Strategic Evolution and Business Model Disruptions of Netflix

Foundations and Origin Strategy of Netflix

• The Origin Incident (1997):

  • Early one morning in 1997, Reed Hastings discovered a VHS copy of the movie Apollo 13 in his bedroom closet.

  • Upon returning the VHS tape to the rental store, Hastings learned that he owed a $\$40$ late fee.

  • While contemplating how to break the news of the fee to his wife, Hastings began imagining a superior model for at-home entertainment—one devoid of late fees that leveraged newly developed DVDs.

• Founding Principles and Strategic Framework:

  • Hastings' insight led directly to the founding of the video streaming company, Netflix.

  • Over its operational history, Netflix adopted three distinct business models.

  • Strategic decision-making relied on three core imperatives:

  • Follow the technology

  • Follow the customers

  • Follow the money (identified as the key component to any successful digital media strategy)

• Overview of Strategic Evolution Phases:

  • Business Model 1: Began as a mail service disrupting market leader Blockbuster by offering timely DVD delivery via US mail.

  • Business Model 2: Phased out physical DVDs to deliver movies and television programs directly to customer TVs or mobile devices via internet streaming.

  • Business Model 3: NextFlex transitioned into a creator and producer of digital television shows and original movies.

• Adaptive Value Proposition:

  • Hastings continuously refigured the unique value proposition offered to customers to differentiate Netflix from competitors, recover from business missteps, and avert potential operational disasters.

Disruption Phase 1: Sidelining Blockbuster and Market Entry

• At-Home Video Market Context in the Late 1990s:

  • In the late 1990s, most at-home movie watchers rented VHS cassettes from local video rental stores, such as those in large Blockbuster franchises.

  • Video stores lacked a wide selection of DVDs because consumers were deterred by the initial $\$600$ price tag of DVD players, which were introduced in the United States in March 1997.

• Target Customer Base and Delivery Proof-of-Concept:

  • Hastings aimed to appeal to a higher-income customer base consisting of early adopters of expensive new technology.

  • To test delivery feasibility, Hastings bought a collection of CDs and mailed them to himself to test delivery speed and physical durability.

  • The CDs arrived in $2$ days in perfect condition.

  • Armed with this solution, Hastings officially launched Netflix in August 1997.

• Pivot to Subscription Business Model:

  • Netflix initially struggled to retain new customers, who grew frustrated paying standard in-store rental prices for slower delivery times.

  • In response, Hastings rolled out a subscription-based service allowing customers to rent an unlimited number of DVDs for a flat monthly fee of $\$18$.

  • This pricing compared favorably to Blockbuster, where renting just $4$ DVDs during a one-month period cost a similar amount.

  • The subscription model tapped directly into customer desire to watch as much content as wanted for as long as wanted without incurring late fees associated with in-store entertainment.

• Recommendation Engine and DVD Market Expansion:

  • Netflix introduced a proprietary recommendation system that suggested older movies that were frequently unavailable at local video stores.

  • By 2000, DVD player prices dropped below $\$100$.

  • By 2003, DVD players sold for less than $\$50$ as DVDs increasingly replaced VHS cassettes.

• Financial Milestones and Scalability:

  • Netflix achieved its first operating profit in 2003.

  • Netflix went public in 2003, with its stock debuting at $\$15$ a share.

  • By 2010, Netflix surpassed $2,000,000$ subscribers and held a DVD library of $100,000$ titles.

  • In contrast, a typical video rental store maintained a library of only $3,000$ titles.

Disruption Phase 2: The Transition to Streaming and Strategic Missteps

• The Decline and Bankruptcy of Blockbuster:

  • As the price of Netflix stock climbed, shares of Blockbuster tumbled.

  • In 2010, Blockbuster was delisted from the New York Stock Exchange when its shares hit an all-time low.

  • Shortly afterwards, Blockbuster filed for bankruptcy.

• Industry Transition to Internet Streaming:

  • Customer preferences shifted away from physical mail towards watching programs delivered directly over the internet.

  • Emergence of competitors:

  • 2006: Amazon launched its streaming service.

  • 2007: Netflix introduced streaming in response to Amazon.

  • 2010 or 2011: Hulu and Voodoo were founded.

• The Unsuccessful Service Split and Library Disparities:

  • Realizing the future was online, Hastings announced in a blog post that he was separating DVD rentals from the streaming service.

  • Netflix streaming capabilities lagged significantly behind competitors:

  • Netflix possessed an extensive physical DVD library of over $100,000$ titles, but had only $2,000$ titles available for streaming.

  • Amazon offered over $110,000$ streaming titles.

  • In 2011, Amazon Prime subscribers paying $\$75$ a year could view $10,000$ of those titles for free and pay as little as $\$2$ to view other streaming titles.

• Friction and Price Hike Impacts on Subscribers:

  • To maintain access to both physical DVDs and streaming libraries, customers were forced to navigate significant structural friction:

  • Create two separate accounts with two different domain names.

  • Manage two distinct credit card billings.

  • Maintain two separate sets of ratings and preferences.

  • The service split effectively increased subscriber prices by $60\%$:

  • Prior to the split: Subscribers paid $\$10$ a month ($\$120$ a year) for unlimited access to both DVD and streaming libraries, totaling $120,000$ titles.

  • After the split: Subscribers paid $\$8$ a month for each service separately, or $\$16$ a month to retain both services.

  • Longtime customers were alienated and abandoned the service in droves, enticed by lower subscription and rental prices from competing services as well as longer availability of online libraries.

Disruption Phase 3: Original Content Creation and Value Reconfiguration

• Pivot to Original Content Production:

  • Scrambling after the public flop of the service split, Hastings sought a new approach to promote the Netflix brand by creating original content like a television or movie studio.

  • In a 2016 interview with Business Insider, Hastings admitted: "It seems crazy. At that point, we were still buying DVDs."

  • Making and owning shows was intended to give Netflix a distinct strategic advantage over rival streaming platforms.

• Critical Acclaim and Content Successes:

  • In 2013, Netflix unveiled House of Cards, an American political drama produced for $\$100,000,000$, which achieved critical acclaim.

  • Multiple original shows followed, including Orange is the New Black, which became the most popular streaming series of 2016.

• Revised Pricing Structure and Revenue Growth:

  • Netflix revised its pricing structure to offer three subscription options ranging from $\$8$ a month to $\$12$ a month, based on customer preferences for streaming video quality and the number of screens that could stream simultaneously.

  • Annual revenue rose to $\$8,800,000,000$.

  • Netflix surpassed Time Warner's HBO as the largest subscription video service.

• Original Content Investments and Millerworld Acquisition:

  • Hastings stated to CNBC that Netflix would spend as much as $\$6,000,000,000$ annually on original content to counter "awfully scary Amazon," which had also begun creating original movies and television shows.

  • In August 2017, Netflix acquired comic book publisher Millerworld to strengthen its content library and capitalize on popular characters such as Kick Ass and Old Man Logan.

• Competitive Landscape as of 2017:

  • Amazon Prime boasted more than $20,000$ TV and movie titles that Prime subscribers paying $\$99$ a year could view for free.

  • Netflix maintained $7,000$ total titles; however, it offered a higher number of television shows, and its programs earned more awards.

  • This unique value proposition centered on high-quality, award-winning programming enabled continued growth across both domestic and international markets.