Phenomenal Success of a Netflix Company - Essay Example

MBA 690: Entrepreneurial Management Strategies September 19, Assignment #3 – Week 5 Memorandum September 19, President and CEO From: RE: Netflix’s Recommended Strategy Supporting Material: Netflix is one the most leading internet subscription company based in USA (Netflix d). Netflix has adopted unique selling proposition by not taking any extra charges from their subscribers who are unable to mail back the rented DVDs on time. The company was formed by Reed Hastings and Marc Randolph in Scotts Valley, California in 1997. Initially, the company started to offer DVDs on rents and the company used to charge $4 rental fee and $2 postage fee for each movie by their customers. After watching the DVD, the customer then mailed it back to the address given by Netflix. Netflix was actually formed with the idea to provide Rental DVDs to customers without taking any charges from the customer for returning the DVDs late. Initially the company was taking late charges from their customers but after two years, Netflix changed their strategy and no late payment was charged for returning the DVDs late. The company also introduced the subscription services in which customers could select 4 movies rentals per month for a fee i.e. $15.95 per month. After few months, company offered unlimited plan for rental DVDs in which subscriber can have as many DVDs as they like for only a flat fee $19.95 per month. This scheme led to the success of company and its website volume grew by more than 300 percent. Company also made IPO of 5.5 million shares to raise capital of $82.5 in 2002 in order to expand its business. In the mid of 2011, Netflix changed its pricing and service structure. The company separated the two businesses i.e. DVD rental business and online video streaming with new enhanced price. Formally, company used to charge flat rate $10 per month for both the services. However the new pricing structure brought $8 for each service which collectively costs $16 for subscribers who were using both services. The situation had become worse when almost 1 million subscribers left Netflix’s services and its stock price fell down from $298 to $63 within few months (Netflix b). The CEO of the company, Reed Hastings, found that the root cause of the problem was ineffective communication with customers. He admitted that the company did not clearly mention the reasons of new policy to its subscribers (Netflix c). However, the increasing competition has been a real concern for the company and with the growing market and increasing marketing budgets and campaigns of competing firms, Netflix has been facing threats from the competitors. In addition to this, competitors have been able to attract customers of Netflix by offering them different deals that could meet their needs in a better way and in the year 2011, the company lost almost one million subscribers. The DVD rental industry in USA is very intensive. Major competitors such as blockbuster and Redbox are using various strategies to capture other’s market share. The separation of businesses was a good strategy of Netflix however the company should reduce the increased price of its services to retain its customers. Netflix was actually formed with the idea to provide Rental DVDs to customers without taking any charges from the customer for returning the DVDs late. Initially the company was taking late charges from their customers but after two years, Netflix changed their strategy and no late payment was charged for returning the DVDs late. The company also introduced the subscription services in which customers could select 4 movies rentals per month for a fee i.e. $15.95 per month. After few months, company offered unlimited plan for rental DVDs in which subscriber can have as many DVDs as they like for only a flat fee $19.95 per month. This scheme led to the success of company and its website volume grew by more than 300 percent. Company also made IPO of 5.5 million shares to raise capital of $82.5 in 2002 in order to expand its business. The company had several direct and indirect competitors in entertainment industry such as Blockbuster, Redbox etc. These competitors were able to increase their market share. In 2007, company entered into the business of online streaming in which customers could watch movies and television shows on computers. The company also lowered the subscription charges to $10 per month for both services i.e. online streaming and DVD mail in service (Market Research report, 2009). In 2011, company divided its two businesses separately and also changed their pricing structure. This new policy was not accepted by the customers and company lost one million subscribers within a few months. The company’s stock value also fell down from $298 to $63 on November 2011. This report recommends strategies to the management of Netflix in order to further increase the sales of the