Trends in the Video Streaming Industry: Netflix Analysis

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22nd Mar 2019 Finance Reference this

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Abstract

This paper examines the current statues and trends within the video streaming on demand industry and specifically the well-being and performance of Netflix Inc. Along with examining Netflix Inc this paper looks at the overall competitive market and discusses key elements within the industry and Netflix Inc’s primary competitors. By analyzing both the internal and external environment as well as the overall industry this paper looks to present adequate recommendations for Netflix Inc moving forward within the industry.   

Executive Summary

Netflix Inc. is the primary leader in the home video entertainment market. With its first mover advantage in both the home delivery model and video on demand Netflix has positioned itself to be the industry leader. Through constant improvement and innovation Netflix has maintained its competitive advantage and continues to be the hallmark of excellence within the industry. In this analysis I examined the overall industry as well as the different competitors and threats present to Netflix. Currently Netflix is in a period of unprecedented competition and pressure from both government and industry forces.

Financial Analysis

Netflix has been outperforming its prior year statements consistently over the past several years. Over the course of the past 3 years Netflix has generated more income and has produced an increase in earnings per share. Between 2016 and 2017 Netflix’s net income has increased a total of 100.02%. In addition, Netflix is currently trading at $190.12 as of December 16, 2017. This is a substantial difference from the earnings per share (eps) of Netflix from 2016 which had a basic eps of .44 compared to 2017 which it is at .87 basic eps. These two-metrics lead to the conclusion that Netflix is performing well within the industry, and will see continued success and growth for the coming years.

However, since 2016 Netflix has had a decrease in total revenue from $8,830(m) in 2016 to $8,406(m) (Nasdaq) in 2017, which is a difference of $424,000 (-0.048%). This may lead some potential investors to worry about the financial health of the firm however those who have concerns likely have not taken the firm’s consistent quarterly gains into account. This decrease may be due in part to the accounting report not considering seasonal subscribers during the holiday period as well as a delay in reporting metrics from international markets. The overall financial health of the firm can be best seen in Table 1 regarding the balance sheet. Since 2016 Netflix has reported a 22.04% increase in total balance sheet, meaning the company has increased total assets and market value by almost a quarter of its previous years value.

Netflix has maintained its positions as the industry leader for a variety of reasons. By being both the first major DVD mail delivery and video on demand streaming service, Netflix has capitalized on its industry advantage. Competitors entering the market have had to work hard to differentiate and move away from being labeled as a cheap alternative to the premium Netflix service. When compared to its primary competitor, Hulu, Netflix has consistently outperformed the firm in almost every segment. While Hulu is not an individual publicly traded company, each of its primary owners – 21st Century Fox, the Walt Disney Company, and NBCUniversal – have allowed the company to license and utilize the resources each of these independent firms possess. Regardless of these exclusive assets, Netflix continues to outperform its competition, as seen in Table 2.

Internal Analysis

Primary Activities: Netflix has three reportable segments: Domestic Streaming, International Streaming, and Domestic DVD. The domestic streaming revenues is entirely from monthly membership fees for streaming content services to members in the United States. The international streaming service revenues consist solely of membership fees from consumers outside the United States. The domestic DVD derives its revenues from membership fees for services only for DVD-by-mail members within the United States.

  • Inbound Logistics. Netflix is responsible for receiving the newest movies and storing physical copies. Because the company does not work face-to-face with customers it is important that inbound channels be reliable and efficient. Netflix’s primary inbound activities are broken down into three main segments: video streaming, DVD distributions, and original content production.

Video Streaming: Netflix’s video streaming service has evolved considerably since the introduction of the service. Netflix originally utilized large data centers spread throughout the country to store and distribute the content to subscribers.  However, now Netflix uses the Amazon Web Service public cloud system. This new system allows Netflix to manage the storage and processing requirement of its subscribers with more fluidity to best adjust to market demands. This content is stored across hundreds of individual machines and server rooms.

DVD Distribution: Netflix operates 58 warehouses nationwide which serve roughly 10.6 million subscribers. The returned discs are sorted and inspected manually. Employees at each of these warehouses open the returned disc envelopes, pull the disc from its sleeve and inspect the disc for cracks or scratches, clean the disc, inspect the sleeve, and finally insert the disc back into its sleeve. The disc is then filed into the appropriate bin – either accepted discs or damaged/misplaced discs.  After the manual sorting process is complete the bins are taken to a machine scanner. After this process is completed discs are readied to be shipped to new consumers when the title is requested.

