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Netflix: A Case Analysis Essay

Netflix offers a variety of product services to its customers. The company offers traditional DVD rental by mail, instant streaming of DVD content through home PCS, and streaming on Netflix-ready devices that could be hooked up to one’s TV. Netflix has a subscription based model, which allows customers to utilize their products/services through a per month fee rather than a pay as you go rate. Although the company offers eight different subscription packages, it derives its largest revenues from its $8.99, $13.99, and $16.99 subscription plans that include unlimited DVDs per month, 1-3 titles out at one time, plus unlimited streaming of online content. The Netflix Strategy

Netflix’s strategy so far has been to focus on not just one or two aspects of their customer base, but to focus themselves in a number of directions in order to build upon and capitalize on a growing subscriber base. Their main strategy has been to build and maintain the most comprehensive selection of DVD titles in the industry, and they have done so by creating mutually beneficial relationships with a number of entertainment video providers. Their second main strategy has been focused on product differentiation- not only how customers receive content and consume it, but also how customers choose what to watch. Netflix’s number one competitive advantage is their unique software that takes what a customer has seen or rated, and based upon that information builds a list of suggested titles similar to ones they have just watched. While other companies like Blockbuster had begun to leak into the rent-by-mail niche category that Netflix had started, no other company had customer profiling software quite like Netflix. U.S. Movie, TV, & Video Game Rental Market (2006-2009)

Consumer Movie Rental Market Revenue ($ million)

2006
2007
2008
2009
In-store Rentals
$7,030
$6,215
$5,674
$5,118
Vending Machine Rentals
79
198
486
917
By Mail Rentals
1,291
1,797
1,949
2,114
VOD (cable, digital, & subscription)
993
1,077
1,365
1,684

Between 2006 and 2009, the film rental market underwent a major shift. The in-store rental market declined by nearly $2 million, while vending machine rentals increased tenfold and by-mail rentals nearly doubled. However, VOD services through cable, digital, and subscription also saw major increases. All of these changes meant companies like Blockbuster and Movie Gallery had to either reorganize and make a complete business model shift- or face bankruptcy. Meanwhile, the increases in by-mail rentals and VOD subscription, two services that Netflix offered, meant that the number of Netflix subscribers more than doubled in that same time frame. Purchase decisions from customers were focused on convenient access, price, variety of DVD offerings, ease of return/return fees. Therefore, the key success factors within the U.S. DVD rental industry were quickly becoming: 1) A variety of distribution channels (mail, online streaming, streaming to TV, vending machine, etc) 2) Superior video libraries (including new releases, classics, hard to find) 3) Little to no fees associated with renting or returning DVDs 4) Ease of use (in terms of returning)

5) A strong network of entertainment video providers, i.e. suppliers Customers like variety; a video rental store that only stocks the newest releases will not appeal to all markets. Increasingly, customers are becoming more nostalgic in their movie preferences, searching for titles long past premiere. Customers have also become increasingly busy, often not having the time to go to a store to pick out a movie or remembering to return their rentals on time. We live in a world of instant gratification, where being able to click a few buttons and watch the latest Jennifer Aniston rom-com or an old cult classic like Rocky Horror is extremely important. Customers also do not like fees. More and more companies today are offering free shipping/return shipping, and the same is true in the DVD rental industry.

Five Forces Analysis of the Industry

Rivalry among competing sellers: High. Buyer costs of switching brands is low and product offerings are weakly differentiated. The number of competitors is growing and rivals have diverse strategies for providing their services. Competitive pressure from buyer bargaining power: Medium to high. The cost of switching to competing products is low, as well as the level of convenience for switching. Products are for the most part undifferentiated. Competitive pressure from supplier bargaining power: Low to medium. There are a large number of suppliers within the industry and a variety of ways in with to gain access to the needed material. However, most sellers cannot self-manufacture these movie titles; whereas the suppliers could easily begin offering these services themselves. Competitive pressure from substitute products: Low. The cost per DVD to buy is greater than that to rent or stream a movie. Buyer demand for purchasing DVDs is decreasing due to the lack of disposable income created by the financial crisis, as well as the practicality of owning a vast collection of physical DVDs. Potential of new entrants: High. The market is growing at an ever increasing pace and barriers to entry are low.

