Netflix | Strategic Analysis (Nov 2007)| | Netflix, the online subscription-based DVD rental service aimed to better satisfy customer in a way competitors didn’t, customized and personalized service with unlimited monthly rentals from a great variety of film offerings. Now they want to leverage their strengths to enter into the Video on Demand market| | | 9/18/2009| | 1 1 3 3 6 7 Table of Contents 1. Netflix Strategic Analysis 2. Netflix vs. Blockbuster: Comparative assessment of strategic differences 3. Netflix Competitive Advantage 3. 1 Home video industry – Positioning Perspective 3. VRIO Perspective 4. Video On Demand (VOD) – Strategic Advantage i 1. Netflix Strategic Analysis Netflix, an online subscription-based DVD rental service aimed to better satisfy customer in a way competitors didn’t, with unlimited monthly rentals from a great variety of DVD offerings and personalized service. Netflix created a distinctive value proposition by understanding customer needs and competition offerings; Netflix found the sweet spot to align the firm’s capabilities with the customer needs in a way that competitors could not match them, creating unique activities to deliver to that gap(1).
To take the movie rental to the next level, Netflix used the internet instead of rental stores and offered service only to DVD users while rental stores were still renting VHS. The combination of internet and DVD technology made competition irrelevant, by reaching in an untapped market, Netflix expanded existing industry boundaries and reached for the blue ocean(1). Netflix started building their offering from customer’s frustration such as narrow diversity of films and stressful return due dates which implied late fees.
Netflix was able to hold large amounts of inventory in their warehouses without having the physical space constringency of a rental store, added convenience of delivery and the unlimited monthly rentals of a subscription model, and using technology for customization and personalization of their service. Leveraging best practices from internet retailers (ebay, Amazon) helped Netflix to identify characteristics that were most appealing to internet customers (2). Understanding what customer valued allow Netflix to strengthen their critical success factors. . Netflix vs. Blockbuster: Comparative assessment of strategic differences. 1 Blockbuster focused their strategy on impulse rental customers, while Netflix focused on customers that desired selection and for which watching movies was a way of entertainment. While Blockbuster business relied on newest release (70% of revenue came from hit movies) (2) they kept a narrow variety of movies and their financial success depended highly in maximizing the rental of those hit movies in inventory.
To be able to increase utilization, the movies had a return due date and late fees would be applied if returned after. Netflix business model promoted lower profile films, while working in new relationships with studios to lower cost and quicker access of new releases (only 30% of revenue came from new releases)(2). Netflix continued making deals with movie producers and acquiring movies to enlarge the diversity and size of their DVD library; simultaneously applied the subscription model which allowed customers to reach an unlimited amount of movies per month (keeping three at a time).
Blockbuster scope was to expand geographical coverage nationwide, owning most of their stores (80%) and franchising the rest (2). Netflix had a similar geographical goal, creating more distribution centers (inexpensive warehouses) improving upon its national wide coverage and reducing delivery time. Using technology to develop a recommendation system and personalized their service, Netflix had established a strong market position with a large and solid base of subscribers by the time Blockbuster entered the online movie rental business.
Blockbuster had the power of high retaliation and leverage from their already established brand and existing products, so they integrated its online model with its traditional store business, eliminating late fees, copying Netflix business model and under-cutting price to gain market share, but still it did not offset their loss of revenue by 2005. 2 Blockbuster was too confident in their brand and their reach that failed to see the threat from the online rental business, meanwhile Netflix took advantage of their slow entrance to build a market and leverage on growing technology (DVD) that took off really quickly.
The strategy canvas shown in Figure 1 captures how Netflix’s strategy differs from Blockbuster’s and their areas of differentiation. Netflix shifted their focus to alternative new offerings, building on critical success factors that could not be matched by Blockbuster, even when they entered the online video rental. Figure 1. Strategic canvas of home movie rental 3. Netflix Competitive Advantage 3. 1 Home video industry – Positioning Perspective 3
To understand Netflix’s positioning in the home video industry – offering of movies in the comfort of the home – it is useful to employ Porter’s 5 forces framework to identify the gap they are filling and their strengths and weaknesses. Threat of Entry: To be able to start up a home video business would require a significant investment capital. Although the required capital for infrastructure could be medium to low (open a store and do minimum amount of marketing), it could be expensive for new entrants to invest in movies to create the necessary inventory, especially without relationships with movie studios and producers.
Also retaliation could be expected from larger players if the new business poses a threat. For a possible entrant, high differentiation (for example convenience or diversity) would be necessary to be able to succeed. The threat of entry would be considered medium to low, but Netflix saw the opportunity to get into the industry by highly differentiating themselves to be able to compete. Threat of Substitution: Alternatives to the home video industry would be: first, movie theaters, expensive and lack the convenience of watching the movie in the comfort of the house.
Second, to watch a movie through commercial television, it takes longer time to be available and is interrupted by commercials. Third, to watch movies through the internet, on the computer; it may be convenient, but not comfortable. Also, a customer always has as an option not to spend their free time watching movies. The substitutes are weak until technology allows for easy, quick and cheap movies to be downloaded through the internet and transfer to the TV. The threat of substitution is low. 4
The power of buyers: The source of dissatisfaction of customers comes from the narrow selection of movies and the rental due dates resulting in late fees. It becomes expensive for those who are volume customers and have to pay large amounts of money. But buyers have low switching cost as there are several options for renting movies, despite this fact, individual customers do not hold bargaining power over the price of products in this market since one customer’s decision to buy the service or not will not affect the overall market at all; similarly one customer’s dissatisfaction will not influence other customers significantly.
