Startups vs. Giants: Netflix & the Video Rental Industry
MI703: Computer Information Systems
Barriers to Entry
Definition: Those things that make it difficult for a
new company to compete against companies already established in the field (Ex. patents, network effects, start-up costs, and a dominant brand)
Do internet firms have higher or lower barriers to entry than traditional brick-andmortar retailers?
Enter the Competitors
#1 Video Rental Company: Blockbuster
– 9,076 stores! – 40 million American households have a Blockbuster card. Who here has one? – Blockbuster is so strong its name is a substitute for video rental [I'm going to Blockbuster].
#1 Company in the World: Wal-Mart
– $245B in 2002 revenues – (compared to $1.4B for Blockbuster).
Netflix’s Response?
Price Drop
– BB Online at $14.99 – Wal-Mart's for $12.97 for two DVDs ($17.39 for three) – 3 DVD rental price for NetFlix was $19.95, then it raised the price to around $22, but was forced to drop the price when competition arrived faster than management had expected.
Increased Advertising
– Spent 20% more on advertising – Ad rates going up
The Winner?
Netflix has triumphed (for now)!
– Posted most profitable year on record (despite article projections).
Wal-Mart backed off
– now partners with Netflix to sell DVDs.
Blockbuster is dying a not-so-slow death
– Lost 90% of market value in past 4 years – From $8.2 Billion (2002) to $800M – "Blockbuster will certainly not survive and it will not
be missed”
How’d Netflix do it?
First mover advantage.
– Netflix users LOVE Netflix.
Scale
– Size matters. But what kind of scale?
Software (maybe, maybe not)
– Data from recommendation service
Disruptive Revenue Model A little bit of luck (always the case)
– DVD fastest adoption cycle of any new tech.
1) First mover advantage
Switching Costs
Switching cost (price to get customer to change) =
1. perceived value of product or service + 2. cost to make the change.
Not only have to be better than competitor, have to overcome switching costs. Netflix ranked #1 in customer satisfaction.
2) Scale: Selection
Why go to Netflix above Blockbuster? How many titles at Blockbuster? How many titles at Netflix?
– 3,000 – Only new releases have multiple titles.
– Selection is bigger [than Blockbuster, with all those stores?]
How many titles does NetFlix send out in a single day?
– 1 million – 35,000 unique titles – >10x what you'd see in a store
– 55,000 titles – 42 million DVDs total. – types of genre (British Comedy, 15 different types of anime)
So there's demand for the obscure stuff & money to be made from the obscure stuff.
Scale & The Long Tail
Source: Wired
What’s in the long tail?
Bollywood Films
– 1.7 million (S. Asian) Indians in the US – Not a critical mass (best films open at most on 2 screens) – NetFlix rents 100,000 Bollywood films a month.
NetFlix is leveraging this to its advantage:
– PBS produced & aired an Oscar-nominated documentary "Daughters of Danang. – Wasn't going to release on video - didn't think it justified production costs – NetFlix assumed costs itself for an exclusive. Consistently one of Top 15 documentaries on NetFlix - cost to PBS = $0
3) Scale: Distribution Centers
Distribution centers - how many?
Why do you want more distribution centers? Like Dell? Save lots of money on JIT? Can this be copied? What does it take? So matching NetFlix is no longer a game for 'me too' startups.
– Cash – Yes
– 37 (article may say 35)
– 90% of the country with one day turn-around - key to service.
4) Data and Recommendation
What's their primary recommendation engine called?
How does it work?
– Cinematch
How does it know what you'll like based on past ratings?
– Users rate movies they've seen & NetFlix recommends additional movies.
– It compares your profiles to others – If you three liked Elf, Anchorman, and a Jim Gaffigan comedy special. Amy liked Elf & Anchorman, but hasn't rented Jim Gaffigan, what can you recommend? Gaffigan!
Collaborative Filtering
Technology that monitors trends among customers and uses this to personalize an individual consumer's experience. Examples? Amazon other user of collaborative filtering…Netflix does better because you can have multiple profiles
Software as advantage
Is the software a critical source of competitive advantage?
– Tough to say – Some aspects are patented – Netflix has over 100 patents on things such as the way the customer sets up their rental queue & the way the company sends DVDs. – Yes
Is this data a source of competitive advantage?
– Those with more customer data
Why? What firms are likely to have more accurate ratings?
How much data do they have?
