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Startups vs. Giants: Netflix & the Video Rental Industry . MI703: Computer Information Systems. Barriers to Entry.

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Barriers to entry
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-and-mortar retailers?

Enter the competitors
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
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
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
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.

Switching costs
Switching Costs

  • Switching cost (price to get customer to change) =

    • perceived value of product or service +

    • 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
2) Scale: Selection

  • Why go to Netflix above Blockbuster?

    • Selection is bigger [than Blockbuster, with all those stores?]

  • How many titles at Blockbuster?

    • 3,000

    • Only new releases have multiple titles.

  • How many titles at Netflix?

    • 55,000 titles

    • 42 million DVDs total.

    • types of genre (British Comedy, 15 different types of anime)

  • 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

  • So there's demand for the obscure stuff & money to be made from the obscure stuff.

Scale the long tail
Scale & The Long Tail

  • Source: Wired

What s in the long tail
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
3) Scale: Distribution Centers

  • Distribution centers - how many?

    • 37 (article may say 35)

  • Why do you want more distribution centers?Like Dell? Save lots of money on JIT?

    • 90% of the country with one day turn-around - key to service.

  • Can this be copied?

    • Yes

  • What does it take?

    • Cash

  • So matching NetFlix is no longer a game for 'me too' startups.

4 data and recommendation
4) Data and Recommendation

  • What's their primary recommendation engine called?

    • Cinematch

  • How does it work?

    • Users rate movies they've seen & NetFlix recommends additional movies.

  • How does it know what you'll like based on past ratings?

    • 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
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
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.

  • Is this data a source of competitive advantage?

    • Yes

  • Why? What firms are likely to have more accurate ratings?

    • Those with more customer data

  • How much data do they have?

    • Half a billion ratings

    • A million new ratings each day

    • The average subscriber has rated more than 200 movies.

  • Software can be easily copied (imitable), data can’t

5 disruptive revenue model
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
Power of Cinematch

  • Which studio didn’t participate in Netflix’s revenue model?

    • Paramount.

  • Why did they hold out?

    • At the time, Blockbuster & Paramount were both part of Viacom (no longer the case).

  • How would you retaliate against the supplier that chooses not to participate?

    • 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
Revenue sharing for DVDs

Source: Video Rental Developments & the Supply Chain: Netflix Inc., WUSTL.EDU case

Customer service
Customer Service

  • How have costs improved from 1997 and today?

    • Early days, had 115,000 customers and 100 support reps.

    • Today has 3.2 million (now 4 million) customers and just 43 reps.

  • How does the system help the firm improve their operational efficiency?

    • 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.

  • They're #1 in customer satisfaction. Is it easy to reach them on the phone?

    • No - the # is buried

  • Why?

    • Not all customers are profitable.

    • Phone calls are costly - need to match customer satisfaction with willingness to take frivolous calls.

Controversial practices
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
“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
The Blow to Blockbuster

  • How’d Blockbuster respond?

    • Remove late fees

  • How important late fees were to Blockbuster?

    • About 1/3 of revenues!

    • Hastings famously paid $40 for a late Apollo 13, prompting him to start NetFlix.

  • 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

Customer retention
Customer Retention

  • How many subscribers did they think they'd have by yearend '05?

    • Subscribers increased 60% to 4.2 million subscribers [BBQ3 was flat – no growth]

  • Key marketing issue - churn.

    • It costs more to acquire a customer than keep one (note the 20% marketing spend).

    • 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
Dangers to NetFlix

  • What's the real long-term threat to NetFlix?

    • Video on Demand

  • What's NetFlix doing to prepare for this?

    • Launching a video-over-Internet service

    • Partnership with TiVo.

  • How does Hastings describe their forthcoming effort?

    • "It will be underwhelming"

  • 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
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!


  • 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?