Netflix was founded in 1997 by Reed Hastings, founder and CEO. Prior to this, Hastings founded Pure Software in 1991 and led several acquisitions that allowed Pure Software to become one of the top 50 largest software companies in the world. In 1999, Hastings launched the online subscription service and led Netflix to a subscriber base of over 1 million in just three and a half years, something that took AOL six years to accomplish. Netflix’s business strategy was quite simple, because they had pioneered the online DVD rental industry when DVDs were rare and had developed a strong lead of customers, revenue, and brand recognition.
In response to its ever growing competition, in June of 2003, Netflix won a patent that covered much of its business model and could be used to help stifle future competition or at least demand licensing fees for the service. Additionally, according to Mike Schuh of Foundation Capital, one of Netflix’s earliest financial backers, the barriers to entry in the online DVD rental market were very low, but the barriers to profitability were very high. Lastly, Netflix faced a greater challenge, in that the likelihood that DVDs would soon no longer be the medium of choice.
Since the strategic vision is a road map showing the route that the company intends to take in developing and strengthening its business, the Netflix vision was nothing short of this with founder Reed Hastings exclaiming that, “Our vision is to change the way people access and view the movies they love” (Hastings, 2003). To accomplish this vision, Hastings purports that the company has set a long-term goal to acquire 5 million subscribers in the U.S. and by then, they expect to generate $1 billion in revenue.
The business model of Netflix is one of simplicity on one hand and complexity on the other. Netflix’s business model is very closely aligned with its business strategy in that it drives the objectives of the strategy home. The simplicity of this model is simply easy, convenient, no hassle access to the movies that you want. On the other hand, the complexity involves high technology in accomplishing this objective. Their customers sign-up for a subscription service based upon the maximum number of movies they would like to rent out at any given time in increments of two, three, five, or eight, with never any late fees and shipped free of charge. The key is that customers can keep the movies as long as they want to because they are not allowed to go over the maximum number of movies rented at any given time.
Lastly, Netflix added to this convenience by allowing customers to send the movies back in a preprinted, postage-paid envelope. The complexity involved with this model involves innovative technology that allows the customer to browse and select movies easy. They use an innovative database by Oracle called CineMatch that organized Netflix’s movies into clusters of similar movies and analyzed how customers rated them after they rented them. Additionally, the e-commerce involved with this service is phenomenal, which also involves collecting data regarding user preferences to hone in on providing good custom service.
NETFLIX CORE CONCEPT
Netflix has a great mix of talent in that they seem to have put together an extremely good strategy and have added to it extremely good strategy execution, which makes this team exhibit good management. Netflix built into this strategy, a smooth supply chain distribution system to speed up mail times, which included 15 distribution centers across the country. This decentralized network of distribution centers allowed Netflix to send movies from the closest distribution center to each customer and then have customers ship DVD’s back to the closest distribution center. This took distribution of DVD’s to another level when compared to Wal-Mart and Blockbuster, which sent their DVD’s out of only one warehouse. This allows the customers to receive their DVD’s typically in only one day. The beauty here is that Netflix aligned itself with the U.S. Postal Service to maximize their freight costs while using a distribution system that already goes door-to-door of each of its customers daily without the added cost of using a parcel service.
The DVD player was one of the most successful consumer electronic products of all time and the DVD market was also one of the fastest growing markets while experiencing unprecedented growth since its 1997 debut. DVD movies were available through a wide array of channels to the consumer, which included physical brick-and-mortar retail stores such as Wal-Mart; physical rental stores like Blockbuster; websites of both brick-and-mortar and internet-only stores such as Amazon.com; online rental stores such as Netflix; and movies on demand and download websites such as Walt Disney and MovieLink. The DVD rental market soared from 1% in 1999 to an astounding 74% in 2006 for total DVD and VHS rentals.
COMPETITIVE ENVIRONMENTAL ANALYSIS
Blockbuster had grown to more than 8,500 company-operated franchised stores worldwide, with more than 2,600 stores outside of the United States. They hold a 65% market share of the entire $8.5 billion market, which is astounding to say the least. In 2002, it had revenues of more than $5.5 billion in which 80% came from the United States. Blockbuster’s goal is to be “the complete source” for movies and games, rental and retail. In 2000, Blockbuster began to market the pay-per-view service with DIRECTV in 3,800 of its stores and after its initial success, Blockbuster co-branded with DIRECTV in July 2001 and established its presence in the pay-per-view movie industry to offer 44 movie selections per day to subscribers. In 2002, Blockbuster acquired Film Caddy, which is also an online DVD rental service and one of Netflix’s smaller competitors.
Wal-Mart is the world’s largest retailer with over $244.5 billion in sales in the fiscal year ending January 31, 2003. It has more than 3,200 facilities in the United States and over 1,100 outside of the United States. Wal-Mart entered the DVD rental business with a model that was nearly identical to Netflix’s from the service fee and movie selections to the envelopes that Netflix used. Wal-Mart seemed to have captured the essence of the strategy and business model that Netflix had in place. However, Tom Adams of Adams Market Research clearly pointed out that Wal-Mart would have, at most, about a fifth of the number of Netflix subscribers at the end of 2003. Wal-Mart also only had 7 DVD distribution centers as compared to Netflix’s 15, but they plan to open more centers at Wal-Mart facilities. While Wal-Mart was busy working out the bugs in its online software, it was clear that they were not known for their movie rental expertise.
