NETFLIX IN CANADA: ENTERING THE FRAY

NETFLIX, INC.

Founded in 1997, Netflix began a DVD subscription service in1999. The firm capitalized on a set of opportunities to build anonline DVD mail-order service. This service was legal due to the“first sale doctrine,” which allowed a purchaser to “transfer aparticular, lawfully made copy of the protected work withoutpermission once it had been obtained.”10 Netflix’s average cost perDVD was believed to be $15 per copy, and Netflix might purchase10,000 copies of a major movie for its inventory

Similar to Blockbuster Video, Netflix simply purchased aninventory of DVDs and began to rent them out. Instead of buildingphysical stores and staffing them with hourly personnel, it electedto utilize the U.S. Postal Service to facilitate the delivery andreceipt of DVDs. The U.S. Postal Service’s (USPS) domestic mailservice offered Monday through Saturday delivery and the averagetime required to deliver or receive a DVD was one to two days.12Netflix’s service success was built on strong logistics and anetwork of distribution centres. As the Netflix.com websiteclaimed: “Our 100 shipping points across the United States allow usto provide more than 97 per cent of our members with deliverywithin about one business day following shipment.”13

According to analysts, the USPS First Class postal rate to sendor receive DVDs was about US$0.42.14 Customers selected DVDs andNetflix mailed the order. Once they were finished watching theDVDs, customers returned them via a postage-paid return envelopeand Netflix shipped out the next selection to them. By 2010, it hadexperienced considerable growth and was serving 19 millionsubscribers (see Exhibit 2), or more than six per cent of the 308million people in the United States.15 Netflix in the United Stateshad 89 million individual DVD discs with over 100,000 differenttitles in its inventory.

Netflix charged subscribers a flat monthly fee ranging from$4.99 (one disc at a time, a limit of two per month) to $56.99 permonth for unlimited rentals (up to eight discs rented at any time).A journalist described the shift in consumer attitudes that hadboosted Netflix’s subscriber base over the years:

First, people decided they didn’t want to drive to the movietheater. These days they aren’t too keen on driving to the videostore, either. . . . Brick and mortar video stores are underpressure from the online world, just like record stores andbooksellers before them. We want to rent DVDs quickly by mail orpick them up at the supermarket. And that’s if we bother handling aphysical disc at all. Increasingly, we just stream movies onlaptops and smart phones or download them right to our PlayStationsor Xboxes, so we can watch them on our flat-panel TVs.16

In January 2007, Netflix began offering an added bonus oflimited streaming for subscribers of its mail- order DVD service(between six to 18 hours per month depending on the plan). Itallowed users to stream content to computers running Windows or MacOS X and to devices such as the Wii, Xbox 360, Sony’s PS3, Roku,Sony Blu-ray Disc players, Apple iPad, iPhone, iPod Touch and AppleTV and others. In 2009, 37 per cent of Netflix’s subscribersstreamed some video content for at least 15 minutes. By mid-2010,that figure increased to 61 per cent.17

In August 2010, Netflix paid US$1 billion in a five-year dealwith Paramount, Lionsgate and MGM to stream its movies. It also haddeals with Sony Pictures Entertainment, 20th Century Fox andUniversal Pictures.18 The average cost for a two-year license tostream a major movie was estimated at US$16 million.19 By October2010, Netflix had 16.9 million customers who had access to itsvideo streaming service in North America,20 and two-thirds ofNetflix’s mail-order DVD subscribers utilized the bonus streamingservice.

Netflix increased its U.S. offer, allowing subscribers to have,for US$8.99 per month, unlimited Internet video streaming as wellas a single mailed disk out at a time. The price for this optionwas reduced to US$7.99 in November 2010. On November 23, 2010,Netflix introduced a U.S. streaming-only plan for $7.99 a monthand, at the same time, increased the price for each of its one-DVDand two-DVD plans by a dollar a month.22

When announcing Netflix’s third quarter earnings on November 25,2010, the firm revealed that it had spent $115 million in thequarter on streaming rights for content, up from $10 million in thethird quarter of the previous year. The comparative figures for DVDpurchases for rentals fell 35 per cent to under $30 million.Netflix was estimated to have over 20,000 movies available forstreaming.23 Hastings described the status of the company: “We arenow primarily a streaming video company.”24 In another interview,speaking about the U.S. market, Hastings stated:

Ninety-eight per cent of our management time is on streaming andgrowing streaming, and two per cent is on DVDs. So (there is)nothing material in the DVD space. Our shipments are growing. Wewill have a record Q4 in terms of our nationwide DVDshipments.25

Netflix’s streaming service was appealing to customers: althoughit was only launched with six weeks remaining in 2010, Netflix’sstreaming-only plan accounted for more than a third of its 7.7million new U.S. subscribers in 2010.26 An analyst commented: “In2010 Netflix has made a huge and virtually seamless transition fromits DVD-by-mail roots to streaming, and is now arguably the mostsuccessful paid provider of streaming vide

Rogers Communications Inc.