Original Content Production: Netflix has arranged several multi-year deals with media production companies. Each of these deals involve dozens of studios and production companies who are responsible for creating and producing original content. To begin production of any original show or movie, Netflix’s team of production managers and studio executives review and agree to purchase the licensing and distribution rights of a specific title, leaving the content creators to produce the product with the backing of Netflix’s assets. Once into production the individual studios create the series or movie, and finally Netflix is the sole outlet for video distribution.         

  • Operations. Netflix must ensure that all customers are satisfied and happy with the titles and content they are receiving as well as the quality of the service they expect to receive. Currently Netflix’s most vital and costly operating procedure is maintaining the infrastructure needed to handle the large amount of data needed to deliver across the internet to provide seamless streaming of high quality videos to its subscribers. Through partnerships with Amazon, Netflix has adopted a cloud computing framework to facilitate its distribution of streaming content. However, Netflix still maintains a production department which has distributed ownership to its engineering team, with each team responsible for coding, testing, and resolving any issues on their own work. Through these engineering teams, Netflix has developed tools necessary to monitor and provide insight to detect, diagnose, and resolve technical and customer problems.
  • Outbound Logistics. Each of Netflix’s distribution centers are responsible of receiving packaged and finished products (DVDs/ Blue-Rays). These distribution centers must meet the customers’ needs in a timely manner. Netflix employs a FIFO inventory storage system using an electronic organization system to know where different DVD titles are located around the country (Borrelli). Once titles are received and sorted, they are repackaged, scanned, and labelled. At this point the titles are ready to ship to new consumers. Through the utilization of this method much of the Netflix’s library of content is consistently moving in and out of the distribution centers.
  • Marketing & Sales. Netflix efficiently employs all available mediums and methods to increase market awareness and sales. To acquire the greatest level of market saturation and maintain sales growth, Netflix has priced its service competitively across the industry.

Pricing: Netflix utilizes a monthly membership subscription for both its streaming and DVD delivery service.

DVD/Blue-Ray Rental: Netflix offered 3 plans for their DVD/Blue-ray rental service:

Starter: The first plan offered for disc rentals, this plan is priced at $5 monthly subscription or $6 for Blue-ray rental. This plan allows for a total of 2 discs to be rented out per month and only one disc to be rented at a single time.

Standard: The second plan offered for disc rentals, this plan is priced at $8 for monthly DVD rentals and $10 for Blue-Ray rentals. This plan allows for unlimited monthly rentals however it is limited to one disc to be rented at a single time.

Premier: The final plan offered for disc rentals, this plan is priced at $12 for monthly DVD rentals and $15 for monthly Blue-ray rentals. This plan allows for unlimited monthly rentals and is the only plan which allows for two discs to be rented out at a single time.

Video Streaming: Netflix currently offers several plans for its video streaming service. Netflix bases its price structure around the number of screens one account is authorized to use at one time. 

Basic Plan– The most basic plan offered by Netflix allows for one screen to be used and is priced at $7.99 per month.

Standard Plan– The most popular plan offered, it allows for up to two screens to be viewed simultaneously and is priced at $10.99.

Premium Plan– The most expensive plan offered, this plan allows for up to four screens to be viewed simultaneously and is priced at $13.99.

Promotion: Currently Netflix runs a variety of promotional campaigns as a part of its promotional mix. Netflix’s primary promotional tool is its 1-month free trial program which it uses throughout its promotional and advertising campaigns. In addition, Netflix utilizes social media influencers as well as other media platforms such as podcasts to spread promotional codes to prospective consumers to entice them to try the service for a limited time. This is intended to hook the participants with the hope of them becoming a lifelong subscriber.

Adverting: Netflix advertises through a variety of mediums. Through their free trial system Netflix aims to acquire new members and maintain their membership through their extensive catalog of content. The most successful advertising system for Netflix has been their consumers own desire to share expresses and discuss content with fellow Netflix users. Much of Netflix’s advertising expenses consist primarily of payments made to company partners which include device partners, mobile platforms and ISP’s, and promotional activity such as digital and television advertising.

