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(solution) Hi..I wanted to get a case study done..Can you tell me what is


Hi..I wanted to get a case study done..Can you tell me what is the price for that?It is Netflix case study by Graduate stanford school of business..I want to know the issues present in the case study and recommendations of it.I want to know the problems associated with the netflix approach


CASE: E238

 

DATE : 1/29/07

 

(REV?D: 6/11/08) NETFLIX

 

?Nobody is going to come in and make Netflix obsolete.?

 

?McAlpine Associates

 

?Eventually, Netflix will cease to exist.?

 

?Wedbush Morgan Securities INTRODUCTION

 

Reed Hastings, CEO of Netflix, the online movie rental subscription service, refolded his

 

newspaper and leaned back in his chair. The San Francisco Chronicle had just published an

 

article about the heated competition between Netflix and rival Blockbuster. One paragraph

 

encapsulated much of the recent press and commentary regarding the two companies:

 

?With growing competition from Blockbuster?Netflix executives must now

 

worry more than ever about keeping existing users happy and attracting new ones.

 

They also face a price war and a depressed stock price.? 1

 

Netflix did not contend with significant direct competition in online DVD rentals for six years

 

until the movie rental chain giant entered the market in 2004. Since that time, Hastings?s

 

company had scrambled to maintain share and remain profitable. Investors balked at the impact

 

direct competition had on margins and the unlikely sustainability of price cutting against a

 

behemoth competitor. 1 San Francisco Chronicle, ?Netflix in for Blockbuster battle; Competition heats up for online company that rents

 

DVDs,? Verne Kopytoff

 

Bethany Coates prepared this case under the supervision of Andrew Rachleff, Lecturer in Strategic Management, as

 

the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative

 

situation.

 

Copyright © 2007 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order

 

copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb.stanford.edu or

 

write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University,

 

Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a

 

spreadsheet, or transmitted in any form or by any means ?? electronic, mechanical, photocopying, recording, or

 

otherwise ?? without the permission of the Stanford Graduate School of Business.

 

Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 2 Hastings firmly believed that his company offered better value, selection and convenience to

 

customers. Netflix was also widely recognized for outstanding customer service. However, with

 

sensationalistic stories dominating the industry news, his top challenge had become maintaining

 

focus on near-perfect execution as opposed to anticipating and countering Blockbuster?s every

 

move. Lately he spent a sizeable percentage of his time shoring up investors behind this

 

strategy. He wondered whether this Chronicle article warranted phone calls to any skittish

 

shareholders or if he should just get back to the business of ?delighting customers.?

 

NETFLIX: BEHIND THE SCENES

 

In April 1998, Netflix launched a website offering customers the opportunity to rent or purchase

 

Digital Video Discs (DVDs). Originally modeled after a traditional video rental store, customers

 

could select movies online and Netflix would mail their choices for a seven day in-home rental.

 

DVDs arrived in the mail within one to five days, depending on proximity to a distribution center

 

(DC). Renters returned the discs by placing them in a pre-posted and pre-addressed return

 

envelope supplied by Netflix.

 

The company initially struggled to attract consumers to try its service. It enhanced the in-store

 

model with far broader selection, but lacked the immediacy of walking out with a movie. As

 

Reed described it, ?the first a la carte model was not really working. Rentals were $3 or $4 each

 

and consumers still had to pay for shipping and handling. We also charged late fees.?

 

During the first six months of operations, the company missed multiple customer and revenue

 

growth targets. With the possibility of failure looming, Hastings and his management team

 

replaced the original Netflix model with a subscription service in October 1999 that formally

 

focused the company around three fundamental principles: Value ? unlimited DVD rentals for $15.95/ month, no late fees and free shipping

 

Convenience ? no due dates, fast home delivery and prepaid return envelope provided

 

Selection ? broadest array of titles, powerful browsing, search and personal

 

recommendations Value

 

Under the revamped subscription model, members were charged a flat monthly fee for as many

 

movie rentals as they wanted (see Exhibit 1 for a schedule of pricing changes over time).

 

Customers could have up to four movies outstanding at a time (later reduced to three). The

 

company paid for shipping in both directions and eliminated late fees. Customers clearly

 

preferred the new approach which led to an immediate surge in growth.

 

Netflix was able to keep its customer acquisition costs to a minimum by cutting deals with most

 

of the leading DVD player manufacturers. Sony, Toshiba, Panasonic and RCA all included

 

Netflix promotional offers with the sale of new players. Because of their size and durability,

 

DVDs could be mailed to subscribers inexpensively. After experimenting with 200 different

 

mailing envelopes, the company was able to bring the transportation portion of the shipping cost

 

down to the price of a first-class stamp each way. Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 3 Convenience

 

Two major competitive advantages made the convenience pledge possible. The first was the

 

company?s network of distribution centers (see Exhibit 2). If a customer was within 80 miles of

 

a distribution center, Netflix could deliver DVDs overnight. By the end of 2003, the company

 

expected to open enough shipping centers to service over 60% of its members with ?generally?

 

next-day delivery. The company originally planned to expand the number of warehouses on the

 

theory that faster delivery would reduce the percentage of subscribers who would opt out of the

 

service each month (i.e. churn). However, the company?s customer research indicated that an

 

increase in DCs did not significantly impact churn. Much to management?s surprise, rural New

 

York members who waited the better part of a week for their delivery churned no more often

 

than Bay Area customers who received their movies within one day. The company ultimately

 

realized that customers located far from a distribution center knew about the delay when they

 

signed up and opted-in despite the inconvenience. However, Netflix discovered an even more

 

valuable reason to pursue the build out. The vast majority of potential consumers viewed wait

 

time as a deal-breaker. They simply visited a local video store instead. Adding a distribution

 

center to a region enabled overnight delivery which broadened the company?s addressable

 

market. A larger market created a much bigger opportunity for revenue growth than did reduced

 

churn.

 

The company?s second major competitive advantage was the highly proprietary software it

 

designed to manage the logistics associated with the back end of DVD receiving and shipping.

 

The system helped ensure that customers received their next round of movie choices generally

 

within one business day. It improved operational efficiency by automating the process of

 

prioritizing, tracking and routing titles to and from each of the company?s DCs. As the operation

 

grew in size, employees at each of Netflix?s DCs were able to process over 1,000 returned DVDs

 

an hour. The software matched returned DVDs to a specific customer in the Netflix database.

 

Computers would print ship-to labels based on the data scanned in from the returned disc which

 

included that title?s next destination. Netflix would then mail out movies requested by customers

 

in their online accounts.

 

Selection

 

The company believed that selection breadth was strategically important and therefore made sure

 

to maintain the largest online library of movies of any company in the market. Management was

 

just as passionate about providing their subscribers tools to make informed movie selections. In

 

fact, Hastings explained that the company once considered focusing its business model on movie

 

recommendations. ?In late 1999, we thought about repositioning the company around movie

 

recommendations, but we ultimately determined that the market for online DVD rentals was far

 

larger.?

 

Nonetheless, arming customers with information became a cornerstone of Netflix?s selection

 

philosophy. The company provided advice based on aggregated consumer behavior. For

 

example, the website presented subscribers with cross-referenced titles in the vein of ?customers

 

who rented ?Old School? also chose ?Wedding Crashers.?? The average user rated 200 movies

 

which helped other subscribers decide whether or not to choose a particular title. Being an Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 4 information resource as well as a fulfillment vehicle helped maintain a very high level of

 

consumer satisfaction and increased site ?stickiness.?

 

IPO

 

By 2000, despite the Internet bubble having burst, the company was performing so well under

 

the subscription model that Hastings and his team considered an IPO. At the time, sales were

 

accelerating. The company?s market was growing quickly and had the opportunity to become

 

very large. There were 15.1 million American households with DVD players in 2000 and that

 

number was expected to grow to 60.5 million by 2003. Each household was a prospect for

 

Netflix?s online DVD subscription service.

 

Despite these and other conditions weighing in Netflix?s favor, many security analysts tended to

 

discredit the Netflix model. They noted that the company was still losing money, had low

 

barriers to entry and in their minds it was questionable whether online DVD subscription could

 

grow into a large business. Barry McCarthy, Netflix?s Chief Financial Officer, courted several

 

investment banks before ultimately choosing Deutsche Bank (DB) as the company?s lead

 

underwriter. DB had a well-respected new media group and the president of the firm was

 

McCarthy?s college classmate.

 

Netflix filed its first S-1 prospectus with the SEC on April 18, 2000, but the effort soon stalled.

 

Over the course of the ensuing four months, DB?s new media research analyst left the firm, the

 

public market deteriorated quickly and the company ultimately withdrew the filing. If Hastings

 

and his team had not secured a $50 million venture round days before filing for the IPO, the

 

company would likely have folded. Reed recalled ?It was the easiest money to raise, and if we

 

hadn?t done it at that time, we would have gone bankrupt.?