Rogers was a large telecommunications and media firm. It startedas a radio broadcaster and added a cable television network,expanding into telecommunications in the 1980s. Rogers was thecountry’s largest cable television service provider, with themajority of customers in the most populous province, Ontario, witha population of 13.2 million in 2010. For perspective, Canada had atotal population of 34.1 million.30 Rogers, under its variousmobile telecommunications brands, was the largest wirelesscommunications provider. Its Rogers Media arm owned more than 70consumer and business publications, radio stations and televisionbroadcasting services such as OMNI, CityTV, Sportsnet, OLN and theShopping Channel. It owned the Toronto Blue Jays baseball team andthe Rogers Centre, a multi-functional sports centre.

Rogers Plus was a chain of more than 300 video and media stores:it offered DVD rentals at a price of $4.99 per rental or two for$9.00. Inside Rogers Plus, consumers could rent videos, purchasegames and sign up for wireless or cable access. In addition, Rogershad its Rogers Video Direct online DVD rental service, whichoffered 72,000 titles for rental. Rogers subcontracted thelogistics of sending and receiving these physical DVDs to Zip.ca.It had different pricing plans, all of which included shipping toand from Rogers (see Exhibit 3).

In 2010, Rogers purchased a fibre-optics network (AtriaNetworks), expanded distribution of its products and servicesthrough Sony Canada stores and announced a 10-year programmingpartnership with the National Hockey League teams the EdmontonOilers and the Calgary Flames. Rogers Media developed a newnational sports network called Sportsnet ONE that would featurelive sports such as baseball, basketball, hockey and soccer.Rogers’ On Demand online broadband video service offeredpay-per-view (PPV) programs and movies from studios and networkssuch as Sony, Disney, HBO and Showtime, with prices ranging from“no charge” to $10.00 or more; new release movies ranged from $4.99to $7.99 (for high definition). At the end of September 2010,Rogers’ had a broad customer base in its various services (seeExhibit 4); specifically, Rogers had a considerable stake in thelarge Canadian Internet access market. Industry observers believedthere were about 13 million Internet subscribers in Canada, andabout 29.6 per cent of subscribers had high-speedconnections.31

On July 22, 2010, two days after Netflix announced plans toenter Canada, Rogers modified its cable Internet service, loweringthe monthly usage allowance on its “Lite” plan from 25 gigabytes(GB) to 15 GB, and on its “Extreme” plan from 90 GB to 80 GB. Onthe same day, Rogers raised the download speed of its Extreme planfrom 10 megabytes per second (Mbps) to 15 Mbps (see Exhibit 5)

In contrast, wholesale Internet service resellers such asTekSavvy and Primus did not provide any download caps; in addition,to encourage competition in the market, the CanadianRadio-television Telecommunications Commission issued a decision inSeptember 2010 to force the incumbents such as Rogers and BellCanada to ensure that “Internet speeds provided to smallercompanies that rent portions of the . . . network match the speedthat the (incumbents) offer to their own retail customers.”33

On December 4, 2010, Rogers announced that cable subscriberscould watch their paid-for services on devices such as the AppleiPad, Samsung Galaxy or Research In Motion’s new device, beginningin early 2011. John Boynton, Rogers’ chief marketing officer,commented on this development: “Instead of having to think aboutdifferent services with different prices and different passwords,the value we can bring to people is that it’s seamless. If peopleget that out of us, they’ll stay with us.”34

Zip.ca

In February 2004, Zip.ca started an online DVD rental servicesimilar to that of Netflix in the United States. The firm was ownedby the Momentous group of companies. It attracted customers byoffering various online rental plans, and free one-month trials.One reviewer described the Zip.ca service and how the firm providedadditional features and harnessed feedback from its members:

