Subject is Business: EXTERNAL FACTOR ANALYSIS SUMMARY (EFAS), must stay in the same time period as the case
Case 15 Netflix, Inc. The 2011 Rebranding/Price Increase Debacle Alan N. Hoffman Bentley University In 2011, Netflix was the world’s largest online movie rental service. Its subscribers paid to have DVDs delivered to their homes through the U.S. mail, or to access and watch unlimited TV shows and movies streamed over the Internet to their TVs, mobile devices, or computers. The company was founded by Marc Randolph and Reed Hastings in August, 1997 in Scotts Valley, California, after they had left Pure Software. Hastings was inspired to start Netflix after being charged US$40 for an overdue video.1 Initially, Netflix provided movies at US$6 per rental, but moved to a monthly subscription rate in 1999, dropping the single-rental model soon after. From then on, the company built its reputation on the business model of flat fee unlimited rentals per month without any late fees, or shipping and handling fees. In May 2002, Netflix went public with a successful IPO, selling 5.5 million shares of common stock at the IPO price of US$15 per share to raise US$82.5 million. After incurring substantial losses during its first few years of operations, Netflix turned a profit of US$6.5 million during the fiscal year 2003.2 The company’s subscriber base grew strongly and steadily from 1 million in the fourth quarter of 2002 to over 27 million in July 2012.3 By 2012, Netflix had over 100,000 titles distributed via more than 50 shipment centers, insuring customers received their DVDs in one to two business days, which made Netflix one of the most successful dotcom ventures in the past two decades.4 The company employed almost 4100 people, 2200 of whom were part-time employees.5 In September 2010, Netflix began international operations by offering an unlimited streaming plan without DVDs in Canada. In September 2011, Netflix expanded its international operations to customers in the Caribbean, Mexico, and Central and South America. Key to Netflix’s success was its no late fee policy. Netflix’s profits were directly proportional to the number of days the customer kept a DVD. Most customers wanted to view a new DVD release as soon as possible. If Netflix imposed a late fee, it would have to have multiple copies of the new releases and find a way to remain profitable. However, because of the no-late-fee rule, the demand for the newer movies was spread over a period of time, ensuring an efficient circulation of movies.6 On September 18, 2011, Netflix CEO and co-founder Reed Hastings announced on the Netflix blog that the company was splitting its DVD delivery service from its online streaming service, rebranding its DVD delivery service Qwikster as a way to differentiate it from its online streaming service, and creating a new website for it. Three weeks later, in response to customer outrage and confusion, Hastings rescinded rebranding the DVD delivery service Qwikster and reintegrating it into Netflix. Nevertheless, by October 24, 2011, only five weeks after the initial split, Netflix acknowledged that it had lost 800,000 U.S. subscribers and expected to lose yet more, thanks both to the Qwikster debacle and the price hike the company had decided was necessary to cover increasing content costs.7 Despite this setback, Netflix continued to believe that by providing the cheapest and best subscription-paid, commercial-free streaming of movies and TV shows it could still rapidly and profitably fulfill its envisioned goal to become the world’s best entertainment distribution platform. Online Streaming By the end of 2011, Netflix had 24.4 million subscribers, making it the largest provider of online streaming content in the world.8 Subscription numbers had grown exponentially, increasing 250% from 9.3 million in 2008. At the same time, Netflix proactively recognized that the demand for DVDs by mail had peaked, and the future growth would be in online streaming. With 245 million Internet users in the United States, and 2.2 billion9 worldwide, Netflix saw the opportunity to expand its online streaming base both domestically and internationally to become a dominant world player. In 2011, Netflix expanded into Canada and Central America, and in 2012 into Ireland and the United Kingdom.10 The scarce resource for the online video industry was bandwidth, the amount of data that can be carried from one point to another in a given time period.11 With the introduction of Blu-ray discs, the demand for higher- and better-quality picture and sound streaming increased, which in turn increased the demand for higher bandwidths. At the same time, cheaper Internet connections and faster download speeds made it easier and more affordable for customers to take advantage of the services Netflix and its competitors offered. If the cost of Internet access was to increase, it would directly affect sales in the industry’s streaming segment. Netflix was a leader in developing streaming technologies, increasing its spending on technology and development from US$114 million (2009) to US$258 million in 201112 (8% of its revenue),13and initiating a US$1 million five-year prize in to improve the existing algorithm of Netflix’s recommendation service by at least 10%. Because Netflix had already developed proprietary streaming software and an extensive content library, it had a head start in the online streaming market, and with continued investments in technological enhancements, hoped to maintain its lead.14 However, increased competition in streaming, ISP fair-use charges, and piracy were some of the major challenges it faced. In March 2011, Netflix made its services readily available to consumers through Smart-phones, tablets and video game consoles when only 35% of the total U.S. market were using Internet-enabled Smartphones.15 Thus, the expansion potential for Netflix in this market was substantial. The Great Recession of 2008–2010 was a boon for Netflix as people cut down on high-value discretionary spending, choosing “value for money” Internet offerings instead.16 However, in its annual letter to shareholders, Netflix acknowledged that many of its customers were among the highest users of data on an ISPs network and in the near future it expected that such users might be forced to pay extra for their data usage, which could be a major deterrent for the growth of Netflix because most of its customers are highly price sensitive. Demographics The number of Internet users in the United States had increased from about 205 million in 2005 to 245 million in 2012.17 According to a research report by Mintel investment research database, the percentage of people using the Internet to stream video has jumped from 5% (2005) to 17% (2011), significantly growing the market for online streaming services such as Netflix. At the same time, the recession of 2008–2010, with its high unemployment and slow economic growth had a significant impact on the spending habits of U.S. consumers. More and more people chose to forego an evening at the movie theatre in favor of home movie rentals to save on costs.18 By 2011, the crucial 18- to 34-year-old demographic saw the Internet as its prime source of access to entertainment. However, this demographic, was particularly sensitive to price fluctuations. When Netflix changed its pricing structure in the third quarter of 2011, subscriptions immediately dropped off 3%. Mintel Research reported that only 15% of the under 18–25 age bracket of its customers were ready to pay US$16/month for premium content via Netflix. In addition, the proliferation of free content over the Internet—Mega video, for example, with around 81 million unique visitors and a maximum exposure in the 18–33 demographic became a strong competitor for Netflix, further limiting the pricing power Netflix could exercise.19 The Mintel report also found that American households with two or more children and a household income of US$50,000 or more had a very favorable attitude toward Netflix;20 Netflix fostered this trend by cutting a deal with Disney21 that gave it access to content exclusively targeting young children. At the same time that Netflix was increasing its customer base among the 18- to 34-year-olds and households with young children, both of whom preferred streaming, it lost ground with affluent Baby Boomers who still preferred to rent the DVDs over the Internet. Thus, Netflix needed to fine-tune its strategy to include this older demographic since people over 60 had US$1 trillion in discretionary income per year, and fewer familial responsibilities, making them a prime target demographic for expanding Netflix’s customer base.22 The availability of high-speed Internet at home and the shift to online TVs created opportunities for Netflix. The company recognized that to fully leverage the current world of technological convergence, it needed to compete on as many platforms as possible, and created applications for the Xbox, Wii, PS3, iPad, Apple TV, Windows phone, and Android. The company also collaborated with TV manufacturers to integrate Netflix directly into the latest televisions.23 Netflix’s Competitors Netflix’s great operational advantage in the DVD rental market was its nationwide distribution network, which prevented the entry of many of its potential competitors. While only Netflix provided both mail delivery and online rentals, with the growth of online streaming, Netflix’s advantage shrank and it faced increasing competition from Blockbuster, Wal-Mart, Amazon, Hulu, and Redbox. Netflix’s one-time strongest competitor, Blockbuster LLC, founded in 1985, and headquartered in McKinney, Texas, provided in-home movie and game entertainment, originally through over 5000 video rental stores throughout the Americas, Europe, Asia, and Australia, and later by adding DVD-by-mail, streaming video on demand, and kiosks. Its business model emphasized providing convenient access to media entertainment across multiple channels, recognizing that the same customer might choose different ways to access media entertainment on different nights. Competition from Netflix and other video rental companies forced Blockbuster to file for bankruptcy on September 23, 2010, and on April 6, 2011, satellite television provider Dish Network bought it at auction for US$233 million.24 Redbox Automated Retail, LLC, a wholly owned subsidiary of Coinstar Inc., specialized in DVD, Blu-ray, and rentals via automated retail kiosks. By June 2011, Redbox had over 33,000 kiosks in over 27,800 locations worldwide,25 and was considering launching an online streaming service, perhaps for as cheaply as US$3.95 per month. Vudu, Inc., formerly known as Marquee, Inc., founded in 2004, a content delivery media technology company acquired by Wal-Mart in March 2010, worked by allowing users to stream movies and TV shows to Sony PlayStation3, Blu-ray players, HDTVs, computers, or home theaters. VUDU Box and VUDU XL provided access to movies and television shows; users also needed a VUDU Wireless Kit to connect VUDU Box/VUDU XL to the Internet. Based in Santa Clara, California, the company was the third most popular online movie service, with a market share of 5.3%.26 Vudu had no monthly subscription fee, instead users deposited funds to an online account which was reduced depending on how many movies the user rented. In other words, you paid for only what you watched. In February 2011, Amazon.com, a multinational electronic commerce company, announced the launch for Amazon Prime members