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Netflix: Gaining Competitiveness through I.S.

Winter 2011

1. What should be Netflixs mission statement? What is its business strategy? A companys mission statement is extremely important in defining its reason for conducting business. After studying Netflix and the successes that this company has achieved, their mission statement should relate to the following words: To provide innovation and convenience in the way people enjoy movies and television shows by offering the most expansive viewing selection and fast, free delivery. Netflixs business strategy is to offer customers an entertainment option that they cannot get from any other company. They have achieved this by successfully innovating how people watch movies and television episodes, and they are very good at understanding their competitions weakness and then exploiting it (Ellis, 2002). They entered the video rental industry in 1999 as a dot com startup that received minimal respect from competitors, especially Blockbuster. Their differentiation strategy was focused on addressing the hatred of late fees and the inconvenience of returning movies. They addressed these negatives by offering customers a subscription-based rental service where customers could choose DVDs to rent online, and then receive the DVD by mail. Customers could keep the DVD as long as they wanted, but when they wanted to receive another DVD, they could just send back the previously viewed DVD in the postage-paid envelope. The strategy was appealing to customers and they signed up 239,000 subscriptions in the first year (inc). As the years passed and the customer base increased, Netflix focused on their innovative strategy and expanded their DVD database to over 100,000 compared to a conventional video store offering only 3,000 choices (Gallaugher, 2011, p.209). Netflix realized that there was a demand for less popular titles that brick and mortar stores could not meet. Brick and mortar stores could not meet the demand because the profit made buying less popular titles did not offset the cost to buy those titles. Netflix was able to meet the demands, because their database of DVDs reached customers across the United States and they only had to buy a limited quantity of less popular titles to meet those demands. This came to be known as the long tail approach coined by Chris Anderson and meaning that culture and economy is increasingly shifting away from a focus on a relatively small number of "hits" (mainstream

products and markets) at the head of the demand curve and toward a huge number of niches in the tail. As the costs of production and distribution fall, especially online, there is now less need to lump products and consumers into one-size-fits-all containers (Long-tail). Technology has played a pivotal role in Netflixs innovative strategy. The website starts with a data collecting program called Cinematch which compiles customer preferences of movies. Cinematch develops a map of user ratings and steers you toward titles preferred by people with tastes that are most like yours. Techies and marketers call this trick collaborative filtering. (Gallaugher, 2011, p.212) The more ratings that Cinematch has in its database, the more effective the suggestions are. With over 3 billion ratings, the program effectively suggests less popular titles that customers tend to enjoy, thus increasing the advantage of the long tail approach. Cinematch also exposes customers to movies and television shows that they might not be inclined to watch, making the experience unique to any other form of entertainment. This is why Netflix has been able to keep the churn rate below 3 percent. Along with Cinematch, Netflixs business strategy leverages technology for success by entering the shift from atoms to bits beginning in 2007. In a country where the majority of households have broadband internet access and a computer, Netflix wanted to be able to increase convenience by offering online streaming of select movies and television shows. They also are predicting a shift from physical DVDs to electronic delivery because of the shift that has happened in the music industry. Netflixs strategy is to be a frontrunner when this shift happens, and they are currently working on streaming licenses to make a smooth transition.

2. What is the definition of switching cost? For customers of Netflix, what are their switching costs? How do the proprietary technologies used by Netflix contribute to such switching cost? Switching costs are when consumers incur an expense to move from one product or service to another. (Gallaugher, 2011, p.45) For customers of Netflix, there are many switching costs incurred when cancelling a subscription. This is one of the main reasons that Netflixs churn rate is less than 3 percent.

