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To:

From: Neveen Acero, Gina Garcia, Janet Gonzalez, Claire Holaday and Philip Johnson

Reed Hastings

Re:

Maintaining Netflixs Hold on the Home Entertainment Market

Date:

2/12/13

Mr. Hastings,

We have analyzed a few key aspects of our business: our competition, content deals, distribution channels, and growth and would, respectfully, like to make some recommendations for the future of our company. As you know, historically, we supplanted Blockbuster as the go-to video rental distributor in the 2000s because of our

convenience and flexibility, no late feepolicy, and our proprietary algorithms that provide targeted and relevant recommendations to our customers. By focusing on the customer experience and on video content delivery as our area of expertise, we provide a unique experience for our customers. This emphasis on the customer and on home entertainment is both our value proposition and potentially our Achillesheel.

Competition:

What differentiates us from our competitors is the fact that our company does not sell a tangible product. As a company, our growth is extremely dependent on attaining new subscribers. We has changed the movie rental industry, as we were the first to implement a web-based streaming service which, incidentally, aided in putting retailers such as Blockbuster out of business. For a handful of years, we were the rising starbecause we made media content incredibly convenient and affordable to our customers. In addition, our partnerships with entertainment industry giants and networks allow subscribers more fun-filled digital options. We were, and still are, a trendsetter in the industry. Our subscribers wanted to be part of something modernand cool,which generated a profitable growth-margin for a number of years due to the exponential rise in subscriptions. We have continued to raise the bar by offering members one great rate, with several convenient viewing options.

Over time, our competitive advantage has weakened resulting in lost profits and inciting reason for change in our business model. We decided to increase subscription price, revaluate our overall structure, and reconsider some of our partnerships. This ultimately led to fewer services at a higher cost. Subsequently, we created unhappy subscribers who eventually cancelled their memberships. Within the past two years, our competition has grown incredibly fierce with the introduction of multichannel video programming distributors (MVPDs), Over-the-topinternet movie and TV content

providers, transactional content providers, DVD rental outlets, and entertainment video retailers. Everyday, our competitors are creating new strategies in an attempt to overtake us as the most popular service. These rivalries, in conjunction with a continued decrease in subscribers, could severely challenge the future of our company.

Content Deals & Exclusivity:

The nature of our highly specialized business model is simultaneously our biggest strength and a potential weakness. Arguably the most vital business decisions that we make revolve around the purchase and distribution of licensed media content. Escalating costs, originality, and competition for content are the biggest hurdles we face in maintaining profitability and growth.

In December of 2012, we signed a $4 billion deal with Disney to give us rights to stream content from all of Disney's subsidiaries such as Pixar, Marvel, and Lucasfilm. However, Disney movies will not be available for streaming on our site until 2016 after our current deal with Liberty Media's pay-TV channel Starz expires. The deal is for both new Disney movies and previously released content including classic Disney movies like Cinderellaand Snow White.This deal has the potential to save us from being consumed by our competition if we can maintain and possibly expand our current customer base until we can release this content in 2016.

Even more recently, as of January of this year, we added some more big-name cartoons through our newest deal with Time Warner subsidiaries Warner Brothers Television and Turner Broadcasting. They agreed to give us the rights to some big cartoon franchises including the animated Green Lantern episodes. We have also recently acquired some more risqué adult series from Cartoon Networks Adult Swim programming including the popular "Aqua Teen Hunger Force" and "Robot Chicken." This deal comes into effect on March 30, 2013. We will also get the rights to stream some additional hit TV dramas including "The West Wing."

Our recent agreement with Disney could signal to our customers and investors that we are doing well at defending our turf in the war for quality programming, yet financially we have been taking huge risks by investing hundreds of millions of dollars to attain this content that will not prove itself to be profitable for years to come. Simultaneously, it is necessary that we hedge competitors such as Amazon, Apple, Comcast, and Hulu that are vying for exclusive rights to the hottest new programming.

