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Chapter 10. Case study 10.5: Netflix: How does this movie end? Pages 715 – 719. Answer questions 1, 2, 3, and 4 on page 719. Use appropriate terminologies. Minimum required length 2 pages. (Does not include Title page, Abstract and References)
Case Study Questions
1. What are three challenges that Netflix faces?
2. What are the key elements of Netflix’s strategy today?
3. What are the implications of Netflix’s new strategy for the cable television sys-tems like Comcast?
4. Why is Netflix in competition with Apple, A
In the Netflix online television comedy-drama series, Orange Is the New Black, the lead character is Piper Chapman (Taylor Schilling), a recently engaged blond New Yorker sent to a federal prison for a crime committed years before. Critically acclaimed, and widely followed, Orange Is the New Black follows in the footsteps of Netflix’s earlier successful online TV series House of Cards, a political insider’s tale of Washington politics. House of Cards was the first-ever online television series to win an Emmy award (for best director). Orange won three Emmy creative awards in 2014. In 2014, Netflix racked up 31 nominations. Besides returning award-winning series from previous years, first-year dramas like Stranger Things and The Crown earned 32 nominations alone. Netflix is quickly becoming the non-cable alternative to cable TV. By producing its own content, Netflix is able to differentiate itself from cable TV shows and attract new sub-scribers looking for new shows, not retreads from the cable networks. However, original productions are much more expensive to produce than licensing existing content. And there are plenty of other streaming services this year with very large budgets, among them Amazon and Hulu. While Netflix does not release the number of viewers for any of its original TV shows, executives credit these shows with driving the streaming service to a record 103 million worldwide subscribers by the fourth quarter of 2016 (50 million in the United States where 60% of its subscribers come from). In 2017, Netflix operates in all foreign markets except China. Its subscriber growth rate in the United States has slowed considerably in the last few years because its market penetration is so high. Netflix shares have increased by over 8,000% since it first went public in 2002, and in 2017 its shares have advanced 36%. It is cur-rently selling at over 200 times its projected earnings, much more expensive than Google, Facebook, or other tech companies because it is still perceived as a growth company. In 2015 investors were paying 300 times earnings, so the estimates of future performance have declined. Revenues in 2016 were $8.8 billion, up 31% from 2015, but profits were a paltry $186 million, less than half the previous year. Netflix’s profit margin is 2%, far less than a retailer like Walmart (4% margin). Netflix got its start as a mail order company renting DVDs of older Hollywood movies using the postal system. Founded by two Silicon Valley entrepreneurs, Marc Randolph and Reed Hastings, in 1997, the company started by renting individual copies of 900 DVD movie titles and delivering them to customers by postal mail. In 2000, it switched to a sub-scription model where customers could receive DVDs on a regular basis for a monthly fee. By 2006, it had delivered its billionth DVD and became the largest subscription provider of DVDs. In 2007, Netflix began a video-on-demand streaming service of movies although it still retains a DVD subscription business. In 2017, Netflix is the largest player in the TV series streaming market, and consumes over 35% of the U.S. Internet bandwidth to serve its customers. Netflix is one of those Silicon Valley stories that might make a good movie, or even a television series, because of its potential for disrupting the American television and movie landscape (or what’s called premium video). It’s a dream-come-true story of accomplish-ment, pluck, innovation, and Internet technology. In a few short years Netflix created the largest DVD rental business in the country, then created the largest streaming video service. Today Netflix accounts for 50% of digital movie streaming revenues, while its chief streaming competitors, Apple (19%), Amazon (14%), and Hulu (11%), make up most of the remaining market. Netflix has created the largest database on consumer video preferences and built a recommendation system that encourages consumers to see more movies. Netflix is as much a technology company as a content company: it has developed its own proprietary video encoding system and distributes its video using over 1,000 servers in the United States located close to its customers to ensure high speed and quality delivery. Netflix discovered that older TV series had strong niche followings and built a new model of “binge watching” where consumers could watch all the episodes of a series in several sittings. Netflix has entered the content creation business by developing original TV series. For this reason, Netflix is an example of convergence in the media industry where an Internet company becomes