Challenges facing Netflix in VOD market

One of the main issues that Netflix is forced to contend with as they enter the emerging VOD market is the ever present threat of competition. These competitors include stand alone sites such as Vongo, traditional cable and satellite providers and potentially Blockbuster’s MovieLink. Another significant challenge for the company which could translate to a shift in the business model is the level of commitment required to successfully penetrate the VOD market. Further issues include limited content availability and connectivity challenges.

Analysis/Rationale for issues (1.25)

Rivalry strength is a significant issue for the firm specifically in the VOD sector. As a number of potential new entrants look to enter the market, this space is likely to become saturated by the subsequent competition. Price wars are likely to occur due to the large number of new entrants. Vongo as mentioned in the SWOT analysis is a potential threat as they provide customers with the ability to rent movies, purchase them for viewing and burn them directly to a DVD, all for small fee. Other competitors include cable and satellite companies. Both in home entertainment providers reach a large audience and have begun to offer ‘on demand’ services. As their reach increases they are poised to take control of a large chunk of the consumer market. This ‘free’ offering is likely to dissuade consumers from signing up for Netflix services.

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Alternatively, Blockbuster may also pose a significant threat as they plan to acquire MovieLink. This acquisition will give them access to new movies as well as a pre-existing database. Blockbuster has the ability to leverage its brand name and has implemented cross promotions, giving in store rental coupons to online customers all in an effort to outmaneuver the competition.

Another major challenge faced by Netflix is the intensity and timing of their entry into the online streaming business. The company needs to choose between integrating the option of online video streaming into their core offering or focusing solely on building a stand-alone site. A shift in the business model could lead to Netflix alienating its current customers and even creating confusion among the workforce pertaining to the direction and goals of the business. The issue of limited content availability is due to the lack of a contract with studios and therefore studios are able to exert pricing power. While a solution to the availability of content is vital to the firm, connectivity is also a significant problem. Due to the limitations of their technology, Netflix is currently unable to offer customers the ability to synchronize media viewing devices in the home.

An integrated strategy for the company (1.5)

A broad differentiation strategy is currently employed by the firm. The online DVD rental business currently appeals to large segment of the market. This differentiation was created by decreasing the overall costs of renting DVDs, enhancing consumer satisfaction, offering comprehensive customer service and consistently innovating through the years. In order to build on this success Netflix should take advantage of the emerging internet capabilities and changing technology. Embracing the VOD feature to match the shift in consumer attitudes, as fast paced on- the-go lifestyles become the norm, will provide Netflix with yet another opportunity to create value for the buyer.

The amalgamation of a strategy for Netflix’s VOD feature is largely based on the firm’s key success factors. In order to provide enhanced convenience, faster delivery and meet the needs of a movie loving price conscious consumer, Netflix should offer users movie streaming capabilities. However, the introduction of this feature should not result in the abandonment of their core business model. Instead Netflix should implement a two part structure, whereby the inevitable peak and plateau of DVD rental sales is quickly followed by an increase in the availability of streaming content. The introduction to VOD could take the form of a ‘3 month freemium’ offered to existing customers to gradually begin their transition into online video streaming. Potential consumers on the other hand will be encouraged to try the service with the offer of a ‘1 month freemium’.

Gaining a following within the mass market will depend on the availability of content. A significant element of the overall strategy will depend on Netflix’s ability to leverage their pre-existing relationship with studio owners as explained in the value chain analysis, to negotiate an agreement concerning distribution rights for the online content. The negotiation of exclusive distribution rights pertaining to online content will create a further competitive advantage, helping to combat the threats of competitors such as Vongo and the cable providers. To enjoy success in the VOD market, Netflix will need to ensure the wide distribution of online content that is easily accessible to all potential users. Forming strategic alliances with gaming companies will provide the hardware platform necessary to solve connectivity issues. In addition Netflix could offer a simple connectivity kit allowing laptops to be wirelessly connected to television sets.

Monitoring online DVD rental sales to screen for changes in demand is an essential step in the plan to gain first mover advantage. Utilizing the Netflix brand name and the loyalty associated with it will provide Netflix with a considerable advantage over competitors. To address the potential confusion amongst the workforce created by a shift in the business model, part of the strategy should include creating a cross functional team that will focus solely on Netflix video streaming, the future of the industry.