  • Service: The service provided by Netflix relies entirely on the consumer’s interaction with either a website, app, or other device platform’s ability to access and reliably run the program. To better manage customer expectations, Netflix has created different tools which it uses to work to resolve customer issues and ensure adequate levels of customer satisfaction.

Through its video streaming and distribution service Netflix place’s a high level of importance on its customer service department as well as employee training program for both warehouse and corporate employees. In addition, Netflix places importance on ensuring that customers consistently return. To accomplish this goal, Netflix has implemented an automated system which notifies members whenever new or relevant content is added. These tailored messages ensure that members are always attracted back to the service. Because of the lack of face-to-face interaction with customers, Netflix must focus heavily on its customer service program.

 (B) Support Activities

  • Firm Infrastructure. Founder and CEO Reed Hastings has shaped Netflix to have a laid-back corporate culture which allows employees to work at their own pace. Netflix includes a variety of perks to motivate their employees such as allowing employees to structure their own compensation packages, no dress code, and having unlimited vacation days for salaried employees. These perks are intended to motivate employees to do their best work and innovate while on the job. Through the creation of this ideal workplace, Netflix employees are granted an environment to succeed and if employees fail to reach requirements, Netflix offers large severance packages.
  • Human Resource Management: Netflix currently employs approximately 4,700 total employees. About 3,500 were full time with the remaining 1,200 categorized as temporary employees. Netflix employs a five-tenet principle in its hiring process created by Reed Hastings and Patty McCord, former Chief Talent Officer from 1998-2012 (McCord).

Hire, Reward, and Tolerate Only Fully Formed Adults: This first tenet focuses on only hiring individuals who rely on logic and common sense. The company focus its hiring efforts only on individuals which demonstrate adult-like behavior, which means the ability to talk openly about issues with managers, colleagues, and subordinates as well as the ability to work on a case-by-case basis.

Tell the Truth About Performance: Netflix has removed any form of formal review process and has instead asked managers and employees to have conversations regarding each other’s performance as part of their everyday work. Netflix believes that traditional corporate performance reviews are led by fear of litigation because if an employee is removed there must be evidence of a history of poor performance to validate the decision.

Managers Own the Job of Creating Great Teams: Netflix has taken a unique approach to its philosophy that mangers should follow when creating teams as well as its compensation philosophy for new hires. Managers are encouraged to form teams following their own ideals of what is needed for the team rather than what is available for them currently. This management philosophy required a change in Netflix’s compensation philosophy. New hires and employees were given the option to choose how much of their compensation would be in the form of equity, rather than the traditional stock option on top of a competitive salary. This flexibility directly relates to the other tenant of hiring adults, as Netflix believes that employees can weigh the risk and benefits of these options.

Leaders Own the Job of Creating the Company Culture: Through the development of different companies within different industries, company cultures shift from industry to industry. In a large tech driven company such as Netflix corporate leadership is responsible for molding the culture throughout the company as well as being aware of the subcultures that may require unique individual management techniques.

Good Talent Managers Think Like Businesspeople and Innovators First, and Like HR People Last:  This point focuses on the ability for HR personnel to work within the business departments rather than as a supplement to the overall company. Netflix focuses its HR personnel to be integrated into each department while also working to innovate the HR policy and structure to continually best fit the company’s objective and culture.

  • Technology Development. Netflix’s basic operating procedures revolve around its DVD mail delivery system and its video streaming infrastructure. Each of the company’s main activities utilize different procedures and technology to accomplish its main objective: provide consumers with their entertainment seamlessly and quickly.

DVD Delivery: To maintain inventory, Netflix utilizes a J.I.T (Just In time) inventory system that utilizes machines to scan returned and inspected DVDs. Netflix originally used primarily human capital to sort and package its DVD inventory, however today only the sorting and inspection is done manually with the inventory scanning and product packaging being fully automatic. Netflix uses proprietary machinery to accomplish its sorting and packaging requirement.

Video Streaming: Netflix is responsible for streaming to up to 50.85 million subscribers in the United States alone. To be able to manage this massive amount of content demand, Netflix utilizes Amazon’s Web Service cloud computing service to store and distribute all its digital content. By moving its streaming infrastructure to the Amazon service Netflix has allows its development teams to focus entirely on the user interface and features available to the customers. To accomplish these new user improvements Netflix has developed several proprietary software systems used for the development of its user interface such as Titus and Fenzo.

