Question:

Case Study: Netflix: Disintermediator or Disintermediated?

Baseball great Yogi Berra, known more for his mangled phrasing than for his baseball prowess, once said, "The future ain't what it used to be." For Netflix, the world's largest online movie-rental service, no matter how you say it, figuring out the future is challenging and a bit scary. Netflix faces dramatic changes in how movies and other entertainment content will be distributed. So, will Netflix be among the disintermediators or among the disintermediated? Less than a decade ago, if you wanted to watch a movie in the comfort of your own home, your only choice was to roust yourself out of your recliner and trot down to the local Blockbuster or other neighborhood movie-rental store. Blockbuster is still the world's largest store-rental chain with over 9,000 stores in 25 countries and $4.1 billion in annual sales. But its revenues have been flat or in decline for the past few years. To make matters worse, it has lost money in all but one of the last 13 yearsover $550 million in 2009 alone! Blockbuster's stock price has plummeted to a mere $0.28 a share while the company teeters on the brink of bankruptcy. This riches-to-rags story underscores the fact that the old model for distributing movies is simply not working anymore. One thing about the future is certain. The business of distributing home video is full of disruption and confusion. Things are really changing, and the dust is far from settling. HBO offers its classic subscription service as well as its new premium service, HBO On Demand. Then there's Redbox, the Coinstar Company that rents DVDs for a dollar a day through vending machines in more than 25,000 convenience stores, supermarkets, and fast-food restaurants. That's from a company that no one had even heard of just a few years ago. Adding even more chaos to the mix, Hulu leads the army of start-ups and veterans that show full-length movies, TV shows, and clips for free, as long as you're willing to watch some ads.

THE NETFLIX REVOLUTION

But amid the chaos, Netflix has carved out its own successful niche. Netflix CEO Reed Hastings remains focused on a well-defined strategy with unwavering commitment. That strategy outlines not only what Netflix will do but also what it won't do. The company won't distribute content in brick-and-mortar stores, through vending machines, as pay-per-view, or in an ad-supported format. "Commercial free subscription is where we can compete. It's our best shot." Netflix is demonstrating how its model can flexibly reach millions of viewers through various channels. In the late 1990s, Netflix pioneered a new way to rent moviesvia the Web and direct mail. For a monthly subscription fee, members could make a movie wish list online. The company would then send out a set of DVDs from that list via the USPS. One of Netflix's main selling points was that members could keep the DVDs as long as they wanted. When they were done with them, they simply returned the DVDs in the mail with a prepaid return envelope. Netflix then automatically sent the next set of DVDs from the member's list.

The Netflix DVD-by-mail model was quickly favored by hundreds of thousands of viewers, then by millions. It's easy to see why. As Netflix's clever ad campaign has been pointing out, there is no hassle or cost from those trips to the video store. There is no worry about late fees. The selection from more than 100,000 DVD titles dwarfs anything that a brick-and-mortar store could hold. Finding rare, old, documentary, or independent films is easy. And the cost of rentingset by members based on how many DVDs they can check out at one timeis always the same and as little as $5 a month.

NOTHING LASTS FOREVER

As much as this Netflix model revolutionized the movie rental business, Hastings quickly points out that it will not last forever. In fact, he predicts that the Netflix core business model will be in decline in as little as three years. What Netflix has in store offers a rare case of how a company manages a still-hot business as it watches the clock tick down. Rather than clinging to an entrenched business model, Netflix is determined to out-innovate its competitors. Infact, in a true sign of forward thinking, Hastings avoided naming the company something catchy like "Movies-by-Mail" when he founded it. He knew that such branding would be far too limiting to allow dynamic change.

Netflix's innovation really took off just a little more than three years ago when it launched Instant Watch, a feature that allowed members to stream videos instantly via their computers as part of their monthly membership fee. At first, the selection was slimonly a few thousand movies available for streamingand the quality wasn't all that great. But Netflix has been hard at work expanding its library of streaming videos. That library now stands at more than 17,000 films and TV shows and is growing rapidly. And with technology advancements, viewers can watch movies in beautiful high-definition, full-screen splendor. As media touchpoints exploded, Hastings knew that Netflix's growth would be limited if it streamed only to computers and laptops.

So Hastings assembled a team to develop a prototype settop box that would access the Web through a viewer's broadband connection, allowing members to stream movies remotely to their TVs from the comfort of their couches. Barry McCarthy, Netflix's chief financial officer, recalls that Hastings was so infatuated with the plan that it could be described only as "Apple lust." But just as Netflix neared a public unveiling of the set-top box, Netflix executives had an epiphany. "Are we out of our [minds]?" McCarthy recalls thinking. "We don't even know what we don't know about this business." The Netflix-only set-top box is now available, but Netflix turned it over to Roku, a small electronics company. At that critical turning point, Hastings and his team realized that they had to move into other distribution points. They decided that it made much more sense to partner with experts who already market popular devices. Netflix moved quickly. Now, every xBox, PlayStation, and Wii has become a home theatre, allowing members full access to Netflix's streaming library. The same access can be had through Blu-ray DVD players and TiVo DVRs.

Hastings also sees a future with Web-enabled TVs. He believes that in five to ten years, viewers will interact with the big screen in the same way they now interact with the small screen. "We'll be calling up movies and channels and Web sites with a click of a button or just a spoken word: 'Wizard of Oz.' Or 'ESPN.' Or 'Netflix.'"

In small measure, it's already happening. Instant Watch is available on TVs from Sony, LG, and Vizio. Netflix's streaming service is available only through U.S.-based Web addresses for now. But with a projected 500 million Web-connected devices worldwide by 2013, Netflix plans to expand internationally. Along with TVs, DVD players, and gaming platforms, Netflix is also moving into mobile devices. It now offers an Instant Watch app for Windows Phone 7 and Apple's iPad and iPhone. Other mobile platforms will follow soon, including Google's Android.

FOCUS ON THE CUSTOMER

As Blockbuster's financial performance has plummeted, Netflix's has skyrocketed. With more than 12 million members and 2.5 billion movie views under its belt, annual revenue has increased 70 percent in the past three years to $1.7 billion. Profits have climbed 130 percent. And in less than two years, Netflix stock has risen from $20 a share to $118. That's a return on investment of more than 500 percent for those savvy enough to have bought in at the right time. Such performance is even more amazing when you consider that it happened in the midst of a global economic meltdown. "We were growing at 25 percent when the economy was growing. We're growing at 25 percent now," says Hastings. Hastings has no intention of slowing down. And it isn't just about distribution points. The dynamic Hastings is on a crusade to improve the viewing experience of its members. "For most people, they watch one or two movies a week. Only maybe once a month do they get a movie that's like, 'Wow. I loved that movie!' It really is a hard problem to figure out which ones to watch with your valuable time. We're trying to get it to where every other movie that you watch from Netflix is 'Wow. I loved that movie!' As we get closer to achieving that, we increase human happiness with movies."

Netflix has its work cut out for it. The various delivery models being pursued by its competitors and the complexities of dealing with content producers don't make it any easier. But with unlimited DVDs by mail and unlimited instant streaming to computers, TVs, and other Web-enabled devices for a flat $8.99 a month, the future looks bright for Netflix.

Task: After reading the above case study following questions are to be answered.

a. As completely as possible, sketch the value chain for Netflix from the production of content to viewer.

b. How do horizontal and vertical conflict impact Netflix?

c. How does Netflix add value for customers through distribution functions?

d. What threats does Netflix face in the future?

e. Will Netflix be successful in the long term? Why or why not?