In a weighted competitive strength assessment

ase Teaching Note 05 - Competition in the Movie Rental Industry in 2008: Netflix & Block¬buster Battle for Market Leadership

Teaching Outline and Analysis

1. How strong are the competitive forces in the movie rental marketplace? Do a five-forces analysis to support your answer.

Below is a representative five-forces model of competition in the movie rental industry:

 Rivalry among companies competing in movie rentals—

 Threat of entry

 Competition from substitutes—

 The bargaining power and leverage of suppliers—

 The bargaining power and leverage of people renting DVDs—

Conclusions concerning the overall strength of competitive forces:

2. What forces are driving change in the movie rental industry? Are these driving forces likely to have a favorable or unfavorable impact on competitive intensity and future industry profitability?

Conclusions:

.

3. What does your strategic group map of this industry look like? Is Netflix well-positioned? Why or why not?

Figure 1 A Representative Strategic Group Map of the Movie Rental Industry

4. What key factors will determine a company’s success in the movie rental industry in the next 3-5 years?

5. What is Netflix’s strategy? Which of the five generic competitive strategies discussed in Chapter 5 most closely fit the competitive approach that Netflix is taking? What type of competitive advantage is Netflix trying to achieve?

Netflix’s Competitive Advantage

6. What does a SWOT analysis of Netflix reveal about the overall attractiveness of its situation?

Netflix’s Resource Strengths and Competitive Assets

Netflix’s Resource Weaknesses and Competitive Liabilities

Netflix’s External Market Opportunities

External Threats to Netflix’s Future Profitability

Conclusions concerning Netflix’s situation.

7. What is your appraisal of Netflix’s operating and financial performance based on the data in case Exhibits 2, 3, and 4? What positives and negatives do you see in Netflix’s performance? Use the financial ratios in Table 4.1 of Chapter 4 as a guide in doing the calculations needed to arrive at an analysis-based answer to your assessment of Netflix’s recent financial performance.

 Netflix’s profit margins have changed as follows:

2000

2002

2004

2005

2006

2007

Gross profit margin (gross profit as a % of revenues)

Operating profit margin (operating income as a % of revenues)

Net profit margin (net income as a % of revenues)

Calculated from information in case Exhibit 3.

 The following table shows assorted expense ratios for Netflix:

2000

2002

2004

2005

2006

2007

Subscription costs as a % of subscription revenues

Fulfillment costs as a % of total revenues

Technology and development costs as a % of total revenues

Marketing costs as a % of total revenues

General and admin costs as a % of total revenues

Calculated from information in case Exhibit 3.

Positives (or strengths) in Netflix’s operating and financial performance based on the data in case Exhibits 2, 3, and 4:

Negatives (or weaknesses) in Netflix’s operating and financial performance based on the data in case Exhibits 2, 3, and 4:

8. What does a SWOT analysis of Blockbuster reveal about the overall attractiveness of its situation?

Blockbuster’s Resource Strengths and Competitive Assets

Blockbuster’s Resource Weaknesses and Competitive Liabilities

Blockbuster’s External Market Opportunities

External Threats to Blockbuster’s Future Prospects

9. What is your appraisal of Blockbuster’s performance as shown in case Exhibit 5? What pluses and minuses do you see? Use the financial ratios in Table 4.1 of Chapter 4 as a guide in doing the calculations needed to arrive at an analysis-based answer to your assessment of Blockbuster’s recent performance.

Conclusions:

10. How does Netflix’s competitive strength compare against that of Blockbuster? Do a weighted competitive strength assessment using the methodology presented in Table 4.4 of Chapter 4 to support your answer. Does Netflix have a sustainable competitive advantage over Blockbuster in the movie rental business? Why or why not?

Table 1 Competitive Strength Assessments of Netflix and Blockbuster

(Rating scale: 1 = very weak; 5 = average; 10 = very strong)

Competitive Strength Measures

Importance Weight

Netflix

Blockbuster

Rating

Score

Rating

Score

Number/variety of titles in library of content offerings

Ease and convenience of choosing movies to rent

Ease and convenience of returning rented DVDs

Competitive pricing/variety of subscription plans

Brand image/ability to attract customers

Order-filling capabilities

Geographic market coverage

Ability to access movie rental customers

Financial strength

Sum of weights

Total Rating/Score

12. What recommendations would you make to Netflix CEO Reed Hastings? At a minimum, your recommendations should cover what to do about each of the top priority issues identified in question 11.

13. What recommendations would you make to Blockbuster CEO James Keyes? At a minimum, your recommendations should cover what to do about each of the top priority issues identified in question 11.

