Entrepreneurial and Strategic Thinking

Attachments

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Videos for Use with the Netflix Case. Two pertinent videos are available to accompany your use
of the Netflix case:

A 6:32-minute video of a Bloomberg News interview with Netflix CEO Reed Hastings on

February 18, 2009. This interview covers the movie rental industry, the future of the movie

industry, and costs inherent in renting movies. It can be accessed at

http://www.youtube.com/watch?v=Z_jWgzGjkrY&feature=fvw.

1. How strong are the competitive forces in the movie rental marketplace? Do a five-
forces analysis to support your answer.

Below is a representative five-forces model of competition in the movie rental industry:

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 Rivalry among companies competing in movie rentals—a strong to fierce competitive

force that is likely to intensify in the years ahead

In assessing this competitive force, you should be directed to refer to and utilize the presentations

in Table 3.2, Figure 3.4, and the discussion on pp. 55-59 of Chapter 3.

You should conclude that rivalry among Netflix, Blockbuster, Redbox, and other movie rental

competitors (especially video-on-demand providers that stream movie rentals directly to the

renter’s TV or PC) seems destined to grow more intense. All competitors are scrambling to attract

the patronage of individuals/households that rent movies—the battle for sales revenues and market

shares is very contested and seems destined to become more fierce. Rivalry is centered on such

factors as

• Price of movie rentals (rented either individually or via a subscription plan); variety of
subscription plans to choose from.

• Convenience in renting movies (including returning rented DVDs).

• Breadth of selection (size and diversity of movie rental library).

• Availability of the DVD (are all the copies out on rental or are some available either in the

store/kiosk or in distribution inventory ready to be shipped?). Customers tend to be annoyed

when the DVD they want to rent is not immediately available.

Of course, DVD availability is not a factor when the rented movie is being streamed over the

Internet by video-on-demand providers.

• Ease of browsing through all the selections to determine which movies to rent.

• Policies and fees (if any) regarding how long the renter can keep the DVD (or view the movie

if it is downloaded or rented online).

• Advertising and promotion—Much of the advertising is being done online in the case of both

Blockbuster and Netflix; however, Blockbuster utilizes in-store promotions on a regular basis.

But the DVD rental business is not one that is a heavy user of TV, radio, and newspaper

advertising on a regular basis.

• Image and reputation.

Most movie rental competitors pursue some version of a differentiation strategy to try to set

themselves apart on the basis of one or more competitive factors.

Several factors were working to intensify rivalry among movie rental industry participants:

• All rivals are actively and busily launching fresh promotional initiatives (the free trials and

unlimited streaming at Netflix, for example) and engaging in new marketing tactics and

market maneuvers (Redbox’s rush to deploy more of its distinctive red kiosks and

Blockbuster’s initiatives to reinvent itself) to spur their movie rental revenues and build a

loyal customer base. The large number of fresh strategic initiatives on the part of various

movie rental rivals heightens rivalry.

• Low switching costs on the part of buyers—it is pretty easy for people wanting to rent a

DVD to (a) go to one store location or another to rent a DVD or (b) switch their subscription

from Netflix to Blockbuster or some other subscription service or (c) order the movie through

their cable provider or some other video-on-demand provider.

• Some rivals have utilized rock-bottom subscription rates (and free trials) and low rental fees

as a means of attracting new customers—a factor which intensifies rivalry. Redbox only

charges $1 per day for a movie DVD obtained from its kiosks. It is unclear to what extent

subscription prices might fall to the extent movies are streamed directly over the Internet

rather than being sent-and-returned by mail. Streaming delivery is undoubtedly less costly

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than DVD distribution by mail.

• Rivalry increases when one or more rivals are dissatisfied with their market position and
launch moves to bolster their standing at the expense of rivals. A case can be made that

Netflix, Blockbuster, Redbox, the cable TV companies, streaming video providers, and

Internet sites offering downloadable movie rentals are likely to make further moves to bolster

their unit volumes and market positions. All movie rental competitors seem to be actively

attempting to grow their business.

• Rivalry is likely to increase significantly as “wave of the future” video-on-demand
(streaming movies over the Internet) becomes the most common means of delivering rented

movies to individuals/households—the capability of individuals/households to watch

streamed movies without a hassle is starting to explode. Class members should (quite

correctly) see video-on-demand as a new technology-driven way of delivering movie-

viewing services to consumers—growing use of the movie-streaming channel will greatly

increase the competitive pressures on companies like Blockbuster and Redbox with brick-

and-mortar and kiosk movie rental locations. Over time, there is reason to expect that movie

rental competitors with VOD capability will take substantial sales and market share away

from most other types of movie rental providers.