 

The company regrouped, focused on execution and continued to grow quickly. Revenues more

 

than doubled from $35.9 million in 2000 to $75.9 million 2001. Although not yet profitable on

 

an annual basis, the company substantially cut losses from $57.6 million in 2000 to $39.2 million

 

in 2001. After Netflix achieved its first cash flow positive quarter in the fourth quarter of 2001,

 

McCarthy thought the company once again had a good shot at a successful IPO. He and

 

Hastings wanted to fortify the thinly capitalized company. They decided to pursue an IPO again

 

in 2002, nearly two years after their first try.

 

For their second attempt, Hastings and McCarthy chose to work with Merrill Lynch, Thomas

 

Weisel Partners and U.S. Bancorp Piper Jaffray. The company filed its S-1 prospectus on March

 

6, 2002 and embarked on a road show on May 7, 2002. By the time management gave their last

 

presentation, the offering was 10 times oversubscribed. Netflix priced the offering of 5.5 million

 

shares at $15 per share ? the top end of its expected range ? and raised $82.5 million. The shares

 

gained 12% on the first day of trading.

 

THE THREAT : BLOCKBUSTER MAY ENTER THE MARKET

 

Rumors that Blockbuster would imminently enter the online DVD rental market surfaced with

 

intensity immediately after Netflix filed for an IPO the second time. Wall Street analysts

 

commonly espoused the perspective that Blockbuster, the giant home movie rental chain, would Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 5 prevail by leveraging scale and stores. In contrast, Hastings felt that Netflix had an advantage by

 

what he called the ?contrarian? thesis. Comparing Netflix to Starbucks, Hastings elaborated:

 

[Starbucks] had a contrarian thesis, which was that they could make the love of

 

specialty coffee mainstream. In 1992, they had truck drivers in Seattle drinking

 

espresso, and then [they captured?] the rest of the country. Our story is similar ?

 

in the Bay Area, about 5% of all households now subscribe to Netflix, but in the

 

rest of the country our penetration is only 1%. Blockbuster looks at us and thinks

 

we?re a niche; that video rental is only an impulse business. The business, as they

 

understand it, can?t work. But they just don?t understand the business. When you

 

think about it, if Dunkin? Donuts had gone into the Starbucks business, they

 

would have done a lousy job of it.

 

In 2002, Blockbuster had approximately 40 million offline customers and more than 6000 stores

 

across the nation. It was conceivable that it could launch a powerful DVD rental website to offer

 

a complete solution to its customers. Reed acknowledged the attraction of this massive one-stop

 

shop. ?Customers love our service, but the one negative thing they say is ?What about when I?m

 

out of movies and want a spontaneous rental?? In addition, Blockbuster had ample resources to

 

fund price cuts, build DCs and advertise to new and existing customers.

 

Netflix?s employees were disconcerted by the constant PR about Blockbuster?s impending

 

market entry and the effect it could have on their company. Reed acknowledged their fear and

 

tried to motivate the staff by pointing to the excitement of potential victory. ?How we do in this

 

Blockbuster battle will be our defining moment,? Hastings recalled saying. ?Winning would

 

give us a joy we may only experience three or four times in our business lives. Let?s be first

 

across the finish line.? He also modeled the behavior he wanted to see in his employees by

 

sticking with his business-as-usual routine and priorities.

 

This strategy had worked against another giant. Wal-Mart entered the online DVD rental

 

business in 2002 and undercut Netflix? $19.95 price with a $17 monthly subscription fee. The $3

 

difference was not enough of an enticement for Wal-Mart to overcome slow delivery times and a

 

limited catalog of titles. ?For Wal-Mart, this was just another line of business,? one analyst

 

noted.2 Meanwhile, industry experts consistently praised Netflix throughout 2002 as a tightlyrun and well-managed ship dedicated to invoking a love of movies in their customers. Netflix

 

management felt that if their strategy was strong enough to beat Wal-Mart, it could plausibly

 

marginalize any other competitor, including Blockbuster.

 

Yet the competition failed to emerge. Along with most industry pundits, the Netflix team was

 

convinced that Blockbuster would enter the market shortly after its IPO. Reed noted, ?in ?02

 

when we went public, we thought for sure, ?they?re coming.? Then ?03, we thought for sure. We

 

got all the way through ?03 and have 1.5 million subscribers and I thought, ?Wow! This is weird.