Zip’s site design is excellent; each movie includes memberreviews and ratings, as well as an “Amazon-like” list of other DVDsrented by people who rented that particular film. There is alsoplenty of information about each disc which other companies oftenomit; plot synopsis, cast, crew, bonus features, etc. Browsing issimple and easy with 24 genres to surf, including 6,200+ Frenchtitles (also a French version of the Zip site). They also stockboth HD-DVD and Blu-ray High Definition titles — 1,300 of thelatter at last count (and unlike Netflix in the United States, theydon’t charge extra for these).35

In 2005, Zip.ca signed a logistics deal to provide fulfillmentservice for Rogers’ Video Direct operations. One year later, Zip.careached 47,000 subscribers and shipped 15,000 discs per day. By2010, it was shipping over 24,000 discs per day and offeredcustomers a menu of over 82,000 titles; however, the firm had tocontend with the fact that Canada had a population density of 3.41persons per square kilometer,36 while the figure for the UnitedStates was 33.7.37 The cost to mail a DVD via Canada PostLettermail was $0.67. Canada Post delivered domestic mail fromMonday through Friday, and the average time to send and receive aDVD by mail was two to four days.38

Zip.ca had four distribution centres in Ottawa, Toronto,Vancouver and Calgary. Its customers could create a “ZipList” toindicate their preferences for movie rentals, ranking them on anonline list. As soon as customers returned one disc by mail, theycould indicate on Zip.ca’s website that the disc had been shipped.When Zip.ca was notified, it shipped the next DVD on the ZipList.The company had a variety of rental plans similar to that of Rogers(see Exhibit 6).

Zip.ca also offered ZipRewards, a loyalty program that awardedpoints to members to be redeemed for gifts. As the company wasprivately-owned, no financial information was publicly available;however, an approximation of Zip.ca’s financials could be made bylooking at Netflix’s financials. At the start of 2011, Zip.ca wouldhave been in operation for seven years. For comparison purposes,Netflix’s online DVD rental service was seven years old in 2006(see Exhibit 7).

Blockbuster Video Canada

In 1990, Blockbuster Video Canada opened its first store inLondon, Ontario, offering VHS tape rentals. The U.S.-based firm wasentering a competitive market, with numerous video store chainssuch as Jumbo Video, Rogers Video, That’s Entertainment and BanditoVideo competing for consumers’ attention. It expanded rapidly to430 stores across Canada,39 and had a hierarchy consisting of acountry management team, a team of regional directors — who wereresponsible for groups of stores — and store managers.

Each Blockbuster Video Canada store was set up with long-termcommercial leases. The majority of store- related capitalexpenditures were spent prior to the store’s opening day. Preparinga store required positioning walls, carpets, shelving units,displays, television units and point-of-sale counters, all theleasehold improvements necessary for a retail store. Many of theseassets were still in use 10 years later and, as a result,maintenance capital expenditures were relatively minimal.

Each store, about 6,000 square feet in space, displayed 2,000different titles.40 The new releases were typically shelved alongthe back wall. In the middle of the store was the library of oldermovies, organized by category. The stores sold used and new DVDs,gaming accessories and food items such as potato chips, candy, softdrinks and ice-cream. In addition, depending on movie releaseschedules, stores sold movie- related merchandise such as actionfigures, posters and stuffed animals. There were approximately 10employees per store and they were paid the average retailwage.41

According to estimates, Blockbuster Video Canada customers spentabout $100 to $150 per year. Rental rates were $4.99 per DVD, notincluding extended rental fees. At Blockbuster Video Canada, anadditional charge of $4.99 was levied for customers holding moviespast seven days.

While its U.S. parent was in bankruptcy protection, BlockbusterVideo Canada seemed to be doing well. Using Blockbuster’s overallresults as the starting point, an estimate of Blockbuster VideoCanada’s income statement can be created (see Exhibit 8).

Apple, Inc.

With its popular line of digital music players, tablets andcomputers, Apple, Inc. had grown to become the world’s second-mostvaluable company after ExxonMobil.42 It was the largest musicdevice manufacturer, owned the popular iTunes store that soldapplications (known as “apps”) and music and had a chain of Appleproduct stores across the world. In Canada, Apple sold the AppleTV, a $119 device that allowed consumers to access online contenton their television sets. It also offered online movie rentalsstarting from $3.99 for standard definition movies to $4.99 forhigh definition movies. Consumers had 30 days to beginwatching the rental movie, and they could watch it as many times asthey wished within a 48-hour period.

Questions:

1. Describe the macro environment in which Netflix enters.Conduct PEST analysis (focus on Canada).
2. Conduct Porter’s 5 forces analysis (think first aboutthe industry you’re analyzing)