Memo

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ISOM 310 Netflix Case

Netflix 2013 Case: Online Video Matures

In the 1980s and 1990s, people joked about how difficult it was to program a VCR to record a television program. Products like TiVo and other DVRs (digital video recorders) made it easy for consumers to record broadcasted shows and movies. Today, consumers have a wide variety of options in satisfying their desire to watch movies and TV shows. They can rent DVDs and video games from traditional brick and mortar video stores, such as Blockbuster. Cable TV and Satellite TV companies offer premium subscription channels (such as HBO) for a monthly fee, as well as, video-on-demand services. There are other options for those with broadband Internet connections, such as programs that store entertainment and redirection devices (like Slingboxes
). Consumers also can rent or purchase DVDs, Blu-ray discs, and video games at video rental stores, vending machines (like Redbox
), and also can purchase them at electronic stores (such as Best Buy), discount stores (such as Target), or on the Internet (Amazon and Apple, plus many others). In addition, there still is much illegal file sharing of copyrighted digital content. Today, when consumers want to watch a particular movie at any particular time, they have many options.

The U.S. movie “rental” industry has changed. Direct online distribution of content (whether by real-time streaming or downloading for playback) has replaced physical media as the normal method
. Even traditional DVD retail companies like Wal-mart and Target are getting into the digital streaming business
. In addition, many laptops and almost all netbooks and ultrabooks today are being shipped without an optical playback device (i.e., one that can play a CD, DVD and/or Blu-Ray). Obviously, the same is true for smartphones and iPods. In addition to those mentioned above, there also are additional options for receiving digital streaming entertainment, including Internet-enabled TVs, set-top boxes (like Boxee
), game consoles, computers, and readers like the Kindle or Nook. Nonetheless, as of 2010, eighty percent (92 million) of all U.S. households still had at least one DVD or Blu-ray player, leading many to believe the DVD business will retain demand and some profitability for several years to come.

New Competitors and Content

Numerous companies now compete in the shrinking DVD and video game rental industry. Dish Network purchased Blockbuster out of bankruptcy and, in early 2012, has closed

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00 of the 1500 remaining stores. Blockbuster, the largest video rental chain in the United States, has launched a variety of initiatives to provide online DVD and game rentals. Dish Network limited the customer base of the current streaming service to pre-acquisition customers and Dish Network subscribers. Recently, Samsung announced (February 20, 2012) a deal with Blockbuster to stream thousands movies to the company’s smartphones, tablets, ultrabooks, laptops, smart TVs, and Blu-ray players. Wal-Mart, the world’s largest retailer, briefly offered its own DVD rental service and now partners with Netflix. There is also Redbox, with its $1.20 per night rentals (increased from $1 on 10/31/2011). In 2012, Redbox and Verizon announced a partnership for providing a movie streaming business. The streaming video business is dynamic, with new partnerships and companies continually emerging.

History of Netflix

Netflix Inc. was founded in 1997. According to founder Reed Hastings in 2001, “It probably looks easy to imitate Netflix, but it’s quite difficult to get all the details right that matter to a consumer. We’ve put four years’ effort into building our service.” Hastings, an experienced entrepreneur with a successful track record of managing start-up companies, stated that his experience in paying a hefty $40 fee for an overdue video led him to question why a video store did not work like a health club, where members pay a fixed monthly fee. The term, “subscriber” is the key to Netflix’s unique idea. Originally, movie and game aficionados subscribed to Netflix service paying a monthly fee for the DVD delivery service. Although there were several subscription plans available, the basic plan was $7.99 per month, giving customers access to DVDs via snail mail, on a one-at-a-time basis with unlimited rentals per month.

Here’s how it worked. A subscriber of the Netflix DVD-in-the-mail service created a list of DVDs that s/he wanted to rent from the Netflix library containing more than 40,000 titles. An online recommendation engine assisted subscribers in making their selections. Then, Netflix would send to the subscriber, his or her top three DVD choices by mail, eventually, depending on which plan was subscribed and what was available. The subscriber could keep the DVDs as long as s/he wanted without any late fees (but, the subscriber could not possess more than 3 Netflix DVDs at a time). Whenever the subscriber sent one back, s/he was eligible to receive another. The subscriber returned the DVDs using pre-paid mailing envelopes provided by Netflix. In exchange, Netflix mailed the next top choice(s) of DVDs on the subscriber’s list, usually within 1 to 2 days of receiving the returned DVDs. The cost of shipping was included in the subscription price. On average, the company shipped 1.9 million DVDs a day (in 2010).