company. One of the strategies that have been recommended is the effectively communicating changes in the policies and pricing structure. The company can restore the trust of its subscribers by further improving its services and by coming up with more customized services for different kinds of customers. The other strategy that has been recommended to the management of Netflix is to expand its services. The company has already been planning to expand into European countries and this would increase the sales and profitability of the company. Moreover, the company can also increase its customer base even more by entering into other important regions such as Middle East. In addition to this, the company can make good use of technological advancement techniques such as Kiosk technology to increase its market share in United States. I. Relevant Facts: 1. The strategy of not charging late fee has really worked for Netflix and until 2010, the company achieved 20 million subscribers with a net income of $160.9 million (Netflix a). 2. The new strategy of lowering the subscription charges led to the success of Netflix and in the period where most of the stocks in the market declined, the share price of Netflix rose by 25 percent. 3. In 2010, the company achieved 20 million subscribers with a net income of $160.9 million (Comscore, 2010). 4. The net income of the company has been growing and its average growth of the net profit in the last few years is 39.65% which is very good. II. REAL ISSUE The division of two businesses i.e. DVD rental online and online streaming was not the root cause of the problem. Experts believed that Hastings’ new idea was actually a good move for the company because he had foresighted the future that DVD Rental and online streaming are two separate businesses and the demand of former business would decline in future due to the latest development in technology and more demand in online streaming. However, the major issue was increasing competition and other competing firms like Redbox, Blockbuster came up with different innovative. So, as the market got saturated and customers got different options, they switch to other products and thus it created issues for Netflix. III. Porter Five model forces The entertainment industry has always been major source of joy for many people in the world however in America it has gained importance due to the technological advancement and public interest in entertainment. The entertainment industry includes the sub industries which are providing entertainment to the people. For example, music industry, art industry, film industry, comedy. The categories also include Television, cinema, theatre, radio, Cable T.V, DVDs, CDs etc. Netflix belongs to subcategory of Movies, and TV shows. As far as film industry is concerned, U.S made 10.2 billion dollar through film industry. Therefore movie rental business is also very competitive. People can rent videos in number of ways. For instance, the company can take rental videos from local rental stores, from online websites such as Netflix, and from Pay-per-view. The porter five model forces help to understand this industry through buyers’ power, suppliers’ power, threat of new entrants, threat of substitute products and competitive position in industry. 1. Bargaining Power of Customers Bargaining power of customers in movie rental business is quite high because they have different options available to choose from. The advancement in technology has also made it convenient for customers as they can download the movies instantly through websites or watch online. Therefore, the bargaining power of customers is high. 2. Bargaining Power of Suppliers Movies are purchased by different firms in the industry from the studios that make them. Therefore these studios have bargaining power to a certain extent as only these studios are allowed to sell the movies as they have the rights. But on the other hand, these studios have to earn revenue by selling these movies, therefore they do not possess very high bargaining power. Therefore it can be said that suppliers of Netflix do have some kind of bargaining power but this bargaining power is not very high. 3. Threat of New Entrants The threat of new entrant in this industry is very low and one of the major barriers is the initial cost of such a business which is very high. Moreover, firms that need to run such a business need to acquire licenses of movies which is costly and this investment is irreversible. Furthermore, there is an intense competition in the industry which is another strong barrier that would limit the new entrants. 4. Threat of Substitute Products Netflix threats from different substitute products like pay per view TV, Brick and mortar rental stores and theatres are among the top most. Brick and mortar companies would be considered as the one offering very much similar kind of services like Netflix as the company offers DVD. However, there is a difference that Netflix offers a lot more variety of movies for the customers to choose from and customers are allowed to select the movies anytime. Moreover, when compared with the cost; then the services of Netflix are cheaper in comparison to the brick and mortar rental stores. 