Netflix in the ever changing home entertainment space

Disrupting an old industry in light of new technoligical innovation

Netflix set out in 1997 to revolutionize the way we watch home entertainment. Initially built on a DVD-by-mail service, they were a tremendous disruption to the home movie rental industry and subsequently drove Blockbuster out of business. They achieved these results by riding on the DVD technology wave and taking advantage of the physical properties of the DVD that was flat and sleek, which allows for easy delivery right into the consumers’ homes. This allowed them to eliminate the physical stores of the business and build video centers which supports a much higher amount of movie titles that can be transported to anywhere in the country through their strong operations system.

Using technological innovation to develop core competency

Netflix developed their core advantage based on the observations of an unsolved problem in this traditional industry: that customer demand usually follows the newest title releases. This caused a backlog on the newer titles whenever it comes out and leaves older titles forgotten and underutilized. To solve this, Netflix developed algorithms for film recommendations that not only promoted old content based on customer preferences, but also increased the stickiness of their customers. This approach also allows a natural expansion into the more and more popular online streaming. Shifting from the pay per view model to the subscription model, Netflix was able to change people’s perceptions of DVD rental while building a sustainable business model for more stable finances. Through the above integrated strategy and offerings, Netflix is able to anticipate customer behavior changes to hedge against competition.

Adjusting strategy to survive among shifting trends

Netflix’s continual success also relies on their ability to adjust their strategy according to shifts in new technology advancement that changes consumer behavior. As on-demand content and online libraries becomes increasingly available, they have observed that in order to retain customer loyalty, they needed to shift their business model to become more and more focused on content development. An online content provider has now became a production studio that develops first class content.

Another example would be their actions when facing technological roadblocks. Having observed that there are a significant amount of customers who want to watch streaming services on the television set but were unable to do so, Netflix was able to be at the forefront of technological innovation and partner with Roku to develop a router that allows the Netflix programs to be watched on the TV set and game consoles.

Future challenges

Of course, this doesn’t mean that they have never made bad choices. Netflix’s attempt to separate their DVD-by-mail service under a separate name called Quikster proved to be a bad move. Customers were confused by two separate services with increased pricing that was originally nicely integrated together. After realizing the significant subscription drop after this announcement, Netflix was quick to reverse the decision, apologize and move on. To this day they still mention this event as a great learning experience publicly stated on their official website.

Netflix competes in an ever changing space that is filled with multiple categories of competitors: linear networks, pay-per-view content, DVD watching, other Internet networks, video gaming, web browsing, magazine reading, video piracy, and much more. Over the coming years, most of these forms of entertainment will continue to evolve. However, a company that is transparent, agile and willing to prove their words through action is a good indicator that even through a time of transformation or missteps, they would have the ability to come back and prosper.

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6 thoughts on “Netflix in the ever changing home entertainment space

  1. Thank you for the post, Pipedreamer. You articulated the drivers of Netflix’s success to date very well. While I am a fan of Netflix as a consumer, I worry about its future in a world where over-the-top content is becoming increasingly prevalent. Content owners are trying to dis-intermediate distributors like Netflix by offering over-the-top options themselves. For example, all four major broadcast networks now offer live streams and on-demand content online for consumers who have pay-TV subscriptions (http://www.wsj.com/articles/nbc-to-live-stream-network-shows-1418706061). Moreover, an increasing number of content owners, including CBS (CBS All Access: http://www.cbs.com/all-access/), HBO (HBO Now: https://www.hbonow.com/), and Showtime (http://www.showtime.com/?i_cid=int-default-1010), are offering live streams and on-demand content a la carte. In addition to the content owners’ direct efforts, many other services, such as Amazon Prime and Hulu Plus, are trying to replicate Netflix’s online distribution model. Yet others, including cable companies themselves, Sony, and potential entrants like Apple (http://www.wsj.com/articles/comcast-launches-streaming-service-for-cord-cutting-customers-1436788422) are offering live TV streaming bundles.