a media content producer. Other pure media companies have taken notice and begun to develop their own streaming services, but what they lack is a database of viewer preferences that Netflix has developed over a ten-year period and which helps Netflix make recommendations to subscribers. In the movie and TV business there are only two ways to make money: either own the content or own the pipes that deliver the content. All the better if you can do both. Netflix has become recognized as an important pipeline to a very large audience. For instance, Netflix has a deal with the Weinstein Company, a major American film studio and producer of ten Academy Award films, to become the exclusive subscription TV home for the film studio’s content, beginning in 2016. This move puts Netflix into the same league of premium channel distributors and in direct competition with other cable networks like HBO, Starz, Showtime, and A&E for the rights to show movies about eight months after their theater run is complete. Netflix also has a deal with Warner Brothers to be the exclu-sive Internet distributor of the Batman prequel Gotham, and with Twenty-First Century Fox in 2016 for the FX series American Crime Story. In one possible ending scenario for the Netflix movie, the company challenges the much larger cable television industry, which is based on an entirely different technology and business model, namely, selling expensive bundles of hundreds of TV channels that few people watch, then raising monthly fees faster than the rate of inflation. In 2017 for the first time the number of people using OTT streaming services exceeded those using cable TV streaming services. Given Netflix’s large national audience of streamers, the company makes new friends in Hollywood and New York that are looking for ways to distribute their shows to a new online, mobile, and social world; Hollywood stretches the distribution window so that Internet distributors like Netflix get the same treatment as cable systems by allowing them to show the latest movies and shows at about the same time as cable systems. And the cable television industry is forced to retreat from its bun-dling practices and offer customers the ability to select just those channels they actually watch. Cable industry revenues plunge as a result. In this dream scenario, Netflix goes on to challenge the cable networks by producing its own original TV dramas, and adds comedy and documentaries to the mix. A story with a happy ending for Netflix! But happy endings happen mostly in Hollywood. The outcome of this movie depends on how well Netflix can deal with some consider-able challenges. For instance, one source of Netflix’s poor profitability is that the costs of content are very high, both purchased older series as well as new content, which is far more risky. The owners of older cable TV series and Hollywood movies charge Netflix for the privilege of distributing their content as much as they do established cable TV networks. In 2016 Netflix reported streaming content obligations to content producers of $12 billion! With $6.7 billion in gross revenue, it paid out $5.7 billion in payments to content owners (mostly cable networks) and production studios for original content. Netflix barely makes any profit. Netflix is, after all, mostly a database and delivery plat-form, and the company is in a constant bidding war with both cable and Internet giants all looking for the same thing—popular TV series with a built-in or potential audience. But content owners have wised up to the value of their backlist TV series and have raised their prices accordingly. Series just a year old are very expensive or not available. Netflix is paying hundreds of millions to Disney, Paramount, Lionsgate, and MGM to license hit shows and movies. As a result of content owners charging more for older cable shows, Netflix has taken the more risky option of developing its own original series. But this is very expensive as well. The critically acclaimed House of Cards cost Netflix $100 million for 26 episodes, $4 million an episode. Newer shows like Between, Narcos, and Bloodline are running around $20 million a season. In 2017 Netflix will spend $6 billion on new original content alone. It’s possible that Netflix does not scale, and that the more subscribers it has and the more it attracts them with original expensive content, the less profit it makes because the cost of doing business rises faster than revenue. A second challenge Netflix faces is the risk of creating new content. It’s not as if wealthy Silicon Valley entrepreneurs can fly to Hollywood or New York with lots of cash and simply purchase new content. As one pundit noted, this might lead to a mugging, but not a successful TV series or movie. Silicon Valley is generally not the place to go if you’re looking for story tellers, writers, producers, directors, talent agents, and cinematogra-phers. Algorithms don’t come up with new ideas for novels, plays, movies, or TV series, and they have not proven to be good at guessing what series will succeed in the future. Older series are proven series, and Netflix can identify which of