Key Economic and Industry Variables

Economic

Demand for convenient movie rentals

Movie night as a normal part of entertainment at home

People want a large variety of movies to choose from

Industry

Rise of the online DVD rental business

The beginning of Video-On Demand through the Internet

Unwillingness to pay late fees

Key Drivers for the Industry:

Emerging new Internet capabilities and applications

Improved technological changes and process innovation (i.e. consumers are now able to download movies on their laptop instead of purchasing a DVD from a retail store)

Netflix was able to rent out movies through the internet and deliver it via USPS to customers rather than using traditional “brick-and-mortar” retail stores

They also offered consumers enhanced technological products such as DVDs rather than VHS’

Changes in who buys the product and how they use it

Greater number of consumers are using internet railing as a substitute to shopping in a physical movie retail stores

Product innovation

DVDs and DVD players were introduced which appealed to many consumers

With greater adoption of big-screen, high-definition TVs, consumers no longer wanted to view movies on their laptops

Changes in cost and efficiency

Offering products through the internet to consumers saves Netflix from expenses incurred due to building/renting a physical store space

Changing societal concerns, attitudes, and lifestyles

Consumers attitudes change as they now require “video on demand”, lower fees and access to older movies that are not available in stores.

The above mentioned driving forces have made a significant impact on the industry as it now allows consumers access to a pool of movies on demand, a service which was not previously available.

Porter’s Five Forces

Rivalry Strength:

Rivalry strength for Netflix is currently strong as there are “multiple competitors with approaches that spanned the three delivery channels” (advertising-supported video, digital file ownership and online video rental and pay TV).

Competitors include stand-alone online VOD services such as Vongo and CinemaNow as well as established traditional cable and satellite providers. Blockbuster also poses a threat as it expressed its intend in acquiring MovieLink (a venture between several major studies such as MGM, Paramount, Sony, Warner Brothers, and Universal).

Potential New Entrants:

Liongate, Microsoft, and Cisco entered the industry and made the competition stronger with their venture CinemaNow, offering consumers thousands of titles from major studios.

Substitute Strength:

Currently the strength of substitute companies is moderate as buyers can purchase movies from retail stores such as Blockbuster, Wal-Mart, mom-and-pop stores, etc. That being said, as there are technological improvements being made, the trend of VOD will too increase.

Supplier Strength:

The supplier strength is relatively strong as studios are more concerned about pirated downloads and “lack of urgency to supplant their profitable DVD sales” which makes them reluctant to offer content to VOD websites.

Buyer Strength:

The buyer strength is moderately strong as they are able to shift between the several present rival companies in the industry.

As one may conclude, the VOD industry is ever growing and is thus a very attractive industry to be in. However, Netflix’s success is dependent on its external factors such as its competitors and how it deals with it.

Positioning Map of the VOD Industry

This strategic group map illustrates Reed Hastings’ classification of the three available forms of Internet video along with the market share held by the different competing sectors. This map is an estimate of where each sector stands within the industry. As you can see, traditional retail stores such as Blockbuster, is not doing well in the VOD industry as it took them several years to jump on board with this new venture. Stand-alone online VOD services are not providing fierce competition as their consumer base is relatively small and are limited financially to be able to grow. Netflix’s main competitors are the Cable and Satellite Providers since they posses not only the finances to equip them with high-tech products and services but, also have a strong client base that they can attract

Key Success Factors

Price Structure and Cost: Flat monthly fee of $17.99

Rental structure: Movies at home all the time

Large collection of available Movie Titles

Software that accurately recommends available movies to match customer taste

No late fees.

Relationship with Distributors, Studios and Postal Service

Central Distribution Centers: Fewer movie copies needed in inventory to meet demand

Central Distribution Centers: Fast delivery times

Conclusion about the attractiveness of the industry

The emerging video on demand industry is reasonably attractive. The effect of technology to bridge the gap between the television and the internet will drive industry attractiveness. However, disruptive technologies have opened the door for entrants with improved technology to deliver video to the consumer in an easy-to-use format direct to their television or PC. Overall, a significant investment is required to provide streaming of videos on demand, but this risk could result in a high reward.

Company’s Resource and Competitive Position

Mission: To be the leading provider of personalized in-home entertainment that customer can access at their convenience.

Vision: Netflix focuses on being an early adapter to new technology that will fulfill customer’s specific needs

Supply Chain Management:

Netflix offers home delivery of DVDs through the mail instead of retail locations.

An agreement with major studios on DVD up-front prices. Pay studios a small fee from the movies’ total number of rentals. Lower acquisition cost for high demand releases.

Operations:

The business is based on online ordering and a quick delivery system. Customers also have the choice of watching movies online.

Operate distribution centers from which movies are shipped and repacked DVDs are redistributed.

Distribution:

Netflix depends on U.S. Postal Services to distribute the DVDs

In order to increase delivery quality and reduce delivery time, Netflix opened distribution centers in many cities.

Sales and Marketing:

When Netflix was founded, it targeted DVD player users. The customers had prepaid subscription membership.

