University of Chicago
Type of paper: Thesis/Dissertation Chapter
Streaming Media and Netflix
Netflix’s main issue is they face increased market competition from new entrants into their industry. In addition, Netflix suffers poor relationships with suppliers, which interferes with their ability to meet market demands leading to increased costs and the need to increase prices. This affects Netflix’s ability to increase market share, and maintaining core values, resulting in declining subscribership, and declining margins.
COMPANY ORIGINS. Thorough analysis of Netflix begins with a discussion of the companies origins. Netflix was founded by Reed Hasting (CEO) and Marc Randolph in 1997 in Scotts Valley, California, with main headquarters now located in Los Gatos, California. The original business model was as an internet TV company providing online streaming and DVD/Blu Ray rentals shipped direct to a subscriber’s home. This subscription and selling service implemented in 1999, and in 2000 launched their personalized movie recommendation service CineMatch (Funding Universe, 2014). Shortly thereafter Netflix executed their IPO in 2002 with approximately 600,000 members in the US and by 2005 membership rises to 4.2 million. Perhaps most important is Netflix introduces video streaming in 2007, and later in 2008, partners with consumer electronics companies to incorporate Netflix video streaming on consumer electronic devices. Further growth is achieved in 2010 when Netflix launches internationally in Canada, Latin America, and Caribbean (Netflix Media Center, 2014).
THE BLUNDER YEAR.
Mid-July 2011 Netflix announces Qwikster, which was an attempt to separate online video streaming services and DVD rentals, resulting in an immediate 60% devaluation of Netflix stock and eventually to a low of $62.37 by December of that year. Ultimately, on October 10, 2011 the Qwikster proposal is scrapped by Netflix. However, the damage was already done because on July 13th their stock price was at an all time high of $304.79, and eventually bottomed out at $55.19 on December 31 of that year (Thompson, 2012).
Once the disaster of 2011 passed, Netflix rebounded by expanding into the Latin America and Caribbean markets. Later in 2012, Netflix expands its international market further by becoming available in Europe that included the United Kingdom, Ireland, and Nordic countries. In addition, Netflix wins its first Primetime Emmy Engineering Award. Furthermore, in 2013, Netflix expands to the Netherlands, and debuts original programming that earns Netflix 31 primetime Emmy nominations including outstanding drama series, comedy series, and documentary or nonfiction special for _House of Cards_, _Orange is the New Black_, and _The Square_ respectively. More importantly, _House of Cards_ wins three Primetime Emmy Awards making Netflix the first internet TV network nominated, and winning, a primetime Emmy award. Furthermore, in 2014, Netflix launches in 6 new countries in Europe that included Austria, Belgium, France, Germany, Luxembourg, and Switzerland. Again, Netflix wins 7 creative Emmy Awards for _House of Cards_ and _Orange is the New Black_. Moreover, Netflix now has over 50 million global subscribers (Netflix Media Center, 2014).
Netflix’s performance has been solid, although they underperformed in the third quarter of this year, 2014, perhaps due to over forecasting which Netflix does often, creating the perception to investors and analysts that the company has underperformed (Seward, 2014). Their numbers remain strong and stock is currently valued $379.01per share (Yahoo Finance, 10/30/14). Moreover, Netflix had $4.3B in Revenues in 2013 and revenue is projected to $4.7B by year end 2014, and current ratio is 1.42 demonstrating the moderate ability to cover current liabilities, See Appendix A, Financial Sheets, Tables 1 through 6 on pages 15 through 20, for additional details of Netflix’s strong financial performance. Generally speaking, all key financial statistics are trending upwards over the past five fiscal years (Market Watch, 2014). Furthermore, as of the third quarter of this year, Netflix has 53.1 million subscribers worldwide and that is forecast to climb to 57 million subscribers at year end 2014 (Netflix Letter to Shareholders, 2014).
FIVE FORCES MODEL OF COMPETITION.
See Figure 1 in Appendix B, Netflix-Porter’s Five Forces Model, page 21, for a graphical analytic tool that summarizes the following forces.
_COMPETITION AND RIVALRIES
._ Competition and rival threats remain high. Netflix’s rival, for content and subscribers, is now Time Warner, who owns Home Box Office (HBO) and possesses a large subscriber base as well as original content. However, when competition involves subscribers, Amazon Prime Instant Video is becoming a direct competitor. Soon, Amazon will air original programming thus becoming a competitor for content as well (Casteele, 2014). In addition, Hulu, Apple TV, Google TV, Google owned YouTube, and CBS All Access has, or will have, original content available in the near future. Although Amazon does not have the number of subscribers that Netflix has, approximately 5 million versus 50 million plus for Netflix, both have the edge against traditional networks by using customer data instead of market research and Nielsen data for developing original content (Kleinman, 2013). Furthermore, competitors would include cable and satellite TV companies such as DirectTV, Comcast xfinity, and the movie theaters.
