Business Case Study: Survival of Netflix

Will Netflix survive the competition? Business Case Study

J P Morgans analyst Barton Crock put out a statement, wherein he said that Netflix is facing tougher competition from blockbusters than originally expected because Netflix in 2007 was facing a very peculiar situation. And after this news came out, the stock prices of Netflix went down by 5%. The market, in general, became skeptical about Netflix's progress. But Netflix was so strategically able to navigate through the situation that, in the next 10 years, Netflix went on to become one of the best- performing stocks in the world which gave out a return of more than 10,000% from 2007 to 2018.

But very few retail investors knew that, in 2021, Netflix is in trouble again. And coincidentally, this trouble situation is very similar to that of 2007. And how it reacts to the situation will actually go on to determine, whether Netflix stock shoot up or crashes down.

This is a story that dates back to 1997 when the very popular Blockbuster failure saga actually started. Back then, Blockbuster was a movie rental service that had physical stores of DVDs all across the United States. And the general American tradition back then was, renting a movie on Friday and giving it back on Monday. In 1997, Blockbuster was a billion-dollar company with more than 6000 stores in the US alone and had a revenue of 3.91 billion dollars. But the problem was 60% of that revenue came from late fees, which was annoying millions of customers. That is when one of the customers were fined an exorbitant amount of 40$ in the late fees.

And, it annoyed him so much that he went on to start a company of his own. This man was none other than Reed Hastings and the company he founded is what we know as Netflix today. He was so pissed that the very tagline of Netflix itself was No Late Fees. In 1997, Netflix started out as a subscription- based DVD mail service. If someone wanted to watch a movie, instead of going to a Blockbuster store, make a list online and send it to Netflix. They would deliver the DVDs within 2-3 days. And, when you return the DVD that you had, they would send you another one. All of this was being offered at an affordable subscription fee and without any late fees.

Over here, the X factor turned out to be the mindset of the company. While on one hand, Blockbuster was extremely adamant upon keeping their late fees and made millions of dollars out of the pain of its own customers, while on the other hand, Netflix leveraged the same undesirable attribute to build a million-dollar business. And by 2004, it had a revenue of 500 million dollars. This is when there came the first twist in the tale.

In 2004, Blockbuster understood the DVD in-mail service is a big market and they made a grand announcement and launched their own DVD in-mail service as a direct competition to Netflix. And they started growing as fast as Netflix, adding 2.1 million subscribers in the very first year itself. Now, on paper, Blockbuster was all set to crush Netflix. Because on paper, they had such a vast network of stores that 90% of the American population were at an accessible distance to a blockbuster store. And this meant, when Netflix DVDs will take 2-3 days to come from a warehouse that is hundreds of kilometers away from the warehouse, Blockbuster could have delivered the same movie within just 2 hours because those movies will come from the nearest Blockbuster store of the customer which was hardly a few kilometers away.

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But to our surprise, Blockbuster still failed. Why? Because they did not use their store network to deliver DVDs and on top of that, within just that one year, they cut down on late fees which costed them about 200 million dollars in revenue and setting up the DVD in-mail service cost them another 200 million dollars. So, they were practically 400 million dollars in debt and this made it very difficult for them to experiment with new methods and systems. But even their market share kept growing rapidly and by 2007, they started eating into Netflixs revenue.

In that year itself, Netflix lost 55,000 subscribers as Blockbuster kept growing steadily. This is a context- based on which J P Morgan put out the statement saying that Netflix is facing tougher competition from Blockbuster than originally expected.

And this is where Netflix did something amazing to surprise the world. They identified 2 major threats to their business. First one was obviously Blockbuster entering the DVD in mail service because considering their huge network of stores, they could have delivered a much better service than Netflix with very less efforts, using their existing supply chain itself. Secondly, they realised that they had a hidden competitor who was strangely eating into the profits of both Netflix and Blockbuster. And this mysterious entity was none other than Walmart.

What does Walmart have to do with entertainment and why is it competing with Netflix and Blockbuster?

