10/14/2011

Netflix

Remember when Blockbuster and Hollywood Video began to look more like a ghost town than profitable businesses? The speed at which these businesses went from dominating the market to closing their doors was almost alarming. While some believe it had more to do with"inertia", I would contest game changing technology—in this case—multiple new technologies; elasticity of demand; and change in consumer tastes were all major contributors to Blockbuster and Hollywood Video's inability to compete.

Netflix picked up considerable market share by offering DVD’s via mail, and providing movies that can be streamed on their website. Redbox built upon existing technology (vending machines) and applied them to the movie rental market. Why was this combination so potent to the traditional main street movie store? Beyond the introduction of new technology, these new companies had much less overhead to contend with, and in Netflix's case, a compressed distribution chain and favorable economies of scale were also at work. Maybe most influential was the price. These business models proved to be efficient, and allowed them to offer movies at a much lower price; waiting in line for 20 minutes on Friday night (despite the cool posters and popcorn) was no longer appealing when we could pay a quarter the price with almost zero wait time.

Netflix may have forgotten how it captured as much of a market share as it has: price and flexibility for the consumer. Netflix recently increased their price from $9.99 (for online streaming and DVD by mail) to $7.99 for each. Obviously, management believes their demand to not be overly price elastic (meaning they know it is not inelastic), and will therefor not experience too many lost subscriptions. However, if they are wrong, they may have jumped into a conundrum. The most profitable arm of Netflix is the streaming side of the house, yet they cannot grow the streaming division without additional quality content. Thus far, their streaming service has provided inferior movies and release dates, but compensated by offering documentaries, and TV shows that are not usually offered in a Redbox. Initially they even made things worse by making it more complicated for customers to order movies by dividing the streaming and mail order sites into two different businesses. Of course this was short lived and Netfilx has done an about-face by announcing they will keep both services on one site. Still, are re-runs and old movies enticing enough to compensate for higher prices and lack of flexibility? Can re-runs and dated movies grow subscriptions? If they do not grow their subscription base, content providers become less willing to provide the additional content needed to grow. According to Jason Gilbert of the Huffington Post, Starz, a content provider for over a 1000 online Netflix movies, will not renew their contract for 2012 so Netfilix will have to fill its content with less re-run friendly networks such as the CW.

If the elasticity of quantity demanded is greater than management believed: Netflix subscriptions will continue to fall and they may have just given the increasing number of substitutes available a chance at substantial market share. Management would do well to remember what made them successful in the first place.

10 comments:

Gunny said...

Netflix made the decision to spin off and separate their DVD service in order to focus better on their streaming service. Netflix can make this decision work if they actually improve their streaming service. Focusing on streaming will help give them a competitive advantage in this market. This is contingent upon landing new contracts and getting movies and TV shows available quicker. If they don’t improve their content then this will be their demise. From the sounds of it they are already losing streaming content by losing Starz. An increase in price and a decrease in quality is a perfect way to decrease your demand. Netflix better have some tricks up their sleeve or they will be joining Blockbuster and Hollywood Video in bankruptcy.

Mitchell Stone said...

It seems like there was not enough research done into this strategic change of direction for Netflix. In comparing the costs to the company, I would guess that the cost for better market research would be much less than customers leaving because they are frustrated, marketing costs to promote the new services, and the PR costs spent defending their decision. It goes to show that there are many other factors other than elasticity to consider when making strategic decisions in a business.

Dr. Tufte said...

-1 on Joe for spelling.

I have commented a bit on Netflix elsewhere on this blog, so let me talk about video stores here.

I wonder if this is also a case of an industry not understanding what they were selling. Superficially, video stores are selling a movie experience. I wonder about this: movie experiences still sell.

Think about it: Blockbuster lost business on both ends - to Redbox with less variety and to Netflix with more variety. What's up with that? If you think about it, Blockbuster was kind of like a local library: not really competitive with your friend who can pass on a small number of books (like Redbox) or with Amazon.

In sum, I wonder how much of Blockbuster's problem was an insidious increase in costs, without an increase in revenue.

But, what's wrong with that? Why doesn't it work? I think there are a couple of reasons. First, few people checked out all the movies from Blockbuster, or books from the local library. To me, this suggests that this is a durable good, who's demand can be "played out" by poor management. Second, what both Redbox and Netflix have eliminated is the heartache of aisle wandering. I think most people, within a year or two of frequenting video stores, started to spend a lot of time wandering the aisles: looking for new movies to rent, or to be available. This was time that was costly to consumers, and that they are glad to avoid at Redbox and Netflix. How many times did you spend 30-40 minutes looking for a 90 minute movie to watch. Was it worth it?

