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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.
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

http://www.olin.wustl.edu/workingpapers/pdf/2004-03-225.pdf

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!
discussion
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?
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