Netflix industry analysis 2017

NETFLIX: INTERNATIONAL EXPANSION1 Won-Yong Oh and Duane Myer wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-04-26

In October 2015, Netflix released its report on its third-quarter earnings. Although growth in the United States was weak, with profits dropping 50 per cent compared with the year before, the number of international subscribers was nonetheless increasing at a rapid pace. However, not all international subscribers were satisfied with Netflix’s service.2 Global expansion was strategically important for the company to offset the financial impact of its slow growth in the domestic market. Reed Hastings, the chief executive officer (CEO) of Netflix, stated that accelerating the company’s international expansion would put it on the right track and would offer resources for reinvestment in its service, as well as developing and licensing more content.3 However, U.S. operations still represented about two-thirds of Netflix’s revenues, and the company faced challenges ahead in its push to expand internationally. COMPANY OVERVIEW Netflix was a publicly traded company that offered subscription video streaming and online digital video disc (DVD) and Blu-ray Disc rental services, all for a flat fee of US$7.99 a month.4 By January 2016, the company had an estimated 74 million subscribers worldwide, ranging from its domestic market of the United States to markets as geographically diverse as South Korea and Poland. As of 2015, Netflix employed more than 3,500 full-time employees and reported revenues upwards of $6.78 billion (see Exhibit 1). Its plans for 2016 included further expansions targeting a worldwide market (barring selected countries with stringent regulatory restrictions).5 The company’s status as a dominant power in the Internet streaming services industry found its roots in relatively humble beginnings. Netflix was conceived as the solution to the common, but annoying, problem of overdue fees on video rentals. Founded in 1997 in California by current CEO Hastings and entrepreneur Marc Randolph, the idea for Netflix came about after Hastings faced a $40 late fee on a video he rented and forgot to return for six weeks.6

For the exclusive use of P. Vitale, 2017.

This document is authorized for use only by Patrick Vitale in BUS400-Spring2017 taught by Michael Roberto, Bryant University from January 2017 to July 2017.

Page 2 9B16M070 The Rise of Netflix and the Demise of Blockbuster At the time of Netflix’s conception and launch, the video-rental industry was dominated by Blockbuster, a video-rental company that relied on multiple locations in suburban centres and the willingness of customers to patronize its locations. Randolph and Hastings launched the Netflix website on April 14, 1998, as a pay- per-rental DVD-mailing service, charging $0.50 per rental. They introduced the concept of a subscription- based service in 1999, moving away from the idea of stand-alone rental stores that Blockbuster had popularized.7 Netflix experienced substantial growth at the turn of the new millennium. In 2002, it launched an initial public offering (IPO) to sell shares of its common stock, selling 5.5 million shares at $15 per share. The popularity of Netflix’s business model quickly resulted in the obsolescence of the model that Blockbuster had so successfully utilized. Ironically, the video-rental store chain was offered the opportunity to purchase Netflix in 2000 for $50 million, but Blockbuster declined the offer.8 On September 23, 2010, amidst the rising demand for streaming services and declining demand for DVD rentals and sales, Blockbuster, facing declining market share and $900 million in debt, filed for bankruptcy protection.9 Move to Internet Streaming and VOD In 2007, Netflix began to reengineer its core business model away from mail-order DVD rentals to Internet streaming and video-on-demand (VOD), accurately predicting that the volume of DVD sales and rentals would eventually fall.10 By 2010, its streaming service had experienced substantial growth and expansion in the U.S. market (see Exhibit 2), a change that soon became reflected in a shift of corporate strategy in 2011. In the same year, Netflix announced its intentions to separate and rebrand its DVD-rental service as the stand-alone subsidiary company Qwikster, effectively dividing its two core services and focusing its existing brand and activities on its streaming service. The intended strategy was never implemented, largely due to subscriber backlash that resulted in the company’s first-ever decline in subscribers.11 Since 2011, the company had experienced steady periods of growth in both subscriber numbers and total revenue. In 2014, the company hit a subscriber milestone when it surpassed 50 million worldwide subscribers, 36 million of whom were in the United States.12 Netflix had supplemented its role as a content provider by providing original content, acting as a developer of popular TV programs such as Orange Is the New Black and House of Cards. Netflix concluded the 2015 fiscal year with a market value of $32.9 billion, making it more financially valuable than established television networks such as CBS.13 Business Model Netflix’s business model was dependent upon the full integration of the Internet — its successful incorporation and utilization of the Internet were critical in competing against, and eventually overtaking, Blockbuster in the home entertainment industry. Netflix generated revenue primarily through its subscription system, through which subscribers paid a flat monthly fee to have access to its digital library of movies, television shows, and other original content. Although Netflix moved away from its roots as a primarily DVD-by-mail service, the company continued to generate significant cash flow from its business in the DVD-by-mail sector.14 Its DVD-by-mail business,