With reference to Mitchell's comment about elasticity, I think your vision of what an elasticity can be is too limited. We can have an elasticity with respect to anything ... it's just a matter of measuring it and talking about it. So if you talk about the effects of alternative variables being important, there is only an elasticity that isn't apparent if you haven't gone out and measured it.

Jack said...

Netflix online streaming is going down hill with the loss of Starz. They are already struggling with offering any kind of new material to watch.

Many have switched to putting several movies on there blue ray or portable hard drive. Where they can have the latest movies without having to pay the Netflix cost for outdated movies.

The bottom line is that Netflix needs to innovate and increase there online library. Simply because people that have had Netflix for a while have probably watched everything worth watching. They need to constantly be getting new inventory online. If they can achieve this they will succeed. If they don't then why pay for outdated movies?

Kevin said...

I really don't think this was the best move, but maybe Netflix is saving millions by not mailing movies. All I know is that I have been watching their stock, and it is definitely not reflexive of a good move. This past Tuesday the stock opened at nearly 37% less than the previous close ($118.84 down to $74.90). I personally do not subscribe to Netflix because I don't watch $7.99 worth of movies each month. Hulu and Redbox are great competitors, and I get all my media fill through them.

I will say that in order to stay a competitor in the media market, product adaptation is a must. I love how Blockbuster has a few movie boxes like Redbox and some local grocery stores. They've tied a knot at the end of the rope are are hanging on for dear life. It is difficult to keep the competitive advantage in an electronic world that changes daily.

Lando said...

One of the issues with the Netflix company is that streaming has become an open commodity market. Of course there are restrictions and rights to each movie administered or sold by the producer. However, we have more fresh companies coming up in this industry that also offer movie streaming, such as Hulu. This creates price erosion as companies begin to bid competitively on the best price required by the consumer. Though this is an opinion, Netflix did not lose power and market share solely on the division splits and price increases. Demand may be driving elsewhere because the consumer can stream in so many more places now. For example, remember when DVD players came out and cost an arm and a leg? There was not enough being produced or demanded to drive down prices. Until more companies mass produced DVD players these prices stayed high. As the competitiveness came into play, prices were driven down, and today you may buy a DVD player for $20. As streaming becomes more widely used and supplied by online companies, streaming prices may drop out of sight as companies bid competitively on this streaming market. I believe this is one of the reasons that Starz decided not to do business with Netflix as Gunny has stated.

Dr. Tufte said...

-1 on Kevin for a grammatical error.

Joe said...

Lando I agree.

Not only was the increase in price and the splitting of the two divisions the cause for the “Netflix Exodus” (as it has come to be called), but the number of suppliers for online streaming has also increased. I don’t think that this was the primary reason though, rather I think it may be the long-term issue Netflix has to deal with. Your observation makes Netflix management’s decision all the more curios—why would they take a strategic "u-turn” when they clearly dominated the mail order market? The only reason I can think of is that mail order is simply not cost affective and they wanted to sell it. But if that is the case, it seems that retaining the mail division (even if that division was taking a loss) and keeping it bundled with the streaming division would have been a better choice. Doing so would have differentiated them from other streaming suppliers and allowed them to build their streaming division to the point that it was the dominating equivalent to the mail order division. This would have been the opportune time to sale the mailing division—they clearly mistimed it. All of this is of course speculative because I don’t know the internal numbers but as it stands today, Netflix may now be experiencing a type of death spiral. I think they will be okay, just not the dominating force they could have been.

Brandon said...

As Joe and Lando have pointed out, Netflix clearly dominated the mail order market for DVDs. So unless the mail order service was actually unprofitable, it doesn't make a lot of sense that they would try to spin-off their successful DVD mail order service for the chance at trying to become one of the major providers of streaming movies online.
I believe that this makes Joe's statement about how Netflix may be suffering from some sort of a death spiral to be somewhat appealing. Another fact that seems to support this problem of an increase in Netflix's internal costs was brought up in this week's Bloomberg Businessweek issue (Oct. 31 - Nov. 6). Netflix, which has already lost over 800,000 customers in the U.S. due to the frustration of the aborted attempt to split the company, is predicting even more cancellations due to an increase in the price of services. Even though they overturned their decision to split the company into two different entities, they are still going to raise the price of their services. This seems to show that if Netflix had simply left things as they had been, they would have come across a similar issue in the future of having to deal with declining revenue numbers. This makes me think that Netflix's mail order service must not have been doing as well as we originally thought.
Also, if both divisions were profitable, then why didn't Netflix simply ask their customers which service they prefer to use more and build off of their customer's comments?

Dr. Tufte said...

-1 on Joe for multiple grammatical errors.

I think Joe is right, and I like Brandon's editions: this whole thing is fishy. Is Netflix actually doing worse than we think?