Summary of the Article
Anders Bylund’s article in The Montley Fool titled “What is Netflix, Inc.’s Competitive Advantage?” provides a key understanding of Netflix today. The article reviews the gains and the valuation ratios of Netflix’s business growth and provides insight into the business growth strategy of Netflix. The article mentions three key components of company’s success. These components are investing cash into content development, developing high quality content, and providing an easy to use Netflix platform. The article further expands on investing cash into content development by putting larger portion of its total content budget into the original TV shows and movies. The idea here is to build a content portfolio of lasting value by spending large amount of money that should keep subscribers hooked for future years. Additionally, the author suggests that Netflix is developing high quality content by building up Netflix original TV shows and movies with industry leading directors and actors. Finally, the author states that the easy to use Netflix platform is the subtlest aspect that makes Netflix special by giving it a simple interface whether it is being accessed from a smartphone or laptop or big TV screen. Taking off the online Ads from the website has removed the distraction for the viewers making it simpler to use.
The author concludes that these three components are the winning strategy for Netflix to grow its online streaming membership business while the competition focuses on add-on revenue streams.
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Netflix’s Business Overview
Netflix, Inc. is an internet television network with more than 117 million streaming memberships worldwide with access to 140 million hours of TV shows and movies including documentaries, original series and feature films. The company launched its streaming services in 2007 which has experienced growing consumer base with the acceptance of the delivery of TV shows and movies over the internet. Their strategy is to grow the streaming membership business globally by expanding their streaming content and improving their user interface.
Netflix’s primary competition includes other entertainment video providers, such as multichannel video programming distributors (MVPDs), internet-based content providers, video gaming providers and DVD retailers and more broadly against other sources of entertainment. To strive against these competitors, they are improving their service by improving technology and content which is exclusive and curated.
Netflix’s Strategy Overview
Netflix believes that internet entertainment is replacing linear TV entertainment. The company’s opinion is that while consumers love their TV content, the consumer behavior is changing from linear TV entertainment towards an internet based on-demand content delivery model. This shift in consumer behavior is also leading to a shift in the entertainment industry as world's leading linear TV networks now offer their programming on-demand through apps that run on phones and smart TVs. The company believes the consumers will utilize the apps that are modern and easy-to-use, while other apps will lose viewing and revenue. As internet data transmission speed and reliability increases, more consumers will switch to internet-based content.
Netflix uses the flat-fee unlimited viewing commercial-free subscription model. The subscription is tiered based on the number of simultaneous viewers but there are no other restrictions on the amount or content. This simple model results in easy to subscribe membership which is preferred by customers.
Netflix also believes that consumer taste is diverse even within the same market. The company has therefore developed a platform that quickly identifies the user taste and recommends content based upon user taste. The company licenses content for a specified amount of time, which may include multi-year exclusive subscription video-on-demand (SVOD) for a given title. The content licensing market has a lot of licensors and licensees. This leads to competing bids for exclusive SVOD rights from various cable networks, broadcast networks, and online video competitors. Since 2013, Netflix has increased its focus on developing its own content which is exclusively available on Netflix. This content development provides economies of scale as content can be developed based on user preference. Additionally, Netflix’s own content is available for new viewers even years after the content is published.
The largest proponent for the change in consumer behavior from traditional cable or satellite dish subscription to internet-based model is the access to high speed internet via internet service provider (ISP). As consumers want to utilize the access to internet they reduce cable cost by “cord-cutting”. Netflix works with hundreds of large and small ISP to directly interconnect with the Netflix network for free in regional locations rather than incur increase costs with third-party transit providers. In some regions, large ISPs such as Verizon and Comcast, usually charge Netflix for interconnection to the network. Netflix therefore supports strong network neutrality which reduces costs for Netflix and all ISPs. MVPDs that have internet-capable TV set top device usually offer integrated viewing experience with Netflix to increase the consumer usage of set top device.
Netflix’s competition is with a lot of entertainment service providers including, but not limited to, linear networks, pay-per-view content, DVD watching, other internet networks, video gaming, web browsing, magazine reading, video piracy, etc. Additionally, other content developers also increasingly building their own app-based membership service to capture the service membership. These platforms, such as HBO Go and Showtime Anytime, are increasing in direct competition with Netflix to capture the consumer subscription.
Porter's Five Forces Analysis of Netflix
While Netflix can be regarded as an industry leader for internet entertainment company and Netflix can also be regarded as a leader within the entertainment industry, the company does face all of Porter’s five forces within the market place. Further analysis on each of the five forces are provided below:
Threat of new entrants:
The threat of new entrants within the internet-content delivery industry is existent and expanding as content developers create their own apps to host their own content. Netflix understands that having consumer driven proprietary content will differentiate it from the competitors. Netflix also faces similar strategy being used by other content owners such as HBO, Amazon, and Showtime. Therefore, it’s a key strategic goal for Netflix to keep developing new and attractive content which keeps the existing customers happy and attracts new customers, and to distinguish Netflix from new competitors. Netflix also helps build its own brand as it develops its own content. Consumers know that many series titles, such as House of Cards, Stranger Things, and others, are available only on Netflix. As consumers understand and prefer Netflix content, more new members join to view only Netflix content, thus helping the company with brand recognition.
Netflix also benefits from economies of scale compared to new competitors in the market. First, Netflix has developed an easy-to-use platform with sophisticated algorithm that identifies taste for members. While this is a differentiator for Netflix, it is also a proprietary tool that competitors will need time and years of compiled consumer data to develop a similar platform. Therefore, it is more cost effective for Netflix to manage its platform compared to a competitor to build a new one. Secondly, Netflix has built a substantial content development segment. In 2018, Netflix spent $12 billion on original content. Netflix won four Oscars awards in 2019 (“Netflix's 4 Oscar wins solidify the new normal in Hollywood”, February 25, 2019). While Amazon Studios is fierce competitor, Netflix has proven to its competitors that it has a strong content development segment.
Threat of substitutes:
Netflix has developed itself from a substitute to linear TV to a leader in internet-based entertainment. During this time, Netflix has maintained its prices for members as it knows that consumers are price sensitive to any sudden price hikes. This has provided Netflix with loyal consumer base and word of mouth marketing. As the internet speed and access is provided at a cost-effective solution, there are significant competitors to Netflix. While these competitors are fighting with Netflix to garner a member base, they are not direct substitute to Netflix. Given Netflix’s cost-effective membership prices, the only real substitute is illegal piracy and peer-to-peer sharing. While a lot of budget-minded consumers will identify illegal piracy and peer-to-peer sharing as an option, most consumers will opt to pay for the service given its relative low cost. Should this membership cost rise, consumers will be more open to using illegal services.
While Netflix understands that there are many options for consumers to choose when it comes to entertainment, Netflix wants to be a leader in internet-based entertainment. Therefore, Netflix must be competitive with other content developer as well to build quality level programming. Should this quality drop in appreciation, then Netflix would be a cheaper quality to other content developers such as HBO and Amazon Studios.
Bargaining power of customers:
Consumers in the current entertainment industry have tremendous bargaining power over Netflix and other entertainment providers. Under the new cord-cutting phenomenon, consumers want two things from their entertainment companies, no contracts and low monthly fees. Netflix has been the leader in helping consumers optimize their internet-based entertainment and helping them ‘cut their cord’ with the cable companies such as Verizon and Comcast. While Netflix has helped start this phenomenon, other content providers are bringing their own subscription-based content app and membership such as Amazon Prime Video, HBO Go, Showtime Anytime, etc. Memberships to these content apps and websites have similar pricing structure to Netflix and can be enrolled monthly without any contract. This provides a market share that is fluid and dependent on the level of content provided. Consumer that subscribe to a given service and are unsatisfied with the service will have the flexibility to switch to a different service within a short timeframe.
Netflix’s strategy to gain and keep the market share is to develop its own content that is unavailable on rival’s app or service. Creating this content and having a strong following among Netflix’s consumer will provide Netflix with a bit more leverage over the consumers compared to pure online content distributors. The reason behind this is that consumers who are hooked on to shows, like House of Cards and Strangers Things, will keep their subscription on rather than switch it on and off. This also provides Netflix with a clear understanding of consumer behavior of current and historical Netflix customers compared to new customers. Therefore, Netflix can cater to their own market share without easily losing it.
Bargaining power of suppliers:
There are two areas where Netflix is a buyer and cannot commend a significant power over the seller. First, regional and large ISP have a significant power over Netflix. With the dismissal of Net-neutrality laws by the Federal Trade Commission (FTC), regional and large ISP can charge, and price discriminate against Netflix for this interconnection fee. While Netflix likes to work with small and large ISP to reduce the network costs, regional and large ISP that have monopoly within some markets will charge fees that are discriminatory against Netflix. Given that there is no other alternative for the connection to the network, Netflix pays these fees to ISP to provide access to all members and customers. Second, Netflix has built a large segment for content development. While this segment is being developed, actors, directors, writers, and other professionals in the entertainment industry has a union. While Netflix pays these professionals based on market level, the unions could decide to walk-out or create a strike for higher pay. Since these actions cannot be controlled by Netflix, it can be argued that the costs of content development can be increased or decreased based on compensation agreements with the actors, directors, writers and other professionals.
Competitive rivalry:
Netflix has a significant competitive advantage over other internet-based entertainment companies. This advantage is fueled by Netflix’s spending on original content development and its increased push to gain a larger and more decisive market share of the entertainment industry. While this strategy is sustainable for the short-run, it can be difficult to sustain such large expenditure with cash for the long-run. This will push Netflix to update and modify its strategy to a more efficient model. Netflix knows that this market is competitive and that new entrants will further create an ongoing market share battle for existing customers. Content which has been created benefits Netflix as it is an asset, but this content will depreciate over time as viewers are less likely to keep their subscription for old content. One thing is for certain, as cord-cutting phenomenon is increasing, more content providers will encroach on Netflix’s market share creating more competition.