5. Rivalry within the Industry Rivalry within rental video industry is very intense. Therefore, every other firm is looking to increase its market share. The use of advertisement using electronic media, print media and social websites is very high to engage the customers. Major giants of the industry are Netflix, blockbuster and Redbox. Redbox and Blockbuster are using Kiosk technology for their rental businesses in different places which are for a convenient way for subscribers. However these competitors charge more than Netflix for DVD rentals. Redbox charge S1.20 a day for normal DVDs. Therefore it can be said that the rivalry within the industry is very high. IV. Teece Model According to the Teece model, the organizations are analyzed on two important factors; imitability and complementary assets. These two factors define determine who will at the end of the day gain profits from an innovation. The term imitability is referred to how easily someone can copy or imitate the products, processes or technology underpinning the innovation. The figure of Teece Model can be found in the appendix section. By analyzing the above image of the Treece Model and examining the situation of Netflix then it can be said that the technology used by Netflix is not very easily imitable though it is imitable as the company has different competitors offering different kinds of services therefore it can be said that Netflix would enjoy moderate to high level of imitability. The profitability of the company has been growing over the years as the financial statements of the company reveal and therefore it can be said that the complementary assets are tightly held and the company can be placed in the right top corner. V. Shaping Strategy Hagel III, Brown and Davison (2008) explain about how to formulate a shaping strategy. There are three important elements in formulating a shaping strategy and these are; participants, platform and the view. Figure 2 in the appendix shows how Hagel III, Brown and Davison (2008) have explained about formulating a shaping strategy. The view identifies the opportunities and what the company would like to do and achieve. This element focuses on the big picture rather than small actions. Moreover, it analyzes the industry factors and forces that influence the participants. The second element is the platform which defines the standards and practices in order to guide to meet the needs of the participants which is the third element. Organizations improve the platform in order to offer better products and services to the participants. One of the recommendations that have been given to Netflix is to adapt the technology of Kiosk and implement it in the United States. Netflix as has been a prominent name in USA market, and therefore by implementing this technology the company would be able to better serve and satisfy its customers. So, in this case the view element would include the factors such as competition, convenience for the customers and other factors. However the platform that the company would be using is the adapting the kiosk technology to attract more customers and increase the value of the goods and services they are delivering to the participants. VI. Realistic Options & Implications: 1. Do Nothing The rental business industry has great potential due to the rapid technological development in the industry. The customers in this industry are price sensitive and they want more value at fewer prices therefore the company should focus on its price structure and reduce the price as they were before. This is all what they have been getting from the services of Netflix. The main strengths of Netflix were their low price rental video service with no delaying charges. This was the unique selling preposition of Netflix which created a unique identity in the minds of customers. That is why company has been able to rapidly acquire large base of customers. The company reduced prices by 50% within three years of its launching and added unique values in their services such as, no extra fee charged by customers who are unable to mail back DVDs on time, and the launching of online streaming services. These strategies helped in increasing the subscribers of the company even in the recession and intense competition. The strategies also reveal that customers are price sensitive and they want more value in fewer prices. The company initially started with the net loss but gradually the company becomes profitable company. The company’s past five year annual statement i.e. from 2006 to 2010 has been showing positive trend in the company’s growth. Company’s Revenues have been increasing