Buyer demand continues to increase as well, and existing industry members are looking to expand their market reach. (See Appendix 1 for a visual representation). There are a number of drivers of change affecting the movie retail industry. As mentioned previously, there has been a shift in consumer’s willingness to go out of their way for certain products or services. The consumer climate has shifted to an instant gratification model, in which if acquiring a movie to watch requires more effort than clicking a few buttons, then it is no longer worth the consumer’s time. This force is somewhat unfavorable in terms of competitive intensity because it will drives firms within the industry to compete in a never ending sprint to offer the most titles in the shortest amount of time, which will eventually hit its peak and taper off. However, this force will also positively impact future industry profitability since the more streamlined the process becomes, the more users and more uses the industry will gain. Another force driving change is the switch from buying physical DVDs and acquiring movie collections to accessing them online as needed.

This saves consumers valuable time and money, and they no longer need to worry about keeping their DVDs in good condition. This force will positively affect future industry profitability because it will reduce the number of distribution plants needed to sustain video libraries, thus significantly reducing operating costs. Not having to stock multiple copies of millions of DVDS will mean that companies will no longer have to spend money on: Multiple large plants

Staffing said plants with a large labor force
Operating said plants in terms of rent, utilities, etc
Postage (in terms of Netflix specifically)
DVD maintenance
Mailing and location software
One more force that is affecting the movie rental industry is the introduction and proliferation of VOD services offered directly from cable networks and providers. Barriers to entry for these already existing firms is extremely low, and if all networks chose to offer these services, a large portion of profits would be cannibalized from outside companies such as Netflix or Hulu. This force will negatively affect competitive intensity, but positively affect future industry profitability. If the large supplier companies (cable networks & providers) all started offering their own VOD, competition from smaller independent renting firms would disappear. Yet profitability would increase due to the ease of access to entire network libraries. Mapping the Movie Retail Industry

The competitive characteristics that differentiate firms within the movie retail industry are as follows: Use of distribution channels
Product line breadth
Price
Geographic coverage
Ease of access/use
In conducting my analysis of the strategic positioning of firms within this industry, I chose to focus on price and use of distribution channels (See Appendix 2). Netflix and VOD providers are positioned most favorably on the map because both offer moderately priced subscription packages for access to a comprehensive list of movie and TV show offerings using a variety of distribution channels. Netflix is positioned most favorably due to its relative low cost compared to the variety of products it offers access to. Redbox is priced well, but it only offers one method of distribution. Whereas Blockbuster is priced higher than average, but has begun to offer streaming and mail rental options in addition to in store rentals.

A Financial Analysis of Netflix

Overall, Netflix has fared fairly well over the past several years, even surviving the financial crisis. They continue to generate a profit, and their revenue has grown at a steady rate indicative of the growth of the mail rental & online streaming movie retail market.

The company has been growing at an average rate of 20% over the last four years. However, from 2007 to 2008, Netflix only grew at a rate of 13.22%. This noticeable fluctuation in their growth rate can most likely be contributed to the financial crisis that swept the nation during that year. Aside from that dip, Netflix can be expected to continue to grow at a rate indicative of the continued growth of mail and digital movie rental industry.

Product costs for Netflix have remained relatively stable over the last four years at over 60% of revenue, fluctuating only by 4% or less. This is despite the fact that revenues for the company have been steadily increasing. This clearly shows an inability to control manufacturing & operating costs. As Netflix expands, so does its physical DVD inventory and size/number of distribution plants. Although one of their strategies is transition subscribers to streaming delivery as opposed to mail delivery, it is obvious that they have yet to be truly successful in that endeavor.

Netflix’s ROA hit an all-time high of 17.05% in 2009, which is somewhat surprising given that the company is deriving most of its revenues from a nubile market. The mail and digital movie rental industry is still growing, so to have an ROA that high is quite an accomplishment. It is clear that the company’s investments in new assets are succeeding in generating returns. (See Appendix 3 for a complete financial analysis of Netflix from 2006-2009).