Software can be easily copied (imitable), data can’t
– Half a billion ratings – A million new ratings each day – The average subscriber has rated more than 200 movies.
5) Disruptive Revenue Model
What percentage of movies in users' queues come from the firm's recommendation engine?
– 60% – NetFlix recommendations move inventory!
So what key partners in the firm's value chain are likely to consider this a big deal?
– Movie Studios
Power of Cinematch
Which studio didn’t participate in Netflix’s revenue model?
Why did they hold out?
– Paramount.
How would you retaliate against the supplier that chooses not to participate?
– At the time, Blockbuster & Paramount were both part of Viacom (no longer the case). – Don't recommend their products – In 2001 the #4 film rented was Mel GIbson's "What Women Want". On NetFlix it didn't even crack the top 100
Revenue sharing for DVDs
Source: Video Rental Developments & the Supply Chain: Netflix Inc., WUSTL.EDU case http://www.olin.wustl.edu/workingpapers/pdf/2004-03-225.pdf
Customer Service
How have costs improved from 1997 and today?
How does the system help the firm improve their operational efficiency?
– Early days, had 115,000 customers and 100 support reps. – Today has 3.2 million (now 4 million) customers and just 43 reps.
– If problem, 1 rep deals with the problem…10 work to make sure it never happens again. Monitor 'failures' and figure out how to prevent them next time! – At times, system prompts reps to call a customer back to interview them. – No - the # is buried
They're #1 in customer satisfaction. Is it easy to reach them on the phone? Why?
– Not all customers are profitable. – Phone calls are costly - need to match customer satisfaction with willingness to take frivolous calls.
Controversial Practices
There are other insights on the operational model - what's 'throttling'?
– Slowing down the pace at which it sends out movies to some customers.
Why are some customers throttled?
– They're high volume customers
Why is NetFlix concerned about them?
– It likely makes less money the more movies you churn through [cost of postage & fulfillment] – Remember, revenues are fixed regardless of how many movies you rent.
“A Little Bit of Luck”: The rapid rise of DVD.
1997 - DVD players available in US 1999 – Price point crosses $300 2003 – DVD Rentals surpass VHS rentals, new releases no longer carried by major retailers 2006 – DVD players $30 - $80. Projected last year new releases on VHS.
The Blow to Blockbuster
How’d Blockbuster respond?
How important late fees were to Blockbuster?
– Remove late fees
Is Blockbuster’s scale (stores) an asset compared with NetFlix?
– Pay rent on 4,000 stores 4 million people don't visit! – So here's a firm that deployed information technology ahead of competition that created advantage that appears to be, in the mid-term, sustainable. – Cut 1/3 out of revenues
– About 1/3 of revenues! – Hastings famously paid $40 for a late Apollo 13, prompting him to start NetFlix.
Customer Retention
How many subscribers did they think they'd have by yearend '05? Key marketing issue - churn.
(note the 20% marketing spend).
– Subscribers increased 60% to 4.2 million subscribers [BBQ3 was flat – no growth]
– It costs more to acquire a customer than keep one
– Churn of 4% (less than one in 20 people leave NetFlix in a year). Despite Wal-Mart & Blockbuster battles this year churn is at a record low! – As an FYI: customer acquisition cost was about $40 this past quarter, vs. around $35 a year ago. – How did they keep me as a customer.
Dangers to NetFlix
What's the real long-term threat to NetFlix?
What's NetFlix doing to prepare for this?
How does Hastings describe their forthcoming effort?
– Launching a video-over-Internet service – Partnership with TiVo. – "It will be underwhelming"
– Video on Demand
Why?
– Limited titles available. – Remember - studios are key point of the value chain they're suppliers & the suppliers don't want to play.
Channel Conflict
Why don't suppliers want to share with NetFlix for VoD? They've successfully cooperated with physical DVD rental.
– Fear of piracy – Want to maximize existing revenue from sales
Channel pressure from retailers (Wal-mart) limits studio VoD availability.
– Walmart handles 40% of DVD sales nationwide. Threatened not to sell Disney movies, because Disney distributing through iTunes. – Wal-Mart has executive in Hollywood, just to bully studio execs…don’t do it or lower your prices to us. Message to studios, – WalMart is no dummy…we are watching you!
Discussion
Do you think VoD will threaten Netflix in the short term? What about Blockbuster’s new model, rent online and/or return to store? Do you think Netflix will remain viable in the future?