At the time Netflix entered the market, they were a small player in what was essentially an oligopolistic market. In 1996, when Netflix was first entering the market, Blockbuster had grabbed 23% of the market share (Landler, 1996) and by 1998 this number had increased to 27%, according to Paul Kagan Associates (“The Media Business,” 1999). A 1999 Businessweek article describe Hollywood Video and Blockbuster as the “…industries Coke and Pepsi” despite the fact that Hollywood Video only garnered 8% of the market share versus Blockbuster’s 30% at the time (Browder, 1999). The rest of the market went to small, independent and regional video rental companies. By 2002, after Blockbuster began revenue sharing with movie production companies, they had between 38% and 40% of the market share (Anderson Forest, 2002). This deal made entry in the video rental industry increasingly harder for small independent mom and pop stores. During this time Netflix was a relatively unknown entity with the goal of building brand awareness and increasing profits before taking on Blockbusters market share.
Once DVD players become more common in homes, and Netflix refined and expanded their business plan, their market structure began to change. Initially, Netflix began a competitor in the Oligopolistic market structure of home video rental. Blockbuster responded to the perceived threat of Netflix by forgoing $600 million in revenue by eliminating their late fees and beginning a mail service based on Netflix’s business plan (Shih, et als., 2007). This reaction further supports that this industry was an oligopoly. These companies had interdependence on each other and responded directly to price and operational changes.
As technology has evolved and more players have gained hold in the video industry, today, this market structure is a monopolistic competition. There are several DVD rental by mail companies, several companies offering video on demand (through the internet and the television), and standard brick and mortar stores. According to the founding father of monopolistic competition, Edward Hastings Chamberlain, the factors that distinguish a market as a monopolistic competition are the competing products act as substitutes for each other, there are some but relatively few barriers to entry (licensing remains the only significant one), there are non-price differences between the companies perceived by consumers (i.e. Netflix’s recommendation software), and each company has some degree of control over pricing (Chamberlain, 1962).
The initial pricing strategy of Netflix was in line with it competitors and could be justified by early technology adopters, of DVD players, as DVDs were not mainstream and were still considered to be a “premium” product. The pