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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




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: 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.?




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




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 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.?




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.




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.




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


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




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 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.




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.




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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