Netflix had a recommendation system which helped customers choose the movies they liked.

Easy membership cancellation- able to cancel memberships online. This increased the rate of return customers.

Service:

Netflix relied on surveys and customer feedback in order to increase customer satisfaction. Hassle free cancellation.

R&D:

Netflix focused on its development in order to increase customer satisfaction. Netflix engineers developed a propriety algorithmic recommendation system that helped customers choose movies easily.

Netflix is looking to develop and introduce VOD

Competitive Advantage:

Netflix has gained competitive advantage based on its way of operations. Netflix offers video delivery that attracts many customers who enjoy the renting movie without going to the store.

Netflix’s recommendation system, which suggests movie titles to the customers, gives a competitive advantage to Netflix comparing to Blockbuster and the other competitors which have staff with little knowledge of movies.

Netflix also enjoys the advantage of having variety of videos since the competitors have to deal with shelving space. For instance, Blockbuster offers limited number of videos because they don’t have enough shelves to keep all videos. Thus, Blockbuster may prefer not to offer some videos to its customers.

Financial Analysis

Since Netflix was founded in 1997, it enjoyed significant growth in revenue and its customer base. By 2006, Netflix enjoyed $1 billion of the approximate $8.7 billion in revenues in the movie rental industry and had accumulated over 6 million customers. This growth is depicted in the chart below.

Beginning in 2002, Netflix generated positive cash flow for the first time and began to hit its stride. Gross margins and marketing costs began to stabilize and subscription costs as a percentage of revenue began to decrease. This appeared to be, in part, due to Ted Sarandos joining the company in 2000 and negotiating deals with studios. In 2003, the company generated positive income from operations for the first time.

Other cost savings measures included working closely with USPS to increase delivery times and increasing the number of distribution centres. Netflix successfully decreased fulfillment costs as a percentage of sales in each year from 130% in 1998 to 9% in 2006. These strategies also aided in providing better service. This led to an increase in the number of customers and the net profit per customer.

It is clear based on the above that customers are interested in convenience. This is because the company became more profitable and began to grow more quickly as Netflix refined its online ordering system, enhanced the delivery times and opened more distribution centers. It is also apparent that customers are interested in unlimited plans and no late fees. This is evident by the strong growth that Netflix enjoyed since inception and the reaction from competitors such as Blockbuster (i.e., their attempt to copy the business model of Netflix).

The percentage growth in the subscriber base began to decline in 2005 and 2006, suggesting that the DVD delivery business was at the early stages of market saturation. In this regard, it may be prudent for Netflix to begin to offer online streaming of movies, etc. as a growth strategy. The factors above leading to Netflix’s success (i.e., convenience, unlimited plans, etc.) suggest that there is a bright future for Netflix in this area and with fulfilment costs at nearly $100 million in 2006, there would be significant funds available for other uses if Netflix chooses this route.

SWOT Analysis

Strengths

Strong brand name and company image.

Lead market share of online rentals.

Largest online library of DVD titles to rent.

Fastest delivery time of any online DVD rental company with 44 distribution centres around the world.

Over 90% of DVD’s are received by customers within one day of ordering.

Cheap monthly plans.

Allowing customers the freedom to return movies at one’s convenience by letting customers keep the DVD until they want to see the next one in their queue.

Netflix rating system suggests and recommends movie titles for their customers that they otherwise wouldn’t have known about or selected.

Weaknesses

Presence in only DVD segment.

The studios can dictate some serious pricing power terms to Netflix, limiting when various movies become accessible or for how long.

Trouble providing enough copies of new, popular movies.

Cost of acquiring new releases is too high for Netflix, which has the tendency to drive away current and potential customers.

Monthly fee could discourage membership from less frequent movie watchers.

Opportunities

Product line expansion (such as Video games, educational, institutional etc.).

Expand downloadable movie offerings.

In order to keep growing, the company must internationalize, which may lead to more pricing power.

Entering the VOD market through offering streaming videos as opposed to movie downloading will distinguish Netflix from its competitors, and decrease the probability of price competition.

Threats

Blockbuster’s potential purchase of MovieLink.

Vongo, CinemaNow other stand alone sites already established in online video business.

Competition from cable companies-traditional cable and satellite providers provide on demand service, including number of “free” offerings. . .

By analysis of the table above, it is quite evident that Netflix has a lot of key areas of strength. Their unique and large number of DVD collections, as well as their rating system, has been appreciated a great deal by users. However, there is still room for improvement by expanding their product line into other segments such as Video Games. Also, online video streaming is a unique market for Netflix to excel in, but they must be aware of potential threats by companies already established in the business.