Value Chain Analysis of Netflix
While Netflix is a service-based entertainment company, it still faces significant amount of value chain activities that are vital for the company’s growth and sustainability. Further, Porter’s value chain analysis on Netflix’s primary and secondary activities is provided below:
Primary Activities:
Netflix’s inbound logistics include intellectual property on original content developed and licenses on third-party content. Netflix’s operations include daily management of website and operational activities such as coding, development, and management of website. Outbound logistics include providing consistent streaming services and managing the connection to ISP networks. Netflix manages marketing and sales by managing promotions with partners, running advertisements and providing trial subscription to new customers. Netflix’s service includes providing seamless streaming and viewing services to its members via the internet.
There are two main primary activities that are significant for Netflix. First, is the operation of the streaming services for members. This is by far the key aspect of the Netflix’s primary activity. Netflix wants seamless viewing and streaming for members. This includes streaming on apps, phones, and via the website. Netflix therefore allocates a significant amount of time to reduce outages and issues. They also need to invest in customer services to assist with operational and technical issue with the service. The other significant primary activity is sales and marketing. Given that customers need to be hooked onto Netflix’s original content as soon as they cord-cut, its important that customers are hooked via advertising of Netflix’s content. Therefore, sales and marketing play a key role in increasing the membership subscription for Netflix.
Secondary Activities:
Netflix’s firm infrastructure is built around the streaming service. The platform provides a strong infrastructure to the user and a seamless streaming delivery tool. Netflix’s human resource management must maintain a strong team of developers and content producers. As the platform runs on algorithm, Netflix invests heavily on technology development related to the platform and the algorithm. Netflix procumbent includes procure licenses for content, developing new original content and managing relationships with ISP providers.
There are two secondary activities as well that are significant for Netflix. First, is the development and maintenance of the platform. Netflix has developed and easy-to-use platform with a state-of-the-art algorithm that helps suggest content to users. While the infrastructure for the platform a capitalized cost, the ongoing development of the platform and the algorithm is a long-term activity for Netflix. This is a vital activity to differentiate Netflix and help Netflix grow. Secondly, the significant amount of cash used to develop in-house original content is a large activity for Netflix. While the sustainability of this activity for the long-run is heavily debated, the company has confirmed that it plans to make original content development a core part of the company’s long-term objective. While other secondary activities are important, these two secondary activities are core part of Netflix’s long-term growth plan.
Conclusion on Company Impact
Netflix’s opportunity to stay competitive by developing its Netflix’s original content is key for Netflix’s future. While all of Porter’s five forces are applicable for Netflix, Netflix’s strategy currently wants to focus on two, threats of new entrants and competitive rivalry. Netflix knows that new entrants will enter the market, so they must make their platform the most state-of-the-art to attract customers. To be competitive, Netflix is focused on content development as it wants to stand out as the industry leader in content development.
Recommendation
While Netflix’s strategy is currently effective as both its old and new customers are happy with the content. The key question is how long Netflix can afford to invest in new content. Currently, the operating margin of Netflix has been maintained despite large amount cash being used. But in the long term this may not be feasible. Netflix should therefore have a strategy to retain the customers without using so much cash for content development. One option by which Netflix can reduce its cost for content development is to have exclusive partnership with current content developers. This will help mitigate risk and reduce cash outflow. As defining a new strategy may be a complex issue, the company and the shareholders are content with the current strategy.
Works Cited
- Bylund, A. (2018, July 21). “What Is Netflix, Inc.'s Competitive Advantage?” Retrieved February 17, 2019, from https://www.fool.com/investing/2018/07/21/what-is-netflix-incs-competitive-advantage.aspx
- “Long-Term View”. Netflix, Inc. Retrieved from https://www.netflixinvestor.com/ir-overview/long-term-view/default.aspx
- Netflix, Inc. (2018). “2017 Annual Report”. Retrieved February 23, 2019, from https://www.sec.gov/Archives/edgar/data/1065280/000106528018000069/q4nflx201710k.htm
- “Netflix's 4 Oscar wins solidify the new normal in Hollywood”. (2019, February 25). Retrieved February 26, 2019, from https://finance.yahoo.com/news/netflix-wins-4-oscars-roma-cuaron-and-period-end-of-sentence-124918844.html
Summary of Terms
- multichannel video programming distributors (MVPD): a service provider that delivers video programming services based on a subscription fee.
- subscription video-on-demand (SVOD): a service that gives users unlimited access to a wide range of programs for a monthly flat rate.
- internet service provider (ISP): a service provider that provides services for accessing, using, or participating in the Internet.
- linear TV: real time television services that transmit content based on a schedule. Usually referring to broadcast TV service.
- cord-cutting: the consumer pattern under which consumers cancel their subscription to linear TV services available over cable for rival media available over the Internet.
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