SWOT Analysis of Netflix’s Standing within the Market
Strengths
Opportunities
Netflix cornered the market on direct mail renting before anyone else offered it Has a wide geographic coverage and the fastest turnaround rate Known for its 1 month free trials
The brand has a following across a wide variety of consumer segments Their strong relationship with a large network of entertainment video providers Top management realizes the importance/emergence of the digital environment and is trying to shift subscriber use accordingly Netflix has developed unique and comprehensive movie selection software that customizes the consumer experience by capitalizing on their movie tastes and making accurate suggestions Netflix offers the most detailed movie information including customer reviews, critic reviews, etc The increasing demand for digital streaming is clearly an opportunity The shift from by mail rental to digital streaming gives Netflix an opportunity to restructure its subscription packages and price them even more competitively The firm can look at joining forces with some of the networks that are beginning to offer VOD streaming

Weaknesses

Threats
Netflix is a market leader in by mail rental, which has now capped off and started to become a declining category The company’s comprehensive DVD libraries and distribution centers are eating up a large chunk of their revenues Unlike other movie rental/streaming companies, Netflix does not offer access to newly released films Changing subscriber preference towards online streaming will affect Netflix’s current portfolio mix The increasing intensity of competition from other companies, such as Hulu with their Hulu Plus program will eat into Netflix’s consumer base Increasing number of networks that are beginning to offer free streaming of content on their websites

For the moment, Netflix’s overall situation is fairly attractive. Being the first company to introduce a new niche in a market is a huge asset. A company cannot simply ‘buy’ cornering the market on a good or service. Since Netflix already offers unlimited direct streaming, that puts it ahead of some of its competitors. However, Netflix will need to restructure and reevaluate the profitability of its by mail rental service in the near future.

Compared with Blockbuster and VOD Providers, Netflix has the highest level of competitive strength at 46 points. Netflix by far has the most comprehensive number of products and distribution channels, given that consumers can either rent DVDs by mail or stream them on their PC or TV. The number of distribution channels factors into the company’s ease of use, as does the fact that their DVDs come with prepaid return envelopes. VOD Providers are a similar ease of use to Netflix given that consumers can just click a few buttons on the TV and instantly be watching their chosen film. Blockbuster is ranked lowest in terms of price & fees because their prices are based on a per DVD cost, and when sales began to decrease, the company increased its prices. Not to mention that there are late fees associated with renting, whereas with Netflix you can keep a DVD for as long as you like without incurring fees. Blockbuster also scores lower in terms of the number of products because their library is limited by store space, whereas Netflix and VOD Providers can have a virtually unlimited library of titles spanning the entire duration of the movie industry.

Performance Concerns

Overall, Netflix’s performance is quite satisfactory. The company persevered through the financial crisis and has managed to hold on to market majority despite growing competition from rival firms. a) My main concern for Netflix is the amount of revenue that is currently being eaten up by product costs. Despite steadily increasing revenues, Netflix’s COGS continues to take up more than 60% of said revenue. In the coming years when the market shifts entirely to direct streaming, Netflix will be left with millions of DVDs and operating costs associated with the large distribution centers required to house these DVDs. If the company takes too long to phase out this aspect of its product/service portfolio, it could lose out on major profits and potentially wind up in debt. b) A second issue I see for Netflix is that more and more companies are beginning to offer streaming of their own content either for free to the public, or free to subscribers of certain cable companies. Since Netflix has a cost associated with it, its customer base could be cannibalized by these new entrants.

Recommendations

a) Given that by mail renting is on the decline, Netflix should work quickly to phase out this service from its current offerings. Right now there are still companies out there willing to take on extensive DVD libraries- five or so years from now, that may not be the case and Netflix will have lost out on an opportunity to avoid a significant loss. b) Netflix needs to look at restructuring and re-pricing their current subscription packages. The number of packages and their prices that the company offers are no longer relevant to demand. With more and more entrants into the market, Netflix is losing its competitive pricing advantage. In sum, in order to remain competitive Netflix needs to restructure both its product offerings and pricing strategy. The company should be looking ahead to see what the next big thing in movie rental/streaming will be and capitalize on that, while other firms are still entering the market and developing what Netflix already has.


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