• Rivalry increases as the product offerings of rivals become more standardized. We see the
differentiation between Netflix’s online product offering and the online offering of

Blockbuster as growing smaller, not larger. And, in the future, the main differentiating factor

among VOD providers will be the size and content of their respective movie libraries.

However, the image/reputation differentiation between Netflix and Blockbuster is growing

stronger, despite Blockbuster’s presence in the online movie rental business—Netflix’s

number of subscribers dwarfs that of Blockbuster’s subscriber base. And there will be

continuing differentiation among movie rental providers based on the means of delivery

(streaming versus providing a physical DVD).

On the other hand, there is at least one factor acting to make rivalry somewhat weaker—

somewhat rapid growth of the market for movie rentals, especially in the VOD/streaming

segment. Most of us are likely to take the position that the demand for VOD/streaming movie

rentals will grow briskly in the years ahead. There are already clear signs that Netflix subscribers

are shifting in greater numbers to streamed delivery as opposed to mail delivery. Rapidly growing

preferences of individuals/households toward watching streamed movies acts to weaken rivalry in

the VOD/streaming channel—but in this case, the market growth is probably not fast enough to

override all the factors acting to intensify rivalry.

We think it is hard to be definitive about just where the overall market demand for movie rentals is

in the life-cycle. The VOD/streaming rental segment is almost certainly in the rapid growth stage.

However, demand for DVD rentals at retail stores is stagnant at best and at places like

Blockbuster/Movie Gallery has been eroding rapidly—as evidenced by Blockbuster’s dismal

prospects and the recent demise of Movie Gallery. Video-on-demand has big growth potential as

of 2010 and beyond. The growth potential of renting movies from vending machines is unclear,

but would not seem to qualify as a “wave of the future” distribution channel relative to the Internet

and VOD segments. Redbox’s growth is tied to the appeal of its conveniently-located kiosks, its

$1 per day rental fee, and the decline in business at Blockbuster and Movie Gallery (some of

which can be attributed to Redbox stealing customers away from Blockbuster, Movie Gallery, and

other local movie rental stores. Thus, the overall growth prospects of the combined movie rental

segments is a mixed bag.

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Threat of entry—a weak to moderate to strong competitive force, depending on the segment or

means of distribution.

In assessing this competitive force, you should be directed to refer to and utilize the presentation

in Figure 3.5.

In 2010, the windows for entering the brick-and-mortar segment of the movie DVD rental

business and the mail-delivery subscription segment are pretty much closed. It will become

increasingly difficult for new entrants using business models like Netflix or Blockbuster or

Redbox to overcome entry barriers and capture enough business to compete profitably. And trying

to go head-to-head against Netflix (and to a much lesser extent Blockbuster) in the online

subscription segment seems unattractive as well (the entry barriers are high). We ought to

recognize that the barriers to entry into online subscription segment of the movie rental business

are moderately high for enterprises wanting to cover a large geographic area and compete on a

“national” scale:

• The costs of developing a Web site.

• Developing order fulfillment capability to equal the short delivery times offered by Netflix
and Blockbuster.

• The added investment in DVD inventories.

• Expenditures for advertising and promotion needed to draw visitors to the web site and
convert them into paying subscribers. (From case Exhibit 3, students can see that Netflix is

spending over $200 million annually on marketing.)

In the brick-and-mortar movie rental segment, there may be very limited entry opportunities for

small niche players in local markets to get into renting movie DVDs to customers living near their

store locations. It is relatively easy for a local retailer to open a DVD rental outlet and compete on

a very small scale for business within a 2-5 mile radius; but such entry poses little direct threat to

Blockbuster and Redbox (or even Netflix) as of 2010.

Clearly, the biggest entry threat into the movie rental marketplace in 2010 and beyond are

enterprises that enter the video-on-demand or streaming movie rental segment. But we think

the remaining time to enter is growing short. The most likely entry candidates into the video-on-

demand or Internet-streaming segment are those few companies that have the resources and name

recognition to compete successfully against Netflix and other present video-on-demand providers

(for instance, cable TV providers and the phone companies offering TV and other entertainment

services). The near-term entry threat from this type of competitor is relatively high (since

there are signs that VOD/Internet streaming is on the verge of exploding (many TVs and DVD

players are either Internet-ready or have built-in Internet access capability) and Google is

launching Google TV.

