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Startups vs. Giants: Netflix & the Video Rental Industry . MI703: Computer Information Systems. Barriers to Entry.
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Startups vs. Giants: Netflix & the Video Rental Industry MI703: Computer Information Systems
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 • #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? • 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? • 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? • 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 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 • 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 • Source: Wired
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 • 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 • 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 • 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 • 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 • 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 • 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 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 • 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 • 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. • 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 • 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 • 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 • 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 • 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 • 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?