix’s strategy was hiring Ted Sarandos as chief content office to manage content acquisition.
He managed (due to his relationships) to negotiate direct revenue – sharing agreements with nearly all the majors studios. So Netflix was able to improve its relationships with its suppliers. The benefit was not just lower acquisition costs but the promotion of lesser known movies. So, customers had the benefit of large variety of movies. Also, using the proprietary recommendation system and the national inventory Netflix was able to replicate almost perfect inventory. This gave them a serious competitive advantage, since retail stores needed three or five times the copies of a movie to satisfy the same customer demand.
Assess Netflix’s performance? Use multiple performance measures (strategic and financial). Table below shows (in 000$) Netflix’s performance using 2 financial ratios in year 1998 and 2006. (source : Netflix 2006 10-k) As we can see from the table, in year 1998 Netflix had poor performance. We can see that it was losing 16. 84 thousands of dollars to subscription (sales= revenue of subscription). Net profit margin was not any better a -18. 940$ . We can see that their operating profit margin was 0. 69 thousands of dollars and net profit margin was 0,04 thousand of dollars in 2006. Why was there such a change in profitability?
Answer lies in the number of total subscribers which has grown from 107 000 in 1999 to 6 316 000 in 2006. (source: Netflix 2006 10-k). Number of subscribers was constantly growing since 1998 due to good strategy decisions like : proprietary recommendation system , hiring of Ted Sarandos and opening more distribution centers. All of these moves had one purpose: to add value to their product by increasing customer’s satisfaction. How does Netflix’s strategy compare to Blockbuster? Compare and contrast each’s value chain. Factors which determine the value of the product: Price – of the movie
Delivery Time – how long do the customers wait for getting the movie Convenience – what actions do the customers have to do to get the movie Other factors(recommendation system, availability of new movies) Late fees Although prices of Netflix and Blockbuster for a single DVD rental are now the same (10$ per movie-source: http://reviews. cnet. com/4520-11445_7-6325775-1. html), Netflix had an additional value because it offered unlimited rental with the same pricing (an example: you pay monthly fee and you can exchange movies, so you can watch several different DVD”s for the price of one).
If you want to rent a movie from a Blockbuster retail store, you can do it in a relatively short time (time you need to get to a retail store) as management proclaimed 10 minute drive for 70% of US population. Delivery time for Netflix is their disadvantage in comparison to Blockbuster, it takes a day or two. Convenience – Netflix has the advantage here since you can order movies from the comfort of your home by using the internet. Blockbuster doesn’t have a recommendation system like Netflix. It only has an employee that can recommend movies to a customer.
Netflix has advantage here since it can recommend a movie accordingly to the taste of each customer. New movies are available pretty much the same for both companies. Late fees – in 2005. Blockubuster decided to abolish late fees which gave them an advantage over Netflix, increasing customer satisfaction but also gave them significant costs: 60 milion $ marketing + 600 million dollar of revenue loss. What challenges and opportunities does Netflix face? What are the major risks? Major challenge for Netflix’s online DVD rental business is VOD (video on demand).
VOD offers additional value to the customer – no waiting period, since it uses streaming technology to provide customers a movie with no waiting period. This is also an opportunity for Netflix since it has the possibility to implement this new technology into its core business but there are several cons of doing so. First issue is that this feature would cannibalize the core business because Netflix would replace stream of positive cash flows with another. Also Netflix found no way to differentiate itself against competitors like MovieLink and Vongo.
Another major risks or challenges for Netflix are cable and satellite providers which offer pay-per-view system, providing HD on demand. For now these services had two primary limitations: technology and content availability. Another major challenge is the entry of Blockbuster in the DVD online rental market. As a bigger company Blockbuster has the financial funds to attract more subscribers using heavy marketing. This entry directly enters Netflix’s niche market and now Netflix has to find a way to differentiate. For starters, what would be Netflix’s entry strategy to these new markets?
It could ship the DVDs from USA but this option would have serious disadvantages like import tariffs, shipping costs, long delivery time which would lead to customer dissatisfaction and a very small market share with probably losses rather than profits. If Netflix would open a subsidiary in Europe it would not have problems like the latter but it would need investors since financing the whole subsidiary may present a problem for Netflix. Another issue is that Europe, as a difference to the US, is consisted of many small independent countries with their own laws and import tariffs so this could be a problem as well.
Another problem is the customers preferences. If Netflix would try to ship movies from the US (which would also present shipping costs) the European customers might not like US movies that much. They might prefer European movies better. Another issue is that Netflix doesn’t have an established relationship with any European movie studio. So they would lose the competitive advantage that they have in the US. Another problem is the language barrier. In many countries like Germany, Italy, or Spain, movies are synchronized into their mother tongue. So customers might not be willing to rent these movies in the English language.
Another issue is the competition in Europe which perhaps would be more competent than Netflix since they know better the customers needs, laws, and other issues mentioned already. Netflix as a company started with an emerging technology – DVD, then. Now the new technology is Blu- ray and as the VHS format was replaced by DVD there are good chances that Blu-ray will replace DVD format. Because Blu-ray technology gives a better resolution than a DVD customers might be willing to switch so Netflix should start to fill its inventory with blu-ray discs and maybe like they did in the past with VHS promote and rent only Blu-ray discs.
The goal for Netflix’s is to find the best media (low cost, high quality) for watching a movie or even better - no media at all. Netflix’s, as I see it, biggest threat to DVD rental business is online video streaming. Why? With this technology customers have no waiting period and complete convenience. And these are very important factors when customers are making their decision about watching a movie. Decisive competence key for Netflix is the recommendation system and they should use it with online video streaming.