Well, as it turns out, Walmart was also eating into the profits of both Blockbuster and Netflix because it was using a pricing model called the loss leader pricing model. It is a type of pricing model wherein one sells a low cost, low margin product just so that, customers can be exposed into buying a high cost, high margin product. In this case, Walmart was giving away DVDs on rent at a dearth price just so that it could entice its customers to come to the Walmart store. Eventually exposing them to shop other products, which gave them more profits. Walmart did not care about making profits through DVDs which was the core business of Netflix and Blockbuster.

And this is where Netflix ventured into online streaming and pivoted to another segment. And they invested heavily into data analytics to build a formidable personal recommendation algorithm and used the Internet to distribute the content instantly and cost-effectively. This is how, Netflix, the streaming service that we know today was born. Meanwhile, Blockbuster being too late to the streaming party actually crippled with the debt, eventually, filed for bankruptcy and the rest is history.

Netflix became an early adopter of the internet in the entertainment space. And in the next 10 years, Netflix went on to become one of the most successful companies in the world.

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But, fast forward to 2021. 14 years later, Netflix is again facing the same 2 threats that it faced in 2007 and it is practically back to square 1. These 2 threats are:

Just like in 2007, Blockbuster already had a profitable network of stores and all it needed to do was to go online and merely by delivering DVDs, it could have beaten Netflix very easily. Just like that in 2021, Disney and HBO, both already have an extremely profitable network. Disney makes a billion dollars through theatre releases itself. And before the movies come to the OTT platforms, they have already made the company a ton of money. And HBO does the same through the television network. And all they need to do is start pulling out content licenses from Netflix and Prime and launch them all in their own OTT, which by the way, is happening very quickly. something, Netflix identified way back in 2011 itself.

They knew that someday or the other, these companies start pulling out content from Netflix. And it cant just keep making money merely by reselling movies of other companies. And hence, Netflix ventured into its 3rd orbit and started making its own content, which is what gave us the iconic House of cards in 2013. And from there onwards, Netflix has invested very heavily to become a production company by itself. And all of this is being done just so that they can keep their subscribers from leaving even when everybody else is pulling out content from their platform. But then producing content like House of cards require a huge budget and if they have to consistently keep doing it, they need to bring in more and more revenue. But as of now, the only stream of income that Netflix has is subscription fees.

The second threat is what Walmart did to Netflix in 2007, is what Amazon Prime Video is doing to Netflix in 2021, i.e., it is using the loss leaders principle to attract customers at such an ultra-cheap price that it is almost impossible for Netflix to match its prices. The best example of the same is Mirzapur and The Family Man. If we take a step back and analyze both these series, we can realize that kind of money they have invested in producing this content, it is nearly impossible that they make money through the meager Prime Video subscription cost.

In fact, most of us have either watched the series with one of our friends Prime accounts or our friend must have watched these series through our Prime account. Now, Amazon is doing this because it doesnt care about making money from Prime video as long as we remain a Prime subscriber and we use our friends Prime account to order from Amazon. Because if one has prime, it will eventually lead us to shop more expensive products from Amazon which is the profit that they are looking out for.

Therefore, just like Walmart in 2007, Amazon is using the core offering of Netflix as a loss leader which makes it impossible to match its pricing. Meanwhile, since Disney makes a lot of money through theatre releases and TV distributions even Disney can afford to give away their content for free, just so that it can entice its viewers to pay for exclusive series like Loki and Wanda vision. Eventually, it can turn its free viewers into paid subscribers. So, to put that straight, Netflix has lost its unique selling proposition and most of its best content are disappearing, forcing it to keep producing a mammoth amount of content. But at the same time, while competitors have multiple streams of income, Netflix is solely dependent on subscriptions which makes it very difficult to maintain its profitability.

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Therefore, we can say Netflix is in trouble again. Now, its not like Netflix will go bankrupt or something, its just that it might no longer remain the market leader that it is today and once people start opting in for other services, Netflix might just be another streaming app that people have opted in for. And this brings us to the 4 very most important questions that we need to ponder over which will go on to determine the future of Netflix,

ANSWER these questions

1. How will Netflix build an alternate stream of income? Will it run ads? Or make theatre releases? Or increase its subscription?
2. Can Netflix match the content production both in terms of quality and quantity with giants like HBO and Disney?
3. Is it going to leave its market leader position and just be yet another app that people have opted in for?
4. Could it partner with the giant like Walmart to serve as a loss leader to help Walmart compete with Amazon?