every year and thus proving that the number of subscriber of the company have increased every year. Not only the revenues, there has been an increasing trend of net income of Netflix (Market Watch, 2011). Company’s net profit has increased up to 350% within four years which indicates that the ratio of revenue increases every year is greater than the ratio of total cost increased. Furthermore, company’s revenue and net profit also has increased in the recessionary period where almost every company have shown poor figures as compare to previous year. The following table shows the net income of the company from 2008 to 2010 and there has been a positive growth observed: Year Net Profit Growth of Net Profit 2008 $83,026 (Netflix, 2008) 2009 $115,860 (Netflix, 2009) 39.55% 2010 $160,853 (Netflix, 2010) 38.83% 2011 $226,126 (Netflix, 2011) 40.57 Average Growth 39.65% So, if the company does nothing then even at this situation it would be able to grow at a very good rate by keeping its same strategies. 2. Investing in other Markets like Dubai One of the options that the company has is to expand its services. The company is already planning to expand in European countries, however it could at the same time think about other regions as well. In this regard, this report has research and identified that Middle East can be an attractive option for Netflix. The report has applied Shaping strategy to analyze the situation of Netflix. Using the shaping strategy, the view which is about the external environment and as the industry is growing and Middle East has become an important region of the world where investors from different parts of the world are identifying different investment opportunities. Therefore with the growing number of foreigners particularly Western investors, Middle East has become an important place for investment purpose. The participants would not only be the Western or immigrants in the Middle East but the Arabs living in the Middle East can be profit participant as well and thus Netflix would be able to take first mover advantage in that part of the world. 3. Implementing Kiosk Technology Netflix is an important player in the American Market and it can further capitalize on its market position by giving more value to the customers. One of the recommendations in this regard is to use the kiosk technology. The total startup cost to successfully implement Kiosk technology in different places of California is $5.25 million. Company should first implement this technology in the place where it was originated. If this strategy becomes successful for Netflix, the company can further increase the number of Kiosk Machines in California and can also expand this technology to different states of America. Redbox and Blockbuster have already implemented this technology and are successful. The benefit of this technology is that customer can rent and return back DVDs from any of the Netflix’s kiosk machine and thus this would make the transaction with the company more convenient. There are number of reasons why Netflix should go for Kiosk. One of the reasons is that the competing firms like Redbox have used kiosk technology to a good effect and with kiosk technology, Redbox is able to increase its market share. Therefore using of kiosk would not only allow the company to retain its customers but at the same time it would attract more customers. So the target audience of kiosk would not only be the existing customers of the company to provide them more value and more convenience but it would be target to attract new customers as well. Therefore it would be helpful in generating more revenue. Also as the US market is the most important market for Netflix and therefore investing in this market would make the position of the company stronger. VII. Recommended Option: The company is already planning to invest in different parts of the world. The management is eyeing European countries at the moment; however Middle East can be an important region as well for the management. There are different reasons for investing in Middle East. One of the reasons to invest in this part of the world is that there are lots of immigrants and this group can be targeted easily. Although there are different options that Netflix has like the BRIC countries but the main reason to choose Middle East is the level of competition which is low in this part of the world and thus Netflix can eye this region for investment purpose. As investors around the world are investing in Middle East and Netflix can also gain advantage by investing in Middle East. Moreover, the target audience would not be only restricted to the immigrants but local Arabians can also be targeted. The total start-up cost of doing business in Dubai is $103,000. The company should start business through rental office in the prime location of Dubai. The cost of Advance payment, first month rent, manager salary, lower staff salary and