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
DATE : 1/29/07
(REV?D: 6/11/08) NETFLIX
?Nobody is going to come in and make Netflix obsolete.?
?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
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Purchased by: Kim Nguyen [email protected] 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
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 [email protected] 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
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.
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
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 [email protected] 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.?
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 [email protected] 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 [email protected] 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
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.
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
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
3 Blockbuster 2003 Annual Report, p. 29 Purchased by: Kim Nguyen [email protected] 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
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
5 Blockbuster 2003 Annual Report, p. 10
The Chicago Sun Times, December 19, 2004, ?Great American Success Stories,? Lloyd Sachs Purchased by: Kim Nguyen [email protected] 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…