An “on-demand” service was added in 2007 allowing the customers to view movies immediately on their PCs or Macs. In 2008, this service was enhanced to allow subscribers to instantly stream movies and TV shows on their TV though Netflix-ready devices, such as Internet-enabled Blu-ray players or Microsoft’s Xbox 360. As of 2010, Netflix streaming became very popular, in part because the service was bundled in the flat-rate monthly subscription charge. Netflix’ streaming choices were ever growing, with over 17,000 items available in Netflix’s “Watch Instantly” library (in 2010). Netflix-ready devices (both set-top boxes and Internet-ready TVs) also have expanded, covering the market with multiple streaming-ready gadgets. As of 2010, Netflix offered 12 million subscribers over 100,000 movie choices (in contrast, a typical video rental store offers an average of 500 DVD titles and many fewer in a Redbox). This was Netflix’ mode of business until the middle of 2011.

In mid-2011, Netflix changed its marketing and pricing strategy. First, Netflix divided the company into two business units and renamed DVD-by-mail service to
Qwikster
. Customer outrage made them reverse this naming decision but not the new pricing. Now, there is a separate monthly fee for each service (DVDs by mail or streaming). Second, Netflix changed their focus from DVD-by- mail to streaming. The default free trial memberships and new memberships are for streaming only. DVD-in-the-mail service can be added for $7.99 and, for an additional $2.00 per month, Blu-ray discs are included. As of the end of 2011, the number of streaming subscribers was double that of the DVD-in-the mail subscribers. Netflix is set to continue to expand its streaming business, while the number of DVD subscribers will continue to decrease. The future is about streaming. As mentioned earlier, many are forecasting the demise of the DVDs and Blu-Ray disks.
Nevertheless, how to evolve remains uncertain. Netflix’s new strategy was devastating to market share (see chart). They had to reverse their decision ultimately.

Figure 1 Netflix Share Price 2003-2013

Netflix Current Strategy

Netflix currently operates in the United States, Canada, and Latin America. In 2012, it began services in the United Kingdom and Ireland with plans for more international expansion. International expansion requires new content such as non-English movies, international television shows, and providing movie subtitles in more languages.

The company has contracts with nearly 100 movie studios and distributors to supply the company with content titles. Netflix receives a digital file of a movie and is licensed to produce the physical DVDs and/or to deliver by streaming. As of 2010, Netflix has purchased approximately $100 million worth of titles from these suppliers, placing Netflix as one of the studios’ largest customers. Netflix needs constantly to license new content from its owners (i.e., movie studios, HBO, etc.). Unfortunately, this strategy is risky. Some famous failures include Netflix’s loss of the Starz content in May 2013
.

Unique to Netflix is its extraordinary recommendation system, Cinematch. Cinematch is an algorithm built into the servers that uses customer data to personalize a subscriber’s movie rental/viewing experience to a degree previously not possible. This personalized service observes what people watch and browse through online logs. It also asks the customers to rate movies using a 5-point rating scale with ratings of hated it to loved it. Netflix’s Cinematch recommendation system displays other titles that the subscribers might enjoy based on statistics calculated in the background. Recommendations drive about 60% of all selections (2008)
. Netflix has accumulated over 300 million ratings in a database (2010), with more than 1 million ratings added each day, more than any other competitor. This database provides Netflix with deep insights into subscriber preferences for movies. In 2006, Netflix started a contest to improve their movie rating and recommendation system. The grand prize of one million dollars was captured in 2009 by “BellKor’s Pragmatic Chaos”, who improved Cinematch’s results by 10.6%. A follow-up contest was started and promptly cancelled due to lawsuits. From the customers’ perspective, this system could perhaps be improved with a better user interface and by providing more or different information.

The company’s highly sophisticated and integrated purchasing, merchandising and logistics software supports all aspects of its operations. For example, Netflix optimizes its licensing of content by using demand forecasts based on analysis of subscriber preferences. To manage inventories and logistics, Netflix has 30 (up to 58 in 2009 through 2011)
regional shipping centers located throughout the U.S.; 80% of subscribers are able to receive their DVDs in 1 to 2 days (after Netflix gets a returned DVD). Netflix can handle more than 2.5 million shipments per week – more than almost any other e-commerce company (2010). Subscriber feedback in 2003 suggested that occasional system glitches result in delayed or wrong deliveries for some customers. Additionally, analysts reported (when) that customers’ complaints sometimes went unanswered or not handled in a timely manner.

Netflix is not without critics. It turns out that the service “rewards” customers with the fewest monthly rentals, in terms of popular movie availability and promptness of shipping, and “punishes” those with the most turnover. This policy is spelled out in the company’s terms of service, published on the Netflix Website. In 2004, the policy caused a “frequent” Netflix customer to sue the company in a class-action lawsuit titled Chavez v. Netflix, Inc.
The plaintiff in the case, Frank Chavez, claimed that Netflix’s claims that a subscriber could rent “unlimited” DVDs each month and receive them “in a day’s time” were false. Although Netflix denied any wrongdoing, they settled the suit in 2005. Chavez received $2,000, and his lawyers got over $2.5 million.