Epilogue

Netflix reported revenues of $1.36 billion for 2008 (versus $1.2 billion in 2007) and net income of $83 million (equal to $1.32 per diluted share) versus net income of $66.6 million in 2007 and diluted EPS of $0.97. Net cash flows from operating activities were $284.0 million versus $277.4 million in 2007. At year-end 2008, Netflix had cash and cash equivalents of $139.9 million (versus $177.4 million at the end of 2007) and short-term investments of $157.4 million (versus $207.7 million at the end of 2007).

Netflix ended 2008 with approximately 9,390,000 total subscribers, representing 26% year-over-year growth from 7,479,000 total subscribers at the end of 2007 and 8% sequential growth from 8,672,000 subscribers at the end of the third quarter of 2008. Subscriber acquisition cost for 2008 was $29.12 per gross subscriber addition compared to $40.86 for 2007.

In January 2009, Netflix announced partnerships with LG Electronics and Vizio, both makers of big-screen high-definition TVs, that would enable Netflix subscribers to watch movies streamed from Netflix directly to new Internet-connected LG and Vizio TV models that would be equipped with manufacturer-installed devices enabling such streaming. Netflix subscribers with such TVs would no longer need an external device to enable Netflix to stream movies directly to their TVs. Earlier, in November 2008, Netflix announced that its subscribers could have movies and TV episodes instantly streamed to their TVs via the Xbox 360 video game and entertainment system utilizing the New Xbox Experience that premiered nationwide on November 19. The Xbox 360 was the only game and entertainment console that let users instantly watch movies and TV episodes streamed from Netflix to the TV. There was no additional monthly fee for Netflix members who were also Xbox LIVE Gold members.

Netflix management projected that full-year 2009 results would be as follows:

 Ending subscribers of 10.6 million to 11.3 million

 Revenue of $1.58 billion to $1.635 billion

 Net income of $88 million to $98 million

 EPS of $1.43 to $1.59 per diluted share

For the first three quarters of 2008, Blockbuster reported total revenues of $3.90 billion versus total revenues of $3.975 billion for the first nine months of 2007. Both rental revenues and merchandise sales were down slightly from 2007 levels. The company reported a net loss of $22.7 million for the first nine months of 2008, significantly better than the loss of $123.2 million for the first nine months of 2007. Net cash flows from operations for the first nine months of 2008 were a negative $101.1 million. To contain its operating losses, Blockbuster management cut advertising expenditures to $94.8 million during the first nine months of 2008 (versus $158.9 million for the first three quarters of 2007). Long-term debt was $614.8 million, down from $665.6 million at the end of 2007.

At the end of the third quarter of 2008, Blockbuster had 5,843 company-owned stores, of which 3,909 were domestic and 1,934 were foreign. Counting franchised stores, Blockbuster had 7,525 stores as of October 5, 2008, down 305 stores since January 1, 2008. Domestic same-store revenues increased 5.1% in the third quarter of 2008 as compared to the third quarter of 2007, due to a 0.8% growth in same-store rental revenues and a 30.7% increase in same-store merchandise sales, largely driven by a significant increase in sales of games software and hardware. International same-store revenues decreased 3.4% as compared to the same period last year, reflecting a 2.2% decline in same-store rental revenues and a 5.0% decline in same-store merchandise sales. Worldwide same-store revenues grew 1.9% from the same period last year.

On March 3, 2009, Blockbuster announced that it had hired a prominent law firm that specialized in financially-troubled enterprises to advise the company on financing and capital-raising efforts; the company’s stock price plunged from about $1 per share to $0.22 on the announcement. On March 4, Standard & Poors placed Blockbuster on its credit watch list, including its speculative ‘B-’ corporate credit rating, in light of pending maturities of a revolving credit line and term loan A debt in August 2009. There were doubts that Blockbuster would be able to refinance the debt that was maturing in August. On March 5, Blockbuster announced that same-store sales rose 4.4% in the fourth quarter of 2008 and that domestic same-store sales were up 6.4% for full-year 2008. The increase in 4th quarter 2008 same-store sales was comprised of a 2.6% decrease in domestic same-store rental comparables and a 36.5% increase in domestic same-store retail comparables, which was largely driven by increased sales of games, game merchandise and consumer electronics. These sales increases prompted Blockbuster’s stock price to rise to the $0.50-$0.65 range as of March 6, 2009.

Please check the investor relations sections and the press releases at www.netflix.com and www.blockbuster.com for the latest developments on how these two movie rental competitors are faring.

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