  • Procurement. Netflix procurement process focuses mostly on licensing content and producing original content. Regarding licensing content, Netflix must reach agreements with movie production companies for both older and newer releases. Netflix must reach agreements with the dozens of video streaming device manufacturers such as Microsoft, Apple and Roku for members to access all the content. Each of these manufacturers must be compatible with the current software and programming language used by Netflix as well as maintain constant updates for each device. When working on updating or expanding their client relationships, Netflix must consider the limitations of each of the devices in which its service is present.

External Analysis

General Environment: Netflix operates within the jurisdiction of the Federal Communications Commission (FCC). Currently, Netflix must abide by the regulatory ruling outlined within the Net Neutrality communications protocol. Net Neutrality outlines and “Open Internet” scheme to the entirety of the internet.  This communications protocol prohibits ISPs (Internet Service Providers) from “throttling” or manipulating the speed of internet users to specific website or online services. The protocol allows all internet users to have equal access to any site. In recent news, the FCC is currently going through the process of voting to repeal Net Neutrality. The current chair of the FCC, Ajit Pai, plans to repeal Net Neutrality and reclassify internet service providers as “information services” which would allow unrestricted domain to limit internet access to all users within the United States. Without the protection of Net Neutrality, ISPs can charge a premium to access specific sites with a more reliable and quicker connection called “fast lanes”. Until this vote is finalized Netflix provides its service equally on almost all streaming devices except mobile devices.

Competitive Market

The competitive market of the industry consists of a highly specialized and limited group of sellers providing and attempting to acquire a constantly diminishing population of potential consumers. This forms a marginally competitive market where providers are vying for competitive advantage. One of the main causes of this level of competition is due to the highly homogenous nature of the service. Each of the providers that compete against Netflix provide a similar service of comparable quality. However, one of the main factors that impact the competitive ability of the firms is the specific service content each have acquired through licensing deals.

Each of these firms have acquired different licensing deals and content from a variety of providers which are exclusive to each streaming service providers. According to Hub Research (Figure1), 14% of all respondents of a survey conducted said they are subscribed to all three-streaming service which they categorized (Hulu, Amazon, and Netflix). This is more than a double the number which responded the same in 2016 at 6% (Minsker). In addition, 45% of Netflix users said they added Hulu and 33% said they added Amazon Prime Video for a greater content selection. Because of these content gaps among providers, each consumer looks to fill them with competing firms. This causes each of the sellers to be close approximations or near perfect substitutes for one another.

In addition to the homogenous nature of the industry each of these firms capitalized early adoption and were able to circumvent barriers which presented themselves when entering the market. Previously one of the major barriers to enter the industry was the infrastructure needed to maintain the massive number of services needed to house and stream all the content. With recent technological advances, however, both content providers and creators can enter the industry with increased ease. Moreover, many consumers feel it necessary to be subscribed to certain services because there exists a “Network effect” surrounding the unique content created and the impact some of this content has on social media and pop culture. In this regard Netflix holds a steep competitive advantage through its catalog of well-regarded and critically acclaimed Netflix original content which have had a unique impact on the public lexicon and culture.

The 5-forces model

Effect of Threat of Entry:  The home video entertainment industry is segmented between consumer groups and therefore product differentiation is minimal. Competitors are only capable of differentiating themselves through select means such as the device that the content is delivered to. The video on demand market is a collection of distributors in which the market share is measured by their distribution effectiveness. This is an important aspect when measuring the threat of entry. Netflix currently operates within an ever-increasing competitive base spanning several different segments. Each of these competitors utilize different business models that implement different technologies to satisfy market demand. Currently there are no government barriers to entry which allows for virtually no bureaucratic issues when attempting to enter the industry.

Effect of Supplier Power: Supplier power is weak because industry incumbents need to establish and maintain relationships with a select number of suppliers to compete in the industry. Most of the suppliers in the industry are traditional film production companies such as Universal, Warner Bros, and Sony Pictures. Supplier power is also under threat from the ability of forward integration of industry incumbents to establish their own customer base and distribution channels as well as in-house production capabilities.