For the exclusive use of P. Vitale, 2017.

This document is authorized for use only by Patrick Vitale in BUS400-Spring2017 taught by Michael Roberto, Bryant University from January 2017 to July 2017.

Page 3 9B16M070 which operated only in the United States, generated $80 million in contribution profit in the last quarter of 2015, with about 4.9 million members.15 However, the company did not generate any revenue from providing advertising services. In June 2015, Hastings restated his decision on this topic: “No advertising coming onto Netflix. Period.”16 INDUSTRY OVERVIEW The Internet television and video-streaming industry revolutionized the way people accessed entertainment. The VOD business model contributed to the demise of video-rental stores like Blockbuster by offering a wide selection of new releases in a content delivery system that was faster and more convenient for the consumer. The industry benefited from the improvement of streaming technology and in the further development of mobile devices, from which viewers could access streamed content. With the widespread adoption of mobile viewing platforms like tablets, large-screen smartphones, and laptops, VOD capitalized on the business opportunities available by streaming through the Internet. The Internet was an indispensable tool in launching the content-streaming service, but companies in the industry found themselves competing with video file sharing websites like the Pirate Bay and Megaupload, which offered viewers the same, if lower- quality, content for free by avoiding expensive licensing agreements with content providers. Competition The industry was traditionally dominated by a small number of firms, but a diverse range of companies had been looking to expand into the Internet video-streaming business. Many firms operating in the Internet streaming industry sought exclusive licensing agreements with content providers, whether they were cable television networks or production studios. Although Netflix retained a significant portion of market share in the industry, an increasing number of new entrants had changed the competitive landscape with unique competitive advantages. One such firm was Hulu, a subsidiary of Hulu LLC, which was a joint venture between The Walt Disney Company, NBC Universal Television Group, and 21st Century Fox Inc. Conceived and launched in 2006, Hulu offered streaming services to subscribers in the United States and Japan and delivered a wide range of content from its content partners for a monthly subscription fee ranging from $7.99 to $11.99 — the higher fee removing advertisements. By 2015, Hulu had an estimated 9 million subscribers and had managed to secure exclusive streaming rights to a number of popular television programs.17 New entrants to the industry also came in the form of multinational information technology companies that expanded their business interests into the Internet video-streaming sector. An example of such a company was e-commerce giant Amazon, which took advantage of its enormous global customer base, strong brand, and powerful computing infrastructure to launch its Amazon Video service. Launched in 2006, Amazon Video was available in a number of countries, including the United States, the United Kingdom, and Japan, and had an estimated 44 million users, second only to Netflix in market share in the streaming industry. Unlike its competitors, Amazon Video offered users the option to rent or buy movies and television shows without purchasing a subscription. The service was also accessible on a wide range of viewing platforms and streaming devices, from the standard web browser to game consoles such as Xbox and PlayStation.18

For the exclusive use of P. Vitale, 2017.

This document is authorized for use only by Patrick Vitale in BUS400-Spring2017 taught by Michael Roberto, Bryant University from January 2017 to July 2017.