advertisement cost would be included in the final startup cost. Netflix can further spread their offices in different parts of Middle East once the company achieves success in Dubai. The profit and loss statement of the company after investing in the Dubai market and following the same strategies, the profit and loss statement of the company would be as follows: 2012 2013 2014 2015 2016 Total Revenues 4,480,192 6,255,855 8,735,074 12,197,057 17,031,421 Total cost of revenues 2,853,753 3,984,280 5,563,373 7,768,408 10,847,528 Gross profit 1,626,439 2,271,576 3,171,701 4,428,649 6,183,893 Total operating expenses 1,083,351 1,512,887 2,112,732 2,950,415 4,120,238 Net income 320,647 448,050 625,161 872,422 1,217,638 VIII. Market Analysis Dubai has been considered as one of the most lucrative cities for investment purpose. Netflix can go to Dubai and then to other parts of Middle East. The company can take advantage of the number of immigrants that are living in Dubai. It has been found that almost 80% of the people living in Dubai are immigrants. Moreover, the other advantage and reason to invest in Dubai is that other competitors have not eyed Dubai and other parts of Middle East for this market. With the growing needs and growing demand of such industry, Middle East and in particular Dubai can be an important market as Netflix would be able to take the first mover advantage. Moreover, the company can target not only the immigrants in Dubai but also other people and locals that are living in the country. Also because of the cultural differences of Arabs and people in West, not too many companies have analyzed this market for investment purpose and this is another reason why Netflix should invest in Dubai. However it is important for the company to analyze the differences in culture and then come up with proper strategies to minimize these differences and then invest. With the increasing potential of the market and the market of Middle East not being analyzed by others, Netflix can capitalize the prevailing opportunities in the market. IX. Comparison of the Options in Terms of Risk and Return 1. Option 1: Do Nothing Netflix would continue to improve its profitability with the passage of time. The net profit of the company has been growing at a rapid pace, and if the company maintains its current strategy even then it will be able to increase its profitability further more. The financial statement of the company has forecasted for the next five years are as follows and it is evident that if the company follows the same strategy then its profitability would further increase. 2012 2013 2014 2015 2016 Revenues 4,475,192 6,249,605 8,727,574 12,188,057 17,020,621 Total cost of revenues 2,849,753 3,979,680 5,557,623 7,761,220 10,838,544 Gross profit 1,625,439 2,269,926 3,169,951 4,426,837 6,182,078 Total operating expenses 1,083,308 1,512,839 2,112,680 2,950,358 4,120,175 Net income 319,690 446,447 623,463 870,666 1,215,886 2. Option 2:   Year 1 Year 2 Year 3 Year 4 Year 5 Revenue 5,000,000 6,250,000 7,500,000 9,000,000 10,800,000 Cost of Revenues 4,000,000 4,600,000 5,750,000 7,187,500 8,984,375 Operating Income 43,000 47,300 52,030 57,233 62,956 Net Income 957,000 1,602,700 1,697,970 1,755,267 1,752,669 Netflix can also gain substantial profits by expanding its business in Dubai. Based on the average revenue increment from past five years i.e. 2006 to 2010, it has been assumed that revenue will grow by 25% every year. However the cost is estimated to increase by 15% every year. Operating expense such as office rent, manager salary, lower staff salary and advertisement expense would increase by 10%. Net income has shown a rising trend and it will increase in future at a growing rate. NPV 9,462,954 IRR 59% Payback Approx 4 years The Payback period of this project is approximately four years which shows that Netflix in its fourth year of project would be able to cover all its initial investment. The NPV of this project is $ 9,462,954 which is almost 95% more than of its initial investment. Furthermore the project IRR is 59% which shows the rate at which initial investment of the project would be equal to the present value of the future cash flows. 3. Option 3: Kiosk   Year 1 Year 2 Year 3 Year 4 Year 5 Revenue 1,500,000 1,875,000 2,250,000 2,700,000 3,240,000 Cost of Revenues 1,050,000 1,260,000 1,575,000 1,968,750 2,460,938 Operating expenses 30,000 33,000 36,300 39,930 43,923 Net Income 420,000 582,000 638,700 691,320 735,140 Netflix would be able to earn profits if it implements the kiosk technology and it has been estimated that the profitability of the company would increase with the passage of time. However, implementing this technology would require an investment of $2,500,000. The revenues are estimated to increase by 25% and the cost of revenues are estimated to be 60% of the sales. Moreover, the company will also incur other operating expenses which will be $30,000 in the