The level of dissatisfaction with the service would promote a widespread response in the presence of a differentiated product that is more convenient and satisfactory for customers. Netflix “invested in things that were strategically relevant to customer satisfaction potential” (2) taking advantage of discontent of the underserved customers which increased buyers’ switching cost and decreased the buyer power. The power of supplier: High up-front investment is necessary to be able to acquire films.
Without direct relationships with major studios, the industry depended on a small number of movie distributors to acquire the movies with little or no discount increasing the supplier power. Netflix built relationships with major film producers to decrease the up-front cost of new releases by splitting additional revenue; they were able to acquire more movies in a timely manner to satisfy demand. “As Netflix built its film library, it grew in importance as a distribution channel for many small and independent film studios” … “ Netflix acquired the distribution rights to certain independent films through its Red Envelope Subsidiary”(2).
All the actions taken helped Netflix to both decrease the supplier power while increase their movie selection. The mail delivery system had also a major role as Netflix’s supplier. They highly depended on USPS for the success of their model (delivery and return of movies in a timely manner). Netflix took advantage of the declining first class mail industry and strengthen their relationship with USPS, receiving discounts while working on an efficient plan to expedite deliveries and returns and improve customer satisfaction. 5
Rivalry: The home video industry had been highly populated by small and large players with little differentiation offering, basically commodity service in a larger and smaller scale. Blockbuster had been the leader for a long time and smaller “mom and pops shops” did not present strong competition. The rivalry could be considered medium. As industry grew in a constant pace, more people demanded a wider selection with more convenience; this allowed Netflix to get into the industry with a differentiated product that allowed them to succeed. 3. 2 VRIO Perspective
Netflix initial strategic advantage was based on differentiation from using the internet to select the movies, their unlimited monthly movies from the subscription based system with no late fees, the wider inventory of movies and the use of mail for delivery, very different from Blockbuster’s offering. It was a good strategy over the short term, but it only gave Netflix a temporal competitive advantage as anybody could copy what they were doing. To build a sustainable competitive advantage Netflix dedicated a lot of resources to make their offering unique; this helped them to further differentiate themselves.
This strategy leveraged the value proposition of convenience and selection by personalizing their offering and building strong relationships between their system and their customers, their intent was to increase customer retention, offering features that customers could not find at any competitor, and that would be too difficult for a competitor to copy. Netflix invested in technology that allowed them to get to know customers using surveys, movie reviews and monitoring rental trends.
All this permitted Netflix to give customers accurate recommendation of movies based on customer likes while having a queue of movies that would be shipped to them on priority basis. Using their core strengths and building rarity and difficulty of imitability, as observed in the VRIO analysis in Table 1, Netflix customer data base and personalized offering allowed them to have a sustainable competitive advantage in delivering home video entertainment. 6 Table 1: Netflix critical success factors – VRIO break down | Resources| V| R| I| O| | Physical| | | | | | | Technology| * | * | | * | TCA| Logistics| * | * | | * | TCA| | Geographical reach| * | | | * | | | Wide selection| * | * | * | * | SCA| | Brand| * | * | | * | TCA| | Convenience – Easy access| * | * | | * | TCA| | Customer database| * | * | * | * | SCA| Organization| | | | | | | Knowing customer| * | * | * | * | SCA| | Recommendation| * | * | * | * | SCA| | Subscription| * | * | | * | TCA| | No late fees| * | * | | * | TCA| | Relationship with studios| * | * | | * | TCA| Human| | | | | | Team commitment| * | * | * | * | SCA| TCA – Temporary Competitive Advantage (Strength and distinctive competence)
SCA – Sustainable competitive Advantage (Strength and sustainable distinctive competence) 4. Video On Demand (VOD) – Strategic Advantage While Netflix “believed that the DVD rental market would remain healthy for years in the future”(2), they also recognized, just as they did when entering the DVD market, the need to take advantage of the fast pace growing technology and enter the VOD market in its early stages in order to maintain ts superior “position as a giant in the media industry”(2). Unlike Blockbusters’ response when Netflix first appeared with a product so different from theirs, rather than seeing the new offering as an option that would appeal only to a niche market(2), Netflix acknowledged the VOD offering as a service that would benefit the mass market needs(2). 7 VOD presents two main challenges, the first is the hardware requirements to allow connectivity between the computer and television, adopting streaming offering would allow Netflix to establish in the VOD market while waiting for the technology to develop.
The second is “the current limitations in available content” (2). Adopting the VOD business as a separate service could hurt Netflix’s “wide selection” image making it difficult to satisfy its wide range of customers. While Netflix must continue pressuring the studios to let them have more available films in VOD, choosing the option of integrating a streaming online video feature in their core offering, would allow them to build on their current differentiation strengths: unlimited monthly rentals from a great variety of movies and personalized service.
New customers interested in the VOD offering would also enter in the data base helping further growth of Netflix’s customized and personalized system while taking advantage of their variety of DVD movies still not available through VOD. In the initial stages, both DVD online rental and VOD would complement each other. It would be expected for the streaming online video feature to increase popularity while overcoming the technical challenges of VOD. At the same time, the DVD rental business would be expected to decline. This strategy would help them transition effectively in the market.
It will be easier to convert its customer from DVD’s delivered movies to VOD rather than acquiring new customers from scratch. Finally, integrating the current offering with the streaming online video while leveraging from their distinctive competencies, ultimately will give Netflix a sustainable competitive advantage “to allow for the best home video viewing for its customers” (2).
References (1) W. Chan Kim and Renee Mauborgne, “Blue Ocean Strategy: From Theory to Practice” California Review Management, 2005. (2) 8 8 7 7 Willy Shih, Stephen Kaufman and David Spinola, “Netflix”, Harvard Business School, November 19, 2007.