The threat of substitutes remains high. Products viewed as close substitutes include Hulu Plus which may also be considered a rival in some respects but exist more as a complementary product to Netflix and focuses on current run and older TV shows targeted at a younger market. Moreover, Hulu provides fewer movies compared to Netflix and forces subscribers to view commercials when streaming content. Another substitute would include Amazon Prime Instant Video (APIV) available only through a year subscription through Amazon Prime, a free two-day shipping service, and provides an extensive movie and TV library (Shanklin, W, 2014). Furthermore, Vudu is Wal-Mart’s offering of on-line streaming and similar to what one finds on YouTube or iTunes but providing more full length feature films (Prindle, D., 2014). Other substitutes include Google Play, RedBox Instant, and Microsoft’s Xbox video streaming (Shanklin, W, 2014). These substitutes are unlikely to threaten the market in excess, and Netflix’s threats remain with APIV.
The threat of new entrants is strong. In addition, there exists a strong likelihood of suppliers offering content on their own website because of low barriers to enter the video streaming market. The TV market is increasingly moving to the on-demand online streaming model. The recent entry of Time Warner’s HBO, and CBS into the on-line streaming realm is a testament to new entrants. More Web based enterprises will shift or add on-line streaming content because the barriers are already low for these enterprises (Lever & Estienne, 2014). In addition net neutrality rulings leave open the window of opportunity for new companies to enter the market (Selyukh, 2014).
_BARGAINING POWER OF SUPPLIERS._
Bargaining power of suppliers is high. Moreover, suppliers can withhold content and Internet Service Providers (ISPs) can intentionally without quality service to Websites using large portions of bandwidth. Until a net-neutrality regulation is in place, this will remain a major issue for companies providing on-line streaming content such as Netflix (Selyukh, 2014).
_BARGAINING POWER OF CONSUMERS._
Bargaining power of consumer’s is high because on-line video streaming is highly price elastic and consumers will migrate to the perceived better value. Therefore, there is great sensitivity to price and content. Consumers will gravitate to the best suppliers of content and a bargain price without much loyalty. Netflix’s slower subscriber growth in the third quarter of this year was attributed to price increase that the company undertook recently (Sikka, 2014). In addition, the industry must contend with the distribution and use of illegal downloads and the lack of established enforcement of pirating content. Content is king and consumers demand content, and original content is even better.
See Figure 2 in Appendix C, page 22, Netflix SWOT Analysis, for a graphical analytic tool that summarizes the following described strengths, weaknesses, opportunities, and threats.
Netflix will invest a total $3 billion (US) by year’s end in program content to provide content and meet the diverse tastes of its more than 36 million U.S. and 14 million international online subscribers. In addition, Netflix will spend $600 million (US) on marketing and $400 million (US) on technology upgrades. (Netflix ups ante, 2014). Moreover, Netflix possesses brand recognition and the word Netflix even becoming a verb among Internet users.
Furthermore, the Netflix App has created greater accessibility and enabled subscribers to stream media on nearly all Internet enabled devices. Perhaps most important of all is Netflix’s original content of award winning programs such as House of Cards, Orange is the New Black, and Hemlock Grove enhancing international growth. In addition, Netflix has signed a number of interconnection agreements with Internet Service Provider (ISPs) to ensure faster Internet speeds for subscribers (Sikka, 2014). More importantly, Netflix has positive financial ratios although profit margins remain low internationally, and continues to demonstrate outstanding stock market growth.
One Netflix’s largest weakness is their cost of content relating to the mass of licensing packages and the in-house original content production company Netflix is accumulating a large amount of debt and profit margins are low relative to the international market. Furthermore, the DVD and Bluray domestic subscriber market is declining, from 7.0 million paid subscribers at the end of the third quarter 2013 to 5.9 million subscribers at the end of the third quarter 2014 (Letter to Shareholders,.2014). Moreover, Netflix has had a history of subscriber revolt when raising subscription prices and their recent $1 increase was not having any significant impact on subscriptions, however may impact subscriptions nonetheless (Steel, 2014).