 

I guess they?re not coming.?? During those two years, Hastings continued pushing his team to

 

perfect execution, rather than focus on potential competition. Management looked for ways to

 

produce steady, incremental improvement, fine tuning every aspect of the business including

 

marketing, shipping and customer service. This strategy carried some risk. ?Lots of people felt

 

2 U.S. News and World Report, October 18, 2004, ?No pause in DVD rental wars,? Betsy Streisand Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 6 like we were sitting ducks,? Reed noted, ?as though we weren?t taking Blockbuster seriously and

 

we needed to do something bold to change the lines of competition or redefine the market in

 

some way.?

 

By June 2004, more than two years after their IPO, the Netflix team was led to believe that

 

Blockbuster was finally ready to enter the market. Anticipating a price war, the Netflix team

 

decided to increase monthly subscription pricing from $19.95 to $21.99, so as to give

 

Blockbuster room to cut pricing and still settle at a profitable level. The next month, Blockbuster

 

entered with force and quickly gained market share. It was the first time Netflix had to contend

 

with a strong, determined competitor and the transition was painful. Reed recalled, ?we slashed

 

prices, our stock dropped dramatically and our shareholder base completely turned over.? With

 

investors and employees depending on him, Hastings wondered at times if not specifically

 

preparing for Blockbuster had been a mistake.

 

BLOCKBUSTER BACKGROUND

 

In many respects, Blockbuster was formidably positioned in the market at the end of 2003. It

 

owned a 45% market share which was more than three times larger than its next largest

 

competitor. The company dominated the video rental market with 5,703 stores across the United

 

States and another 3,197 around the world that generated revenues of $5.9 billion (see Exhibit 3)

 

and cash flow from operations of $594 million. It was a premier brand with significant

 

resources.

 

In 2003, 77% of Blockbuster?s revenues were generated from the rental of VHS tapes, DVDs

 

and video games. Included in rentals were the late fees charged for products not returned by a

 

particular date. Total rental revenues were essentially flat from 2002 to 2003 despite a net

 

increase of 198 stores. DVD rental revenues grew 49.3% which made up for a 34% decline in

 

VHS rental revenues. It was the first year in which DVD rental revenues exceeded VHS

 

revenues. Merchandise sales represented 22% of revenue and grew by 25% over the prior year.

 

The company noted in its 2003 Annual Report that ?a significant and growing market for online

 

rental subscription services has developed which has had and could continue to have a negative

 

impact on our business. Online subscription, however, also provides us with a significant

 

opportunity for growth.?

 

Blockbuster went on to outline the objectives behind their internet strategy.

 

We intend to be aggressive with our online initiatives [in 2004], as we believe

 

[them] to be a good strategic extension for us and should complement our storebased subscription programs. We expect this service to ultimately drive store

 

revenues by not only attracting new customers who want the convenience that

 

both online and store channels provide, but also by bringing back customers who

 

we have lost to competing online rental services. Our brand, database and

 

distribution network?should enable us to have a substantial advantage over

 

existing competition.3

 

3 Blockbuster 2003 Annual Report, p. 29 Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 7 Blockbuster also expected to incur ?significant? start up costs and anticipated that this

 

investment would lead to operating losses in the online division during 2004 and 2005.

 

The impact did not seem to deter them. The annual report went on to state: ?We are

 

determined to gain appropriate market share in the online rental subscription business,

 

regardless of the expected negative short-term impact on our operating results.? 4

 

A CLOSER LOOK AT THE BATTLE

 

When Blockbuster launched its online service, it reproduced Netflix?s site design wherever

 

possible. Hastings observed, ?It was a pretty faithful copy. The queue, the visual layout, the

 

business model, marketing, the pitch, everything the consumer sees they copied reasonably

 

well.? Yet, although the site appeared world-class, it did not initially function at that level.

 

Users frequently complained that Blockbuster Online was slow, deliveries took several days,

 

and titles were often out of stock or hard to find. One customer and industry commentator noted

 

?A quick test of Blockbuster?s web site revealed some serious deficiencies. Searches for movies

 

I rented [easily] from Netflix came up empty. When I keyworded other titles, the site coughed

 

up no less than 40 choices. Life is too short to spend all that time scrolling.? 5

 

Netflix managers expected Blockbuster to have initially executed better. Blockbuster hired

 

Accenture to build and manage its website because the firm had significant experience building

 

eCommerce sites. While Accenture did not have previous experience with online rentals, it had

 

faced fulfillment issues with many other clients. In addition, Blockbuster was the premier movie

 

rental company and was perceived as knowing the business inside and out.