New entry by resource-rich companies with good name-recognition (like Google TV—which

enables household to combine their regular TV experience with the capability to access videos

anywhere on the Internet) will almost certainly trigger fierce competitive pressures as all

VOD/streaming competitors tout the merits of a movie-watching service that allow viewers to rent

movies “on-demand” and watch the rented movie directly on their big-screen TVs within minutes

of placing the order. In short, technology is advancing in a manner that makes video-on-demand

more and more feasible and more and more attractive to Netflix, other movie rental Internet sites,

cable and broadband providers, and perhaps others (including the movie studios themselves). A

variety of movie rental providers are gearing up to offer video-on-demand. The owners of

Hulu—NBC Universal; ABC’s parent Walt Disney; and Fox Entertainment’s parent, News

Corp—had announced plans to begin offering a premium service for $10 per month that would

provide a bigger library of TV shows to watch. Amazon.com might prove to be a factor in the

VOD segment.

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As more and more households sign on for broadband service and as download speeds advance,

then delivering all kinds of entertainment products via high speed Internet means will almost

certainly catch on with individuals/households. People with iPads and PCs may also become

regular users of VOD..

Hence, the entry threat into the movie rental industry should be viewed as moderate to strong, but

with time running out to enter (since it will become increasing difficult for a new entrant to

overcome the leads of the incumbent and soon-to-enter VOD providers (which now includes

Netflix—indeed, Netflix seems to be driving the transition to streaming). First-mover

advantages and late-mover disadvantages are in play here.

Competition from substitutes—a moderately strong competitive force depending on the extent to

which consumers prefer to rent movies versus seeing them at the movie theaters or buying movie

DVDs for their own personal library.

In assessing this competitive force, you should be directed to refer to and utilize the presentation

in Figure 3.6.

There are currently three principal substitutes for renting movies: (1) buying movie DVDs and/or

the DVDs of new and old TV shows for one’s own personal library, (2) watching a movie on any

of various TV channels (such as Bravo, Turner Classic Movies, HBO, Cinemax, Starz, and other

premium movie channels typically available from cable, satellite, and telecommunications

providers), and (3) seeing the desired movie at movie theaters. Buying movie DVDs has recently

become less expensive (but still not as cheap as renting a movie from any of several sources),

since the strategy of some movie makers is now to price new releases of movie DVDs low enough

to cause more and more people to buy a movie DVD rather than rent it. To a lesser extent, another

substitute is watching movies on all the various TV channels. However, the selection of movie

DVDs at retailers like Wal-Mart or Best Buy or Target is nowhere near as broad as the selection

available for rental from Netflix, Blockbuster, and other rental providers—which, for movie

enthusiasts, limits the appeal of substitutes for movie rentals.

In addition, there are hordes of entertainment substitutes for watching movies altogether—but

these other entertainment forms may not be good substitutes for people who prefer to watch

movies in their home at their own convenience and are frequent or dedicated movie watchers.

All things considered, we should conclude that substitutes for renting movies are a relatively
strong competitive force, given that

• Acceptable substitutes are readily available and competitively priced (in some cases).

• Buyer costs to switch to substitutes are relatively low.

• Many consumers are familiar with and comfortable with using substitutes (buying their own
movie DVDs, going to movie theaters, and watching movies on TV).

• There are many, many entertainment substitutes for watching movies altogether.

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The bargaining power and leverage of suppliers—a moderately strong competitive force,

depending on the type of supplier.

In assessing this competitive force, you should be directed to refer to and utilize presentation in

Figure 3.7.

We should recognize that movie studios have considerable bargaining power and leverage over

Netflix, Blockbuster, and other movie rental enterprises because of their power to heavily

influence the price and other terms and conditions under which their movie DVDs will be

supplied to movie rental providers. Movie studios are already in a powerful position to dictate the

dates when their movie DVDs will be released to all the different movie rental providers.

The movie studios will, in all likelihood, become even more powerful and able to command

higher prices in making their movies available for streaming. Netflix and other VOD/streaming

providers can expect to pay higher fees in gaining the agreement of movie studios to stream their

titles. Why? Because VOD providers will compete on the basis of having a large library of titles

available for streaming. Since the movie studios own these libraries, they will be able to secure

bigger fees in making their titles available to particular VOD providers.

Other suppliers to movie rental participants, however, are relatively weak and have little or no

bargaining power. Web site services, servers, mail services for shipping and returning DVDs, and

the services required for operating retail stores can all be obtained from a variety of sources at the

going market price.

The bargaining power and leverage of people renting DVDs—a weak competitive force

In assessing this competitive force, students should be directed to refer to and utilize the

presentation in Figure 3.8.