Distribution Capabilities & Channels:

We began our business by delivering videos via mail through online subscriptions. With the rise of iTunes, handheld computing devices and YouTube, we began to meet the demand for instant video viewing by offering our customers streaming capabilities. Streaming content now makes up the majority of our business and is the sole method of video delivery to our international markets.

According to Breakthrough Year for Online Streamingi streaming and on- demand video viewing may have surpassed DVD or Blu-ray consumption in 2012; and 94% of that consumption was purchased through our services and Amazon Prime. In order to stream content, however, a viewing device must be linked to the web. This has posed a challenge for us since research shows that people prefer to watch movies on their televisions rather than on their computers, laptops, or handheld devices more suited to short-format content viewing such as YouTube videos or television clips. Therefore, new methods of distribution like Roku may be necessary to maintain our market share (see Figure 1, Appendix). Additional opportunities like our Disney agreement serve to better position our company for further growth and expansion. ii

Growth & Expansion:

In 2010, we began expanding by making our streaming service available internationally in Canada. Since then, we have expanded to Latin America, the United Kingdom, Ireland and the Nordic countries of Sweden, Norway, Finland and Denmark. By the end of 2012, we had subscribers in over 40 countries. Despite a forecasted loss due to this expansion, we reported higher than expected revenues indicating that the international market is ripe for the picking. Cautious expansion, as we recently reported this month, can serve to either open the international market to competitors or allow for us to focus our efforts on original content, distribution partnerships and exclusivity agreements. iii However, tapping into this market may be the best way to increase our number of subscribers considering the rising costs of licensing content.

Conclusion & Recommendations:

By focusing on delivering video content to our customers in a way that both satisfies and delights, we have established high expectations among our subscribers and investors. Because we have simplified our focus, we are able to remain a leader in the video-streaming space. At the same time, our singular focus makes us vulnerable to newer technology and smaller, more nimble competitors. In our efforts to gain market

share and stay ahead of our competition, we must continue to develop innovative strategies for distribution including new international markets and make financially responsible content deals to provide our customers with the best possible experience.

As with any business, however, we always have room for improvement and growth. We are fortunate to have the opportunity to make a variety of different business decisions and develop strategies going forward to continue our growth. For example, it may be helpful to invest in additional market research to determine whether we should diversify the types of content we provide to our customers or invest in expanding existing categories or series. Diversifying programs could open the door to new, potentially untapped, markets such as video game content or high-level educational programming. Additionally, partnering with some smaller competitors or licensing new technologies could expand our overall market and revenue.

Appendix:

Figure 1.1 Netflix streaming content is available through multiple channels including:

PCs

Macs

Game Consoles (XBox 360, PS2)

Smart TVs

   

Home Theater

Internet Video

Vizio/LG TVs

Blu-ray players

Systems

Players (Roku)

Digital Video

Mobile Devices

DVDs

 

Recorders

(phones, tablets)

Works Cited & References:

i Cyran, Dan. "Breakthrough Year for Online Movies." Newsle. N.p., 24 Dec. 2012. Web. 6 Feb. 2013.

ii Ferry, Daniel. "1 Big Win for Netflix." 1 Big Win for Netflix. The Motley Fool, 4 Dec. 12. Web. 3 Feb. 2013.

iii Wilheim, Alex. "Despite a Very Successful Nordic Launch, Netflix Plans Slow International Expansion in 2013." TNW Network All Stories RSS. N.p., 23 Jan.

Reeves, Jeff. "The Slant." The Slant. N.p., 4 Jan. 2013. Web. 8 Feb. 2013.

Rueters. "The Force Is with Netflix in Deal for Disney Movies, including 'Star Wars'"NBC News Business. N.p., 3 Dec. 2012. Web. 8 Feb. 2013.

Riley, Charles. "Netflix, Time Warner Strike New Content Deal." CNNMoney. Cable News Network, 08 Jan. 2013. Web. 8 Feb. 2013.

Boorstin, Julia. "Netflix Rallies on New TV Content Deal." CNBC.com. N.p., 7 Jan. 2013. Web. 5 Feb. 2013.