    Given all these recent and forthcoming developments, the supply-demand dynamic doesn’t look great for Netflix. On the supply-side, Netflix’s content costs will increase at ever-faster rates as content owners have more online distribution options and begin to favor their own offerings. On the demand-side, Netflix’s pricing power with consumers will decrease as they have exponentially more ways to consume content online. And these cost and pricing pressures start from an undesirable status quo – Netflix doesn’t generate any meaningful profits today. You might argue that Netflix benefits from network effects that could mitigate or invert this supply-demand dynamic. In theory, because of its first-mover advantage, Netflix could attract so many users that content owners need to distribute through it, and it could attract so much content that users need a Netflix account. However, competitors like the cable companies, Amazon, and Apple have sizeable user bases of their own (albeit for different purposes in the case of Amazon and Apple). The cable companies also have existing relationships/contracts with content owners (or, in some cases, as with Comcast’s NBC-Universal, produce content of their own) that should ease their negotiating process. Moreover, consumers are not locked into Netflix – because switching costs are de minimus, content owners will attempt to drive traffic through their own online channels. In an unbundled world with low-cost a la carte options, it will be quite easy for consumers to “multi-home” and create their own content packages rather than being forced to rely on Netflix. In short, Netflix’s theoretical network effects may very well fail to generate the profits it expects.

    If Netflix’s content costs rise inexorably, the only way it can make money is to distribute content that it produces itself. Indeed, Netflix has had success in “original programming” with shows like House of Cards and Orange is the New Black. An optimist might argue this success is replicable going forward. After all, given its large existing user base, Netflix could leverage the insights it develops from analyzing content consumption patterns to create shows that people will predictably like. I’m skeptical – it is extremely difficult to translate data analytics into an inherently creative process with predictable results. Moreover, existing content owners with decades of production experience are not without data of their own. I believe content production will remain a hit-driven business and Netflix is no more likely to produce hits than premium content providers (e.g. HBO, Showtime), the broadcast networks (ABC, NBC, Fox, CBS), and the major studios (e.g. Disney, Warner Brothers, NBC Universal).

    Perhaps it’s not such a bad outcome if Netflix becomes another content producer (albeit one that happens to have a lot of direct subscribers). However, Netflix trades at 80x 2015E EBITDA, a far cry from the 10x EBITDA multiples more common among content owners. While Netflix has been a darling of the digital revolution to date, its shareholders might not be so quick to label it a winner when all is said and done.

    1. AP, I wanted to make a comment on your portion in particular. I understand your concern about the EBITDA, but Netflix is not just a U.S. content distributor or U.S. content creator. A lot of its money is spent buying licenses to shows and movies, since many of these shows are released on a timed basis. One movie in particular, Mean Girls, was once put on to Netflix and then taken off of it within a month (https://www.reddit.com/r/netflix/comments/24nmr1/us_mean_girls_removed_already/). Another large portion is spent expanding overseas. Amazon Instant Video is only available in the United States and Hulu is only available in the United States and Japan. By contrast Netflix is now available throughout the Americas (including Cuba), much of western Europe, Japan, Australia, and New Zealand (https://help.netflix.com/en/node/14164). If Netflix was spending less on expansion and content creation the low profits would be more a cause for concern.

      With that said, if pure content developers such as Time Warner (which is distinct from Time Warner Cable) cannot be compared with Netflix, Comcast can because it owns content delivery networks and NBC Universal, and its EBITDA multiple is less than 6x EBITDA. However, Comcast also owns a line of resorts and television channels that range from general (NBC and Telemundo) and the Weather Channel whereas Netflix owns the rights to some shows that other people produced (such as House of Cards, a Sony production, and Marvel’s Daredevil, which was co-produced by Marvel Studios and ABC) and content distribution through Netflix Instant in a number of countries.

      I can see the argument that Netflix is mostly successful due to love for the current digital revolution. I can see a future where Amazon or a revitalized Hulu (or something like it) can become a potential competitor, especially if the broadcast networks finally allow a service such as the Playstation Vue to broadcast them live over the Internet (see http://www.wsj.com/articles/local-tv-creates-hurdle-to-streaming-1441325369?cb=logged0.8768051962833852 for some of the reasons preventing this from becoming a reality for now), but for now it looks like Netflix will do well for some time.