• Individuals have virtually no power to bargain for a lower price on movies they rent from
Netflix, Blockbuster, or other movie rental providers. They can choose to rent or not at the

going rates or to subscribe or not to one rental plan or another, but no one individual is in a

position to negotiate the terms and conditions under which he or she will rent a movie DVD

from Netflix or Blockbuster or Redbox or a cable TV company or any other video-on-demand

provider.

Conclusions concerning the overall strength of competitive forces: Competitive
pressures in the movie rental industry are pretty strong and are likely to grow stronger in upcoming

years as video-on-demand and Internet streaming become the dominant means of distributing rented

movies. Currently, we see rivalry as far and away the strongest of the five competitive forces, followed

by competition from substitutes and the bargaining power of movie studios. We see the bargaining

power of the movie studios as growing stronger as the transition to streaming accelerates.

But while collective competitive pressures are fairly strong and likely to intensify, they are now not so

strong as to prevent many movie rental companies—especially Netflix—from being profitable. Up to

this point, the movie rental companies (with the exception of Blockbuster and Movie Gallery) have

able to cope with rivalry, the bargaining power of the movie studios, and the competitive pressures

from substitutes. It would not, however, come as a shock if the bargaining power of the movie studios

begins to squeeze the profitability of VOD/Internet streaming providers as they demand bigger fees in

return for granting streaming access to the libraries of movie titles.

The dismal financial performance of Blockbuster and Movie Gallery confirm that competitive

conditions for earning attractive profits are pretty tough. Netflix, on the other hand, is doing very, very

well from the standpoints of revenue growth and financial performance. (This is true of Redbox, as

well, which is the subject of the next case)

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2. What forces are driving change in the movie rental industry? Are these driving
forces likely to have a favorable or unfavorable impact on competitive intensity
and future industry profitability?

You may want to direct students to pages 72-76 and Table 3.3 in Chapter 3 in singling out the driving

forces that are at work in the movie rental industry.

We should identify many of the following as driving forces:

Technological changes related to the Internet.

• Many TVs and DVRs were now Internet ready or had built-in Internet connectivity (which is
reflective not only of technological change but also of product innovation).

• The technology of streaming rented movies directly to big-screen high-definition TVs is
improving very quickly, thus enabling streaming and VOD to become the “wave of the

future” in delivering rented movies to viewers. Netflix is providing subscribers with unlimited

movies selections via streaming as part of its regular subscription price and the percentage of

Netflix subscribers watching streamed movies is rising briskly. For some years now, cable

and satellite TV companies had been promoting their VOD services and making more movie

titles available to their customers—their customers could use their TV remotes to place orders

and instantly watch a movie from a list of several hundred selections that changed

periodically. This technology-driven growing interest in watching VOD and streamed

movies is probably the biggest and most important driving force in the movie rental

business as of 2010.

• The number of households with high-speed broadband Internet service was growing—which
broadened the market for both VOD delivery (and Internet streaming) of movies.

• The 2009 requirement that all TV stations in the United States use digital technology and
equipment to broadcast all their programs had resulted in (a) growing consumer interest in

purchasing big-screen TVs with high-definition capability and (b) far more programs

(including movies on various movie channels) being transmitted in high-definition format.

Changes in how the product is used. There is a fast-emerging switch from renting DVDs to watch
movies to watching Internet-streamed or movies from VOD providers. This switch away from

renting a physical DVD is having and will continue to have a profound effect on the entire movie

rental marketplace.

Changes in costs

• Prices for wide-screen, high definition TVs have been dropping rapidly and picture quality
was exceptionally good, if not stunning, on increasing numbers of models—all of which has

spurred sales. Big-screen TVs enhanced the experience of watching movies at home.

• Moreover, streaming movies to subscribers is far cheaper than mail delivery/return or
operating rental locations (stores or kiosks) where customers can obtain/return rented DVDs.

Product innovation (partly driven by technological changes)

• Many new TVs were Internet ready or had built-in Internet connection capability, which
facilitated watching Internet streamed movies. In addition, increasing numbers of devices

were appearing in electronics stores that enabled older TVs to be connected to the Internet and

receive streamed movies from online providers with no hassle. Households with Internet

capable TVs were expected to become big users of streamed movies and to search out

providers of on-demand movies.

Renting a streamed movie could be done either by using the services of Netflix, Blockbuster

Online, Amazon Video-on-Demand, Apple’s iTunes, and other streaming video providers or

by using a TV remote to click to an on-demand provider of filmed entertainment (such the on-

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demand service of a cable or satellite TV provider).

• Rapid increases in the number of household having digital video recorders (DVRs) which
made it simple to record a TV program or movie and then replay it at a convenient time.