The most valuable recent innovation at Netflix is the addition of their own production studios to create their own TV shows, such as House of Cards, which won an Emmy award in September 2013, causing some analysts to believe the fundamentals of TV production and distribution are now in question
. The rebound of Netflix’s stock following their Quickster mistake is largely explained by the emergence of this new TV domain. With their own content, there is no risk of a Starz contract collapse happening again. One might wonder how Netflix knows which TV shows to produce in house. Interestingly, reports suggest that they follow online pirates to understand which discontinued shows have loyal followings
. So far, this approach has led to a large increase in subscriptions.

Netflix Future

Netflix added 1080p high definition and 5.1-channel surround sound to their streaming video content.
In 2010, analysts predicted that by mid-2011, two thirds of subscribers would be watching Netflix content through online streaming. This prediction proved correct. Netflix is already expanding internationally and increasing its TV show production and catalogs. Their movie rental business is stable. But, investors demand increasing growth and promising new strategies. Think about what sorts of innovations are coming in consumer preferences and capabilities as well as information and online technologies. What’s next for Netflix?

Assignment

This assignment has you practice and demonstrate a critical analytical and communications skill required of business analysts and consultants related to the emergence of new technology and information systems opportunities. The basic concept is that you are expected to analyze Netflix in terms of future possibilities and prioritize key recommendations to include in a short memo to Reed Hastings, the CEO. That memo needs to justify your recommendations based on clear logic and evidence. To aid you in completing this activity, you may want to search online and read articles about the film and TV industries as well as emerging consumer preferences and technology for entertainment. Think about Netflix’s core capabilities. Can they be repurposed into other domains as profitable products or services?

Instructions

Complete this assignment individually. You must submit this assignment in Blackboard. Your job is to write a business memorandum (“memo”) to the Netflix strategic planning committee. (Memos are a standard business format you need to know and learn. Templates are available in MS Word. See the Writing Center to learn more about this format and how to structure it.)

In your memo recommend a future direction for Netflix. In this description, be sure to address:

1. Identify at most two key forces among Porter’s Competitive Five Forces model that Netflix needs to focus on. Analyze the market situation in relation to this/these force(s) to illustrate clearly why this/these force(s) are important right now.

2. Next, identify one or more key strategic information technology innovations Netflix should adopt. Explain how Netflix could use your recommended innovation(s) to counter their competitive force/forces identified in (1) and create strategic advantages.

This double spaced memo should be no more than 550 words. You will be graded on the content, as well as, the quality and clarity of your recommendations. Format, grammar, spelling, and punctuation should be professional.

� www.slingmedia.com

� www.redbox.com/

� � HYPERLINK “http://www.nytimes.com/2011/03/06/movies/homevideo/06dvds.html?pagewanted=all&_r=0” �http://www.nytimes.com/2011/03/06/movies/homevideo/06dvds.html?pagewanted=all&_r=0��http://mashable.com/2012/04/20/streaming-video-dvd-infographic/

� http://www.digitaltrends.com/home-theater/target-preps-digital-movie-rental-service-for-launch/

� www.boxee.tv

� www.homemediamagazine.com/research/physical-media-study

� See � HYPERLINK “http://www.kwch.com/kwch-tech-talk-blog-netflixs-je-ne-sais-quoi-20120125,0,6520302.story” �http://www.kwch.com/kwch-tech-talk-blog-netflixs-je-ne-sais-quoi-20120125,0,6520302.story� and � HYPERLINK “http://www.kwch.com/kwch-tech-talk-are-dvds-really-dying-netflix-says-yes-redbox-says-no-20120207,0,6188610.story” �http://www.kwch.com/kwch-tech-talk-are-dvds-really-dying-netflix-says-yes-redbox-says-no-20120207,0,6188610.story�.

� http://www.dailymail.co.uk/news/article-2317467/Netflix-losing-nearly-2-000-movies-streaming-service-Wednesday-including-James-Bond-Woody-Allen-titles.html

� See http://www.nytimes.com/2008/11/23/magazine/23Netflix-t.html?pagewanted=all

� http://www.hackingnetflix.com/2009/05/netflix-opening-new-central-operations-center-in-grove-city-ohio.html

� http://arstechnica.com/old/content/2006/01/5951.ars

� http://online.wsj.com/article/SB10001424052702303759604579092061505560526.html

� http://torrentfreak.com/netflix-uses-pirate-sites-to-determine-what-shows-to-buy-130914/

� http://www.cepro.com/article/netflix_1080p_timeline_when_will_it_come_to_ce_devices/

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