  2. Thank you for sharing your thoughts! While I do agree with the fact that Netflix has been extremely successful so far disrupting the DVD rental business, and also for changing how customers consume video. However, I believe that the future for Netflix will not be as smooth as it has been. There are a few reasons why I have reservations about the future trajectory of Netflix:

    1. Amazon: I single out Amazon because they have undercut Netflix’s value proposition. For a yearly fee Amazon Prime subscribers get access to multiple offerings: Free delivery for Amazon products (core of Amazon), Prime Videos (equivalent to Netflix) and Prime Music (equivalent to Spotify). This competition from Amazon worries me because they can offer to a customer what Netflix offers them and in addition other services. It shouldnt be difficult for them to create content on their own given their deep pockets if that is what stops them from beating Netflix.

    2. Pure Monthly Rental: Netflix continues to operate purely on the monthly subscription model (unless I am mistaken). As a consumer the additional benefit I get from an Amazon, or an Apple Store is the option of purchasing/renting certain movies. Latest movies which are not part of the ‘free’ catalog are available for purchase in Amazon while that is not an option on Netflix. As customers become platform agnostic as content tends to converge these additional offerings will be what drive customer stickiness.

    3. Broadcast networks are all now moving to an OTT model. I am not sure if customers would be willing to pay for the 4 or 5 major broadcasters OTT content, or whether they will stick with one platform from where they can access content from multiple broadcasters. If the latter, the broadcasters might not be a major competitive threat though it is unclear at this stage.

  3. This is a very interesting post, thank you. Some of my own thoughts:

    1. The content creation was driven by the fact that Netflix’s catalog continues to cycle in and out. Many films cycle in and out as contracts with production studios increase in price. One notable example is The Hunger Games: Catching Fire, which will soon be removed from the service. Some series that seemed to be permanent mainstays on Netflix, such as Battlestar Galactica (2004-9), are now missing from the service altogether. This is not uniquely a Netflix problem; in fact HBO started as a premium TV channel in 1972 and did not develop original movies and series until 1983. Netflix’s own competitors are coming to similar decisions. Amazon in particular got 11 Emmy nominations for its original series “Transparent” and Yahoo’s “Community” got one as well.

    2. Netflix has done a good job building a brand name. There is a great deal of buzz around Netflix’s properties such as “House of Cards” but very few people talk about Hulu’s original series or even know Yahoo has a video service of its own. There have also been studies showing that many people are not aware that they have access to a great deal of content through their existing Amazon prime subscriptions; they just do it for the free two-day shipping. It is worth noting that 36% of U.S. households subscribe to Netflix whereas 13% subscribe to Amazon Prime (http://www.adweek.com/news/television/here-s-why-consumers-love-netflix-more-amazon-and-hulu-165547). This is odd, considering that a subscription to Amazon Prime ($100/year) is around the same price as the lowest, standard definition tier of Netflix ($95.88/year) and offers more with its Spotify-esque service, shipping, and more.

  4. Great post! I actually wanted to write a post about Netflix myself, more focused on its content creation business. More specifically, I wanted to ask whether the current Netflix model of collecting consumer preference in creating content will be the standard for future story-telling, if so, how will the traditional Hollywood firms do it?

    Currently, the Hollywood movie studios such as Legendary Pictures are using data to allocate their marketing spending more efficiently instead of creating contents. However, in order to create stories based on data, a company will need a platform to which it can collect the types of content that its consumers are watching. To this point, though, the Hollywood studios do not have such platforms; these platforms belong to the “tech” companies such as Netflix, Hulu, or Youtube.

    Then my question is: how should these traditional movie studios respond? Should they partner with these online streaming services? Or should they just stick to their original model of having “true” story-telling artists create the original works. Also, if future content does take on the model of taking existing preferences of consumers, then will there ever be true innovation in story-telling?

    1. Hi H Li,

      I think your thoughts are very interesting and I certainty see your logic behind it. However, I personally think that studios can gauge and have been gauging into consumer interests for a long time in a very simple way: box office. Even though this might seem not as tech savvy, it actually has the same workings as using data analytics, with at least 400 new movie releases per year in the US alone, the movie industry does have enough data to analyze consumer interest and has designed its content development and whether or not a piece of content goes into theaters or just DVD release based on this data. I think another way that they’ve been collecting this data is from DVD sales performance and also the licensing demand from platform services like Netflix. The pricing of the licensing deals are also determined by market demand. This might be a reliable way for studios to collect consumer preference without having to build and manage tech platforms themselves, but rather focus on content creation.

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