Falling prices for DVRs with Blu-ray technology were spurring sales of DVRs—which could

translate into growth in movie rentals for home viewing. In 2010 more than 85% of U.S.

households had some kind of DVD player or player-recorder. Increasing numbers of

households had Blu-ray DVD players or player-recorders; such devices enhanced the caliber

of the in-home movie-watching experience when viewing a Blu-ray-enabled movie DVD.

Growing numbers of movie DVDs were available with Blu-ray technology (usually at a

higher rental fee).

• The growing number of devices (in addition to TVs and DVRs) with Internet streaming

capability (video game consoles, iPads, iPhones, PCs, and so on)

Marketing innovations

• The push by Netflix and others to watch streamed movies rather than rent physical DVDs;

Netflix’s unlimited streaming feature is having a significant market impact.

• The recent appearance of movie rental kiosks—Redbox and Blockbuster Express

Availability and use of file-sharing programs that facilitated pirating of downloadable movies—

however, streamed movies were much harder to pirate (which resulted in movie studios more

amenable to granting movie rental providers the rights to stream a bigger portion of a movie

studios content library). Movie studios were very leery of pirating because of the resulting erosion

of sales of movie DVDs.

Conclusions: The combined impact of these driving forces in the marketplace should be analyzed
by answering three questions:

What is the likely effect of the driving forces on demand for movie rentals? We should

conclude that the driving forces will likely result in growing overall demand for movie rentals (via

either the Netflix subscription-based business model (with unlimited streaming) or via video-on-

demand/streaming technology and devices).

Are the driving forces acting to strengthen or weaken competition in the movie rental

business? The weight of evidence indicates that the driving forces will all act to intensify

competition among the various movie rental providers. All the new entrants offering

streaming/video-on-demand will be trying to wrest rental revenues and market share away from

traditional movie rental providers. The movie rental kiosks will prove to be strong competition for

Blockbuster and other local brick-and-mortar providers rental DVDs. There will be vigorous

competition across all the different distribution channels—brick-and-mortar rental stores, movie

rental kiosks, mail delivery/return of rented DVDs, Internet streaming, and VOD/pay-per-view.

Will the driving forces lead to higher profitability among the movie rental companies? We

think the best answer here is probably yes in the case of competitors with the ability to supply

movie rentals on demand via streaming/VOD technology. However, brick-and-mortar movie

rental providers are highly vulnerable to the driving forces.

The DVD rental marketplace is likely to be fast-changing for some years to come, as all the driving

forces come into play and the battle among new and existing rivals shakes out.

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3. What does your strategic group map of this industry look like? Is Netflix well-
positioned? Why or why not?

Strategic group maps are beneficial for determining relative company placement in the industry. A

good strategic group map should utilize two strategic variables that differentiate the various

competitors in the movie rental marketplace.

We can choose among any of several strategic variables to divide the DVD rental industry into

strategic groups and illustrate the different market positions they occupy. We have chosen to employ

breadth of product line (in terms of number/variety of movies offered) and the type of distribution

channel or approach to getting the movie rental to customers for viewing. Other possibilities for axes

might include scope of geographic coverage and image/reputation/brand name recognition—there is

not always one single best strategic group map.

A representative strategic group map is shown in Figure 1 (it matches what class members will be

using in the Connect-based exercise for this case).

Once we have come up with a map, then we think we should press them for their evaluation of what

we learn from the map. Any of the following questions can be posed to help draw out their views:

Which company is better positioned—Netflix or Blockbuster? (We favor Netflix because of its lead

in migrating to VOD technology and devices for delivering rented movies to subscribers.)

Which other industry members are well positioned? (Our answer is that companies with the

capabilities to be successful in the VOD channel are best positioned.)

Which industry members are weakly positioned? (Traditional brick-and-mortar movie rental stores)

Which industry members are likely to benefit from the impacts of industry driving forces? (Movie

rental providers that have strong Internet streaming/VOD delivery capabilities)

Which industry members are likely to be injured by the impacts of industry driving forces?

(Traditional brick-and-mortar movie rental stores and movie rental kiosks)

On the whole we like Netflix’s position on the map, especially since it can move vertically over time

and is rapidly enhancing its ability to migrate to an Internet streaming delivery system. However,

Blockbuster is improving its streaming/VOD capabilities, but it trails Netflix in this regard. If

Blockbuster got into VOD, it would be a potent competitor in the sense of being able to access the

casual DVD movie rental customer (via its large network of retail stores and VOD) and the heavier

movie-watching segment (via online ordering/mail delivery, Internet streaming, …

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