its customers watched the series in previous years, and estimate the audience size, and whether new subscribers will be attracted by the re-plays. But when it comes to new TV series, Netflix has tried to use its algorithms to predict what new series its customers might be interested in with mixed results. Netflix has produced some real winners according to critics, but it has also produced some losers that did not get critical acclaim like Lillyhammer, Hemlock Grove, Bad Samaritans, Richie Rich, and Mitt. There has been only one tech company in history that was successful with content production for movies or television, and that is Pixar, which pioneered computer-generated animated feature-length movies. It is impossible to know how well Netflix’s original content is performing because the company refuses to release this data. Nielsen has begun a rating service for Netflix shows. This service is paid for by the content producers who will base their charges in part on how many Netflix subscribers stream their shows. While Netflix stands out as a powerful Internet brand today, Netflix has many power-SOURCES: “Disney Unveils New Streaming Services, to End Netflix Deal,” by Erich Schwartzel and Joe Flint, Wall Street Journal, August 8, 2017; “Netflix Is Winning the Streaming Race—But for How Long?,” by Mathew Ingram, Fortune, March 10, 2017; “How YouTube TV Will Stack Up In The OTT Market,” by Trefis Team, Forbes, March 7, 2017; “Netflix Fuels a Surge in Scripted TV Shows. Some See a Glut,” by John Koblinaug, New York Times, August 9, 2016; “Netflix and 20th Century Fox Television Distribution Announce First Global Agreement,” Netflix Media Center, July 25, 2016; “Netflix Stock History: What You Need to Know,” by Dan Caplinger, Fool.com, July 11, 2016; “Netflix to Be Exclusive Global ful competitors. Netflix does not have unique technology. In fact, streaming technology is widespread and well understood. The success of Netflix’s streaming model has attracted Amazon, Apple, Yahoo, Google, and content producers like Hulu and HBO to the fray. In 2017 Disney announced it was starting two of its own streaming services, and removing its content from Netflix. In 2015, Verizon announced a free, ad-supported mobile streaming service called go90, aimed at Millennials who routinely watch video on their smartphones. Some of these firms are tech firms with very large Internet audiences, strong brand names, and a good understanding of what their millions of online customers want. Apple is the leader in downloaded movies where customers own or rent movies, and of course, it owns iTunes, the world’s largest online media store for the purchase of music, videos, and TV series. HBO, founded in 1972, is the oldest and most successful pay televi-sion service in the United States with over 140 million cable TV subscribers worldwide, and the originator of a long list of highly successful original TV series and movies such as Sex and the City, The Sopranos, The Wire, Game of Thrones, and True Blood. If Netflix has a direct competitor on the creative front, it is HBO, a more traditional programmer that does not use computer algorithms to design its content, but instead relies on the hunches and gifts of editors, producers, and directors to produce its content. Netflix’s competitors have very deep pockets. This means Netflix also has competi-tors for talent and the production of new content, and perhaps price pressure as well. Along with Hulu, Amazon has emerged as the biggest competitor to Netflix streaming. For instance, Amazon offers free streaming to its 60 million Amazon Prime customers,and has taken on HBO TV series to stream to Prime customers without additional fees. Amazon has also moved into original series production with The Man in the High Castle, Transparent, Mozart in the Jungle, and others, winning 16 Emmy awards in 2016. Apple iTunes and Amazon have far larger databases of subscribers and their preferences. Google is actively pursuing long-form content creators for its video channel program. There is no cost to Google users because the service is ad supported. So another possible ending for the Netflix movie is that ultimately it can’t compete with Apple, Google, Yahoo, Hulu, and Amazon, or the content producers like CBS and HBO Now, which have started their own streaming services. Generating a negative cash flow of $1 billion a year, Netflix may run out of investors who make up the difference. Netflix can be imitated by its competitors, and its profitability reduced to less than shareholders can tolerate. Apple’s 2016 revenue was a staggering $215 billion, 30 times larger than Netflix, and it has a cash reserve of $260 billion in 2017. It is entirely within Apple’s capabilities, or Amazon’s or Google’s, and others’ to develop a competing streaming video service. Equally worrisome, major cable networks like CBS and NBC have started their own streaming networks for their original content. Netflix may have created a new world of streaming, bingeing, and content production, but it may not be able to survive the world it created. This show is not over until the last episode is finished. Stay tuned.