 

The Netflix management team began to wonder whether Blockbuster was really such a critical

 

threat. Blockbuster had not been able to copy Netflix?s proprietary logistical software because it

 

was not publicly visible. Even though Blockbuster was much larger than Netflix, its online

 

division did not have Netflix?s scale. Ultimately, ?we underestimated them and said ?they?re not

 

serious,?? remembered Reed, ?We thought ?They only have 23 distribution centers. We have

 

30.??

 

Yet, Blockbuster did turn out to be a serious competitor. Using Netflix?s own ?look and feel,?

 

Blockbuster quickly added new subscribers. When Netflix proactively cut its prices from $21.99

 

to $17.99 to retain market share, BBI immediately countered by dropping its prices from $19.99

 

to $17.49. The price war and the impact it had on margins led shareholders to start defecting.

 

?The investors were freaked out,? Reed remarked. ?Our stock traded down to $10 per share

 

from a peak of $39.?

 

Analysts turned up the volume on their concerns that Netflix would be trounced. ?It hit us hard,?

 

Reed said. ?Blockbuster rapidly grew to 5% of the market, 10% of the market, 15% of the

 

market.? By December 2004, Blockbuster had narrowed the gap by opening 23 DCs in the

 

United States compared to Netflix?s 30 DCs. Blockbuster made good on the threat of leveraging

 

its network of stores. Online customers were given two coupons for in-store game or movie

 

4

 

5 Blockbuster 2003 Annual Report, p. 10

 

The Chicago Sun Times, December 19, 2004, ?Great American Success Stories,? Lloyd Sachs Purchased by: Kim Nguyen KN62093N@PACE.EDU on February 23, 2014 Netflix E238 p. 8 rentals each month. The chain also began running tests in small markets to use its stores as minidistribution centers. ?Customers can choose to rent online or go to a nearby Blockbuster to get

 

the titles they want.? One Blockbuster executive explained. ?They can also trade-in movies and

 

games and receive a credit of $8 for use in store or online.? 6 Hastings and his team considered

 

whether cutting prices again was their only option for long-term survival.

 

FINANCIAL IMPACT ON NETFLIX

 

Netflix took full advantage of the limited direct competition between its IPO and Blockbuster?s

 

entrance into the market. Revenues grew 77% from $152.8 million in 2002 to $270.4 million in

 

2003 (see Exhibit 5). Netflix had a strong balance sheet with almost no debt. Gross margins

 

exceeded 33% in 2003 and the company projected net income of $100 million for 2004.

 

Unfortunately, competing with Blockbuster had a materially adverse financial impact. Actual

 

2004 net income of $21.6 million was well below expectations and at the end of 2004, Netflix

 

forecasted a $15 million loss for 2005. Dropping prices to fend off Blockbuster had clearly

 

taken a toll. ?The price war is a reflection of the fact that it?s not just some tiny little dusty

 

corner of the business,? said a Forrester Research analyst. Industry pundits commented that the

 

innovator?s edge Netflix previously enjoyed could quickly erode as the seemingly deep-pocketed

 

Blockbuster copied much of the experience.

 

Yet, not every development was negative. Prior to competing with Blockbuster, Netflix added

 

630,000 customers in 2003 and ended the year with a total of 1.5 million subscribers. When

 

Blockbuster launched its online DVD rental service in 2004, Netflix acquired 1.1 million new

 

subscribers for a total customer base of 2.6 million (see Exhibit 6). The gain was not

 

exclusively due to reduced subscription prices. Blockbuster?s ubiquitous marketing campaigns

 

increased general awareness for online DVD rentals, which benefited Netflix as well.

 

BLOCKBUSTER RAISES THE STAKES

 

At the end of 2004, Blockbuster issued back-to-back press releases regarding two major

 

initiatives designed to further raise the stakes with Netflix. On December 14, Blockbuster

 

announced the elimination of late fees on movies and games beginning on New Year?s Day.

 

John Antioco, Blockbuster?s CEO noted, ?As of the first of the year, if our customers need an

 

extra day or two with their movies and games, they can take it. Late fees are a thing of the past

 

at Blockbuster.? 7 Late fees had been the leading source of customer dissatisfaction with the

 

video rental industry since the mid-1990s. By doing away w...

 


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