Effect of Rivalry: Rivalry in this industry is strong because of the sheer number of competitors within the industry. Each of these competitors normally specialize in one channel of distribution to acquire specialized licenses with film studios and production companies. Within this industry, competitors are incentivized to stay because of the moderately high exit barrier. The exit barriers are due to the use of long-term assets and inventories to maintain the catalog of content needed to satisfy consumer demand. Because of the need to maintain this catalog, capacity within this industry is updated through small measured increments which can lead to lower fixed costs. As new technologies begin to disseminate into the industry, variable costs will drop which will boost fixed costs and in turn make rivalry increasingly fiercer and less favorable.

Effects of Buyer Power: Buyers within this industry have little power and are of little or no threat to industry members. Because of the lack of product differentiation and almost no switching costs, consumers can access titles however they choose. Firms within this industry must differentiate their product to capture different consumer segments based on each segments preference for how they consume their media.

Effect of Substitutes: Consumers are unlikely to seek out substitutes because they are interested in watching TV programming and movies as their main form of entertainment. Consumer do have options of whether they decide to consume this form of media with substitutes such as existing electronic entertainment options such as live sports and video games. However, due to the increased use of electronic media devices, video on demand services seem to be situated in an ideal position with limited substitutes.

Identification of the firm’s strategy and its competitors’ strategies

Recommendation

Content Providers: Since entering the industry, Netflix has remained committed to being the largest and most varied selection of titles of any firm within the industry. Increasing the number of online media partnerships would be beneficial for both parties involved. The continued expansion of its media catalog should be a primary focus for Netflix moving forward. Maintaining its position of possessing the most varied and exclusive collection sets Netflix apart from the rest of the industry.

International Growth: With the increasing level of competition and therefore market and industry saturation, it is in the best interest of Netflix to pursue international expansion. It is recommended for Netflix to expand primarily in Europe where there is the greatest potential to garner a large audience. This recommendation should be considered for a long-term movement into the international streaming segment. Along with expanding their catalog of content, Netflix must consider region-specific content when expanding internationally.

Recommended Strategy

  • Increase content partnerships domestically to generate greater consumer value for their service. Partnering with more exclusive content creators as well as generating unique and original content will better differentiate the Netflix platform from its competitors.
  • Expand international operations to include and stream as much of the Netflix catalog as possible to the largest amount of countries possible. 

The strategy that may have the best market penetration and lead to the largest amount of company growth is to increase the amount of content partnerships and exclusive original/limited content. By differentiating its product to possess content only available via Netflix, the company will distinguish itself from its competitors and provide a product that is exclusively unique and inimitable from its competitors both domestically and internationally. By focusing on streaming, Netflix will lower its operating costs because it will not need to focus on DVD/Blue-Ray distribution across different distribution channels in the different operating nations as well as lower licensing costs to third-party producers.

Table 1.  Change in Financials

Table 2.  Common Size Statements of Case firm and closest competitor for 2017

Figure 1

Bibliography

Borrelli, C. (2009, August 04). How Netflix gets your movies to your mailbox so fast. Retrieved December 18, 2017, from http://articles.chicagotribune.com/2009-08-04/entertainment/0908030313_1_dvd-by-mail-warehouse-trade-secrets

McCord, P., & Charan, R. (2016, June 27). How Netflix Reinvented HR. Retrieved December 18, 2017, from https://hbr.org/2014/01/how-netflix-reinvented-hr

Minsker, M. (2017, August 03). Netflix Users Look to Amazon Instant Video and Hulu to Fill Content Gaps. Retrieved December 18, 2017, from https://www.emarketer.com/Article/Netflix-Users-Look-Amazon-Instant-Video-Hulu-Fill-Content-Gaps/1016285

Perlberg, S. (2015, April 16). How Netflix Is Shaking Up Its Marketing Strategy. Retrieved December 18, 2017, from https://blogs.wsj.com/cmo/2015/04/16/netflix-marketing-strategy/

Board of Directors Committee Composition https://ir.netflix.com/committees.cfm?bio=8238

Allen, G., Feils, D., & Disbrow, H. (2014). THE RISE AND FALL OF NETFLIX: WHAT HAPPENED AND WHERE WILL IT GO FROM HERE? Journal of the International Academy for Case Studies, 20(1), 135-143. Retrieved from https://search.proquest.com/docview/1647822304?accountid=10216

Wagner, D. (2006). Throttling the customer. MIT Sloan Management Review, 47(4), 10-11. Retrieved from https://search.proquest.com/docview/224962553?accountid=10216

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