Movie Gallery grew through the acquisition of various mom-and-pop video stores and then video chains throughout the Southeast. It continued expanding through this aggressive approach until it reached 1678 stores with more than 8,500 associates in 42 states and five Canadian provinces. Although Movie Gallery launched Moviegallery.com, it had not yet entered the online DVD rental business. In 2001, it won the Retailer of the Year for Large Chain from the Video Software Dealers Association. Through its growth, size and its online position, entry into the online rental industry is not expected to be far away.
WALT DISNEY’S MOVIES ON DEMAND
Walt Disney’s Movies on Demand service takes the movie rental business into new uncharted territory. Through its service called MovieBeam, a customer could order a movie and have it transmitted the same day digitally to a receiver manufactured by Samsung. This would allow the customer to receive the movie the same day versus having to wait at least a day to receive it from Netflix. However, there is a much higher price for this kind of convenience. MovieBeam’s prices included a $6.99 monthly equipment service fee, $3.99 for each new release, and $2.49 for older titles. However, Netflix added to its repertoire, its own version of movies on demand, when it struck a deal with TiVo.
According to Stefanie Olsen and Richard Shim, “Rumors have swirled for months that the two companies would strike a deal. Building new services is crucial for both TiVo and Netflix as they confront growing competition from deep-pocketed rivals” (Olsen, 2004). Additionally, in the same article, Netflix spokeswoman Shernaz Daver is quoted as saying, “If you look at the Internet, it’s really just starting out to be a delivery mechanism for content. Long term, that’s the way we think movies will get delivered” (Olsen, 2004). While movies on demand and other driving forces are keeping Netflix managers on top of environmental scanning, these same driving forces are keeping Netflix on top in the online DVD rental industry.
MOVIELINK’S DOWNLOADABLE MOVIES
MovieLink’s downloadable movies are another source of movies on demand with the only difference being that movies can be downloaded directly to a personal computer. While this service is becoming very popular, there is still much opportunity for growth with only about 50% of United States households having internet access in 2001 (Frommeyer, 2006). MovieLink offers a non-subscription fee, non-membership fee, non-late fee service. However, the only drawback to this service is the requirement of a high speed internet service such as broadband or DSL because of the size of the downloadable movie files.
PIRACY IN THE MOVIE INDUSTRY
Piracy in the movie industry is becoming just as popular as the music industry when places like Napster and other files sharing websites cost the music industry an estimated $2.6 billion in sales in 2002. With the advent of DVD recorders and DVD burning equipment, the ability to copy and burn CDs and DVDs has become relatively easy to do. The growing trend of ripping and burning of movies to DVDs was quickly becoming an underground industry that by late 2003 cost the film industry an estimated $3 billion in lost DVD sales. Sources like Apple Computer Inc.’s iTunes seemed to have provided much optimism among entertainment companies, whereas consumers are willing to accept limits on copyrights if the price was right.
The tools of analysis that I will employ to perform this analysis are a comparative financial statement; trend analysis; measures of profitability; and measures of liquidity and credit risk. Based upon the following comparative financial statement, I was able to place important financial information in a context that is useful for gaining better understanding of the subsequent analysis. The financial analysis will show that Netflix has a proven positive trend in both net sales and net income. The trend analysis indicates an accelerated growth in both sales and income. Additionally, they have out performed their competitor, Blockbuster, in both measures of profitability and measures of liquidity and credit risk. The measures of profitability are of interest to both equity investors and management. Since the profit margin measures how much out of every dollar of sales a company actually keeps in earnings, Netflix has proven once again to be a more profitable company than Blockbuster and that it has better control over its costs. Netflix has also shown that it gives investors a good idea of how effectively the company is converting the money it has to invest into net income through its return on assets trend as opposed to Blockbuster’s.
Finally, regarding the profitability of a firm and through its return on equity, Netflix has proven that they generate more profit with the money shareholders have invested than Blockbuster has done with the money that their shareholders have invested. Netflix’s creditors are particularly interested in the company’s ability to meet its continuing obligations as they arise. Therefore, my analysis of the company’s measures of liquidity and credit risk has shown that they are a viable credit risk. Netflix’s current ratio is about twice that of Blockbuster, indicating to its creditors that it is a much better credit risk than Blockbuster and are pretty much a good credit risk. Historically, some bankers and other short-term creditors have believed that a company should have a current ratio of 2 to 1 or higher to qualify as a good credit risk.
Quick ratios are especially useful in evaluating the liquidity of companies that have inventories of slow-moving merchandise or that have become excessive in size. Netflix’s quick ratio has proven that it has the ability to keep its inventories low and move slow-moving merchandise out and that may be due to its unique ability to gather data regarding user preferences. Finally, the last measurement in determining liquidity and credit risk is working capital. Netflix has proven that it can manage its current assets and current liabilities. In comparing Netflix to Blockbuster, an analyst would determine that the amount of working capital that Netflix has puts them in a sound position and that their trend is heading in the right direction (Williams, 2005).
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