The first switching cost is time. If a customer were to drop a subscription from Netflix for another video rental service like Redbox, he would have to spend time finding a Redbox kiosk then driving to and from that kiosk to get movies. The second switching cost is the loss of data that Cinematch technology provides to Netflix subscribers. If a Netflix subscriber switches to Blockbuster, he will not get suggestions from his past actions on new movies or television shows that he might like. The third switching cost is the breadth of movies and television shows that Netflix offers. Netflix has over 100,000 titles in its database compared to a traditional competitor that carries around 3,000 titles in its inventory (Gallaugher, 2011, p.209) or with Redbox only 200 titles (redbox). This drastically reduces the entertainment choices of the customer. The proprietary technologies possessed by Netflix help to secure switching costs. 58 ultrahigh-tech distribution centers allow subscribers to receive DVDs in about 1 business day. These distribution centers are purposely located within driving distance of 119 U.S. Postal Service processing and distribution facilities (Gallaugher, 2011, p.214). These centers allow Netflix to handle the breadth of DVDs that they offer. Collaborative filtering through the Cinematch recommendation program creates a huge data advantage by developing a map of user ratings and steers you toward titles preferred by people with tastes that are most like yours (Gallaugher, 2011, p.212). This technology creates a different type of entertainment experience only possible with the technology, data collected from previous customers, and the breadth of titles only offered through Netflix. They even took this technology one step further by crowdsourcing and setting a $1 million payoff to anyone who could improve Cinematchs rating accuracy by 10 percent. The challenge attracted over 30,000 teams from 170 countries (Gallaugher, 2011, p.213).

3. Are RedBox and Blockbuster Express a legitimate threat to Netflix? Why or why not? Use a framework or theory to support your analysis. RedBox and Blockbuster Express are not legitimate threats to Netflix, because they do not meet the entertainment needs of the majority of customers, they do not offer the

convenience of Netflix, and their strategies do not focus on innovation. Both Redbox and Blockbuster Express are valid entertainment options, but they are not replacements for Netflix. Redbox and Blockbuster Express fail at offering customers a broad choice of DVD titles. An average, Redbox kiosks only offer 200 new release titles and only hold up to 630 DVDs (redbox). Many times, since the kiosks only hold 630 DVDs, the popular titles will be sold out limiting the customers choices even more. Netflix offers over 100,000 titles (Gallaugher, 2011, p.209) to meet the needs of a broad range of customers. Netflix uses the long tail concept which is a phenomenon whereby firms can make money by selling a near-limitless selection of less-popular products Theres actually more money to be made selling the obscure stuff than the hits At Netflix, roughly 75 percent of DVD titles shipped are back-catalog titles, not new releases (Gallaugher, 2011, p.210). This method ensures that customers always have entertainment choices that they want to watch. Another competitive advantage of Netflix is the ultimate convenience that the company offers. The most strenuous part of being a Netflix member is inserting the DVD into the DVD player. They offer ultimate convenience by implementing a user-friendly website, fast shipping of DVD titles, low-cost monthly subscriptions, free return shipping of DVDs, and online streaming. Redbox and Blockbuster Express offer limited convenience. Kiosks are located in common locations like McDonalds, gas stations, and grocery stores, but the customer still has to physically drive to the locations to pick up and return DVDs. Also, the problem of late fees is still prevalent with Redbox and Blockbuster Express. They both offer $1 rentals, but the customer has to return the DVDs within 24 hours. The penalty is an additional $1 charged per day which can add up quickly. Netflix has been a first-mover in innovating the way people get their entertainment by implementing DVDs through the mail and then changing their focus to streaming movies and television episodes. They have the ability to recognize opportunities before their competitors. Netflix is aware of Moores Law and formulates its strategies around this theory. Moores Law basically states that chip performance per dollar doubles every 18 months (Gallaugher, 2011, p.19). This theory shows how advancement in technology allows more consumers to afford

higher technology, thus opening new markets. The music industry has shown this transformation by going from selling physical CDs to mostly selling electronic versions of albums or songs. This transformation from atoms to bits has influenced Netflix to invest in streaming video. With over 500 million households having access to residential broadband (Netflix), Netflix has spotted an opportunity and will once again be a first-mover in the way people get their entertainment. Redbox and Blockbuster will still meet the needs of a limited amount of customers, but they will not affect the subscription rate and growth of Netflix.

References

Ellis, J. (2002). Strategy. Fast Company, (64), 66.