© 2013, published by Flat World Knowledge 4-1 Information Systems: A Manager’s Guide to Harnessing Technology, version 2.0 John Gallaugher

© 2013, published by Flat World Knowledge Published by: Flat World Knowledge, Inc. © 2013 by Flat World Knowledge, Inc. All rights reserved. Your use of this work is subject to the License Agreement available here No part of this work may be used, modified, or reproduced in any form or by any means except as expressly permitted under the License Agreement. 4-2

© 2013, published by Flat World Knowledge Chapter 4 Netflix in Two Acts: The Making of an E-Commerce Giant and the Uncertain Future of Atoms to Bits 4-3

© 2013, published by Flat World Knowledge Learning Objectives Understand the basics of the two services operating under the Netflix business model Recognize that the firm has experienced wild swings in market perception and stock performance as it attempts the difficult transition from relying on a model that may soon be obsolete to one that may hold promise for the firm’s long-term viability 4-4

© 2013, published by Flat World Knowledge Introduction Netflix started as a DVD rental business – Known for best-in-class service Netflix rightly surmised that digital streaming is the future Firm was split into two – Internet based streaming services – Traditional DVD by mail services 4-5

© 2013, published by Flat World Knowledge Introduction Transition from a DVD based service to Internet based video streaming business resulted in: – Drop in customer base – Drastic fall of share prices To bring back profits, the firm: – Aggressively expanded the firm’s customer base, both domestically and internationally – Sponsored the creation of critically acclaimed, original content 4-6

© 2013, published by Flat World Knowledge Learning Objectives Recognize the downside the firm may have experienced from an early IPO Appreciate why other firms found Netflix’s market attractive, and why many analysts incorrectly suspected Netflix was doomed Understand how many firms have confused brand and advertising, why branding is particularly important for online firms, and the factors behind Netflix’s exceptional brand strength 4-7

© 2013, published by Flat World Knowledge Learning Objectives Understand the long tail concept, and how it relates to Netflix’s ability to offer the customer a huge selection of movies Know what collaborative filtering is and in what ways this software helps Netflix garner sustainable competitive advantage Describe the sources of Netflix’s size advantage in the DVD-by-mail business, and how this large scale is a difficult-to-create asset for any start-ups trying to compete in DVD-by-mail 4-8

© 2013, published by Flat World Knowledge Learning Objectives Understand the role that scale economies play in Netflix’s strategies, and how these scale economies pose an entry barrier to potential competitors Recognize how Netflix built a data asset and why this asset was so valuable in the firm’s original business model Understand the role that market entry timing has played in the firm’s success 4-9

© 2013, published by Flat World Knowledge Netflix: Going Public By going public, Netflix had to disclose its financial position – Resulted in two big competitors entering the market Blockbuster and Walmart Netflix maintained its lead in the market having: – Constant customer and revenue growth – Record profits – Rising stock price 4-10

© 2013, published by Flat World Knowledge Brand Strength Brands are built through customer experience – Walmart and Blockbuster could create brand awareness but couldn’t translate that into an industry advantage Netflix remained segment leader as it had: – An early market entry – Effective execution 4-11

© 2013, published by Flat World Knowledge Scale from the Distribution Network and Selection Netflix’s nationwide network of automated distribution centers collectively delivered DVDs overnight to a large percentage of the population Netflix’s advantage came from the scale of the firm’s entertainment selection Long tail: Large selection of products or content beneficial for Internet retailers – Selection attracts customers – Internet allows large-selection inventory efficiencies that offline firms can’t match 4-12

© 2013, published by Flat World Knowledge Figure The Long Tail 4-13

© 2013, published by Flat World Knowledge Customer Base Scale economies can be attained by leveraging the cost of an investment across increasing units of production Having a bigger customer base enabled a firm to: – Have better cost structure – Have better profit prospects – Offer better pricing 4-14

© 2013, published by Flat World Knowledge Leveraging the Data Asset User data can be leveraged to provide better customer experience and build brands Netflix uses a proprietary recommendation system called Cinematch – Cinematch - Software technology known as collaborative filtering Collaborative filtering: Classification of software that monitors trends among customers and uses this data to personalize an individual customer’s experience 4-15

© 2013, published by Flat World Knowledge Leveraging the Data Asset Data provided by Cinematch is a switching cost – Churn rate: Rate at which customers leave a product or service Advantages of Cinematch – Netflix could tailor recommendations based on availability of products – Studios found an audience for their back catalog of movies and television shows 4-16

© 2013, published by Flat World Knowledge Learning Objectives Understand the shift from atoms to bits, and how this is impacting a wide range of industries Identify how digital products differ from physical products and specify how the streaming business is substantially different from the DVD-by-mail business Know the methods that Netflix is using to attempt to address these differences Understand how the “First Sale Doctrine” applies to physical versus virtual products 4-17

© 2013, published by Flat World Knowledge Learning Objectives Understand key terms such as windowing, fixed versus marginal costs, and bandwidth caps Discuss how Netflix is attempting to create competitive advantage through catalog offerings despite not being able to secure a longest tail Identify opportunities for Netflix to further strengthen and leverage its data asset, and detail how the asset can offer the firm competitive advantage 4-18

© 2013, published by Flat World Knowledge Learning Objectives Understand that while scale in DVD-by-mail differs from scale in streaming, some scale advantages may be achievable Recognize how Netflix made streaming widely available on products offered by many different consumer electronics firms and why the Netflix approach offers advantages over offerings from Apple or other consumer-electronics firms 4-19

© 2013, published by Flat World Knowledge Learning Objectives Identify the major issues driving what is widely considered to be a disastrous rollout and recall of the Qwikster service, and intelligently discuss options that may have limited the fallout in transitioning the firm’s business Describe crowdsourcing and discuss the positive benefits from code contests that Netflix has conducted 4-20

© 2013, published by Flat World Knowledge Atoms to Bits Idea that many media products are sold in containers for bits Shift from DVD-by-mail to the streaming business poses new challenges for Netflix – Content availability – Content acquisition costs – Potential opportunities for revenue and expansion – Potential partners – Competitors and their motivation 4-21

© 2013, published by Flat World Knowledge Content Acquisition First sale doctrine - Ruling that states that a firm can distribute physical copies of legally acquired copyright-protected products – Allows firms to lend or rent products – Applicable only to the atoms of the physical product and not to the bits needed in streaming Windowing - Content is available to a given distribution channel for a specified time window – Under a different revenue model 4-22

© 2013, published by Flat World Knowledge Figure Film Release Windows 4-23

© 2013, published by Flat World Knowledge Original Content Netflix is combating rivals with exclusive content by offering exclusive content of its own – Acquiring or developing original content is an expensive proposition – It can give a firm exclusive first-window streaming rights 4-24

© 2013, published by Flat World Knowledge Streaming and the Data Asset User data is used to: – Make accurate recommendations – Improve user interface design – Help the firm determine the appropriate cost for acquiring content – Shape creative decisions in original program offerings – Make better content investments – Inform the original content investments that Netflix is making – Create ultra-tailored audience promotions 4-25

© 2013, published by Flat World Knowledge Figure Top 100 Most Popular Movies and Television Shows on Netflix and Their Availability on Major Streaming Competitors 4-26

© 2013, published by Flat World Knowledge Getting Netflix Everywhere Netflix wanted its content to be available on television – Set top box was developed, but wasn’t practical enough Software platform was developed and made available to manufacturers – Made it easier to build apps – Allows it to be baked directly into consumer electronics products 4-27

© 2013, published by Flat World Knowledge Risks Involved With Streaming Streaming based business needs a robust and reliable infrastructure Internet service providers (ISP) are placing bandwidth caps – Bandwidth cap: Limit imposed by the ISP on the total amount of traffic that a subscriber can consume 4-28

© 2013, published by Flat World Knowledge Future of Netflix Shift from atoms to bits is a hybrid transition taking place over several years – Quick shift - Loss of customers – Slow shift - Rivals move into the market Options to stay afloat – Grab compelling content at manageable costs – Broaden distribution options – Grow its customer base Lock them in with the switching costs created by Cinematch 4-29

© 2013, published by Flat World Knowledge Netflix DVD-by-Mail versus Streaming 4-30 Netflix DVD-by- Mail Netflix Streaming Content acquisition costs FixedVariable and increasing CompetitorsMostly vanquishedMany with different models Competitor motivationMarket has little appeal for new entrants Maturing tech firms see It as a growth market PlansFixed price per monthUnlimited monthly subscription InnovationVery limitedOpportunities for new content and revenue models

© 2013, published by Flat World Knowledge Netflix DVD-by-Mail versus Streaming 4-31 Netflix DVD-by- Mail Netflix Streaming AvailabilityAny DVD that can be purchased Limited to what studios license Delivery infrastructureTough to duplicateCurrently uses public cloud Delivery toAny device with a DVD player Any network-connected screen with a Netflix client Global expansionExpensive to replicate infrastructure Can be served from the cloud Market outlook/ challenges Mature and likely to decrease Growing but highly unpredictable