first year and it would increase by 10% annually. To analyze whether this decision is feasible for the company or not, project appraisal techniques have been applied; NPV (207,892) IRR 7% Payback More than 4 years The above table shows that the NPV of the project is negative and therefore it should not be accepted. Moreover, the IRR is also less than the hurdle rate which has been estimated to be 10% and therefore the project should not be accepted. Also the payback period of the project is more than 4 years and therefore it also shows that the company will recover its investment late and therefore the project should not be accepted. X. Method of Evaluation Net Present Value, Internal Rate of Return and Payback Period are the techniques that have been used to evaluate whether the project should be accepted or rejected. With the results found, NPV of investing in Dubai is positive and its IRR is also higher than the hurdle rate, therefore the project of investing in Dubai should be accepted. Moreover, the payback period is almost 4 years which is a reasonable period to recover the investment. The other project was to invest in kiosk technology, however the NPV of kiosk is negative and therefore the project should not be accepted. Moreover, the IRR is also less than the hurdle rate which was 10% therefore the project should be rejected. Also the payback period is more than 4 years so the management should not invest in the project. XI. Conclusion Netflix has several competitors that are offering tough competition to the company; however the company has been growing and improving its position in the market. The company has been able to offer cost-effective solutions over the years and this has been one of the reasons why it has been able to achieve high profitability and high growth over the years. Moreover, the growth rate of the company is high and it is expected to further grow with the years to come. There are different alternatives that the company has at the moment. If the company goes on with the same strategies and without adapting any of the two strategies, even then the company would be able to grow and achieve high profits in the years to come. Moreover, out of the two projects that have been considered, investing in the Middle East market and in particular Dubai has been identified as the right alternative. The Net Present Value of investing in Dubai is found to be positive and very high. Moreover, the IRR is more than the hurdle rate and thus the project should be accepted. On the other hand, implementing the kiosk strategy like Redbox would not be a good idea because the project is not showing positive NPV and its IRR is less than the Hurdle Rate. Therefore the project should not be accepted. To conclude, Netflix should continue the way it is operating and at the same time invest in Middle East and in particular Dubai to further improve its profitability. References Netflix. (2010). Annual Report. Retrieved from http://ir.netflix.com/common/download/download.cfm?companyid=NFLX&fileid=460274&filekey=17454C5B-3088-48C7-957A-B5A83A14CF1B&filename=132054ACL.PDF Netflix. (2009). Annual Report. Retrieved from http://ir.netflix.com/common/dar/dar.cfm?DocumentID=2789&CompanyID=NFLX&zid=d940c238 Netflix. (2008). Annual Report. Retrieved from http://www.shareholder.com/visitors/dynamicdoc/document.cfm?documentid=2609&companyid=NFLX&PIN=411852592 Netflix. (2007). Annual Report. Retrieved from http://ir.netflix.com/common/download/download.cfm?companyid=NFLX&fileid=188779&filekey=A5DE0034-8320-4D49-B13B-80C9845E49D4&filename=AR_10K_final.pdf Netflix a. Company Facts. Retrieved October 11, 2011 from https://signup.netflix.com/MediaCenter/Facts Netflix b. Company Overview. Retrieved October 11, 2011 from https://signup.netflix.com/MediaCenter Netflix c. Company Timeline. Retrieved October 11, 2011 from https://signup.netflix.com/MediaCenter/Timeline Comscore (2010). US online video market continues ascent as Americans watch 33 billion videos in December. Press Release. Retrieved October 19, 2011 from http://www.comscore.com/Press_Events/Press_Releases/2010/2/U.S._Online_Video_Market_Continues_Ascent_as_Americans_Watch_33_Billion_Videos_in_December Market Research report. (2009). Movie rental industry drives home entertainment market. Retrieved from http://www.marketresearch.com/product/display.asp?productid=2578264 Netflix d. Historic Stock Lookup. Retrieved from http://ir.netflix.com/stocklookup.cfm Market Watch. (2011). Netflix expected to post strong earnings. (2011). Retrieved from http://www.marketwatch.com/story/netflix-expected-to-post-strong-earnings-2011-04-21?link=MW_latest_news Whitehouse , D. (2011). Netflix to Expand in Europe, Starting With Spain, Figaro Says. Bloomberg. Retrieved from http://www.bloomberg.com/news/2011-06-03/netflix-to-expand-in-europe-starting-with-spain-figaro-says.html Appendix Figure 1: Teece Model Figure 2: Shaping Strategy Read More