The last attempt to raise monthly subscription prices left current subscribers upset and Netflix stock tumbling. In addition, Netflix accounts for about 57% of daily internet traffic (Sikka, 2014). Therefore, with net neutrality laws being struck down, Netflix will either need to assume more debt, which they will spend $1 billion (US) or the next 15 months, or cut content, which they will do the complete opposite. Perhaps most importantly, both Amazon Prime Instant Video (APIV) and Google owned YouTube have announced their own original content productions becoming a direct competitor to Netflix.
Netflix’s greatest opportunity lies in International Expansion and their ability to create original content will enhance international growth. In addition, the international opportunities will depend on Netflix’s superior software apps and service created from their own global technology investment, process knowledge, data acquired from related markets, and their globally recognized brand (Netflix Long term View, 2014). Moreover, Netflix’s original in-house programming should take full advantage of the many entertainment related smart devices with Internet capability. Households that have a TV or other device connected to the Internet, as of 2013, stood at 49% up from 24% in 2010 and is undoubtedly higher in 2014 (Sikka, 2014). There exist an opening for Internet TV and Netflix’s exclusive in-house content will allow the company to take full advantage of that demand.
Because Netflix accounts for about 57% of daily Internet traffic, ISPs have lobbied to require major website traffic contributors pay for the infrastructure needed to support this heavy volume of traffic (Sikka, 2014).. Until net neutrality is resolved one way or another, this will remain a top threat for Netflix. Furthermore, competition such as Amazon Prime Internet Video (APIV), and Google’s YouTube are implementing their own original content and are direct competitors to Netflix. Moreover the expense of licensing and renewing license agreements remain a threat to Netflix’s ability to increase margins. However, in-house production of original content benefits the company by generating a word-of-mouth advertising and elevating the company into an Emmy award winning content producer. In addition, there exists the threat of brand loyalty as subscribers are price conscious and sensitive to price increases.
Possible alternatives range from doing nothing to focusing completely on the international market. If Netflix does nothing and continues their physical delivery of DVDs and Bluray discs will continue to cost more over time because of the need for maintain even a minimum of distribution centers for delivery to subscribers. Another alternative may be to simply pay the premium price required to acquire more and more content through expensive licensing agreements. This alternative as a stand-alone strategy and may not provide the competitive advantage needed to attract the number of subscribers needed for desired growth. A third alternative could be to combine the purchasing of content and licensing with original content programming to attract domestic subscribers and increasing international market penetration in the video streaming market.
The recommendation made by the author is a combination of the reducing and phasing out the physical DVD delivery model combined with the purchasing of content and licensing, and using original content programming to attract domestic subscribers, and increasing international market penetration.
Internet television is replacing linear television, at the same time that apps are replacing network channels. Thus creating the proliferation of viewing screens for streaming content. In addition, Technology is improving and more available than ever before making this technology less expensive. Furthermore, streaming is the leading source for Ultra HD 4k video, and TV everywhere provides an economic transition for existing networks. Hence, new entrants into the Internet streaming realm, including Netflix, are innovating rapidly and driving improvements (Letter to Shareholders, 2014). See Appendix D – Graph 1, Netflix – Market Share Bubble Graph on page 24 for a graphic representation of Netflix’s market share compared to APIV and Hulu.
Netflix should phase out of the physical DVD via mail service market and that will help reduce operating costs. Meanwhile, focus on Internet streaming of content, and producing original content will expand viewership and subscribers, both domestically and internationally, as well as help limit supplier control. This will help contribute to increased margins leading to increased revenue and stockholder confidence. Netflix is in a growth strategy in the international market where investment needs are high. Therefore, margins will be lower than desired expectations, and growth potential in the international market remains very high. Therefore, Netflix should remain on this strategy.
Casteele, J. (February 24, 2014), Netflix vs HBO: Is the Rivalry as Intense as it Seems? The Motley Fool. Retrieved from: http://www.fool.com/investing/general/2014/02/24/is-the-netflixhbo-rivalry-as-intense-as-it-seems.aspx
France-Presse, A. (April 25, 2014). Netflix announces content agreements with several cable companies, RawStory.com. Retrieved from: http://www.rawstory.com/rs/2014/04/netflix-announces-content-agreements-with-several-cable-companies/
Funding Universe (2014). Netflix, Inc. History, _International Directory of Company Histories_, Vol. 58. St. James Press, 2004. Retrieved from: http://www.fundinguniverse.com/company-histories/netflix-inc-history/
Kleinman, A. (March 3, 2013). Netflix vs. Amazon Could Be The Cool New Rivalry, Huffington Post. Retrieved from: http://www.huffingtonpost.com/2013/03/05/netflix-vs-amazon_n_2811454.html
Kline, D. (July 26, 2014). Amazon Prime Continues to Grow Despite Price Bump, The Motley Fool. Retrieved from: http://www.fool.com/investing/general/2014/07/26/amazon-prime-continues-to-grow-despite-price-bump.aspx
Letter to Shareholders, (October 15, 2014). Netflix Corporate Website. Retrieved from: http://files.shareholder.com/downloads/NFLX/3556910032x0x786677/6974d8e9-5cb3-4009-97b1-9d4a5953a6a5/Q3_14_Letter_to_shareholders.pdf
Lever, R., and Estienne, S. (October 19, 2014). We’ve Hit a Watershed Moment For Streaming TV, Business Insider. Retrieved from: http://www.businessinsider.com/afp-with-new-entrants-streaming-tv-sees-waters
Market Watch (2014). Netflix Key Statistics, MarketWatch.com. Retrieved from: http://www.marketwatch.com/investing/stock/nflx/profile
Netflix Long term View, (October 15, 2014). Netflix Corporate Website. Retrieved from: http://ir.netflix.com/long-term-view.cfm
Netflix Media Center (2014). Netflix, A brief history of the company that revolutionized watching of movies and TV shows. Retrieved from: https://pr.netflix.com/WebClient/loginPageSalesNetWorksAction.do?contentGroupId=10477
Netflix ups ante in streaming. (2014, Oct 27). _Investor’s Business Daily_ Retrieved from http://search.proquest.com.ezproxylocal.library.nova.edu/docview/1615897570?accountid=6579
Perez, S. (April 30, 2014). Hulu, Now With 6 Million Subscribers, Will Make Some TV Episodes Free On Mobile, TechCrunch.com. Retrieved from: http://techcrunch.com/2014/04/30/hulu-now-with-6-million-subscribers-will-make-some-tv-episodes-free-on-mobile/Prindle, D. (May 13, 2014). Best Media Streaming, Digital Trends.com Website. Retrieved from: Serviceshttp://www.digitaltrends.com/home-theater/best-media-streaming-services/
Selyukh, A. (May 15, 2014). Amid protests, U.S. FCC proposes new ‘net neutrality’ rules, Forbes. Retrieved from: http://www.reuters.com/article/2014/05/15/us-usa-internet-neutrality-idUSBREA4C0SF20140515
Seward, J., (October 16, 2014). Analysts Believe Netflix Is Victim Of High Expectations, Benzinga Retrieved from: http://www.benzinga.com/analyst-ratings/analyst-color/14/10/4929716/analysts-believe-netflix-is-victim-of-high-expectations?utm_campaign=partner_feed&utm_s
Shanklin, W (August 21, 2014). Netflix alternatives: These 7 services are the closest you’ll get, Geek.com Website. Retrieved from: http://www.geek.com/news/netflix-alternatives-these-7-services-are-the-closest-youll-get-1472327/
Sikka, P., (October 20, 2014). Analyzing the must-know business trends affecting Netflix, Market Realist. Retrieved from: http://marketrealist.com/2014/10/must-know-netflix-stock-steep-fall/
Sikka, P., (October 20, 2014). Why deals with Internet service providers are helping Netflix, Market Realist. Retrieved from: http://marketrealist.com/2014/10/must-know-netflix-stock-steep-fall/
Sikka, P., (October 20, 2014). Why Netflix has long been demanding net neutrality laws, Market Realist. Retrieved from: http://marketrealist.com/2014/10/must-know-netflix-stock-steep-fall/
Sikka, P., (October 20, 2014). Why Netflix doesn’t consider HBO’s streaming service a threat, Market Realist. Retrieved from: http://marketrealist.com/2014/10/must-know-netflix-stock-steep-fall/
Steel, E. (July 21, 2014). Netflix, Growing, Envisions Expansion Abroad, _The New York Times._ Retrieved from: http://www.nytimes.com/2014/07/22/business/media/netflix-says-it-topped-50-million-subscribers.html?_r=0
Thompson, A. A. (2012). Netflix in 2012: Can It Recover from Its Strategy Missteps, _Business Strategy Game._ Retrieved from: https://www.bsg-online.com/users/CorporateLobby.html
Yahoo Finance (October 30, 2014). Netflix, Inc (NTFLX), Yahoo Finance Website. Retrieved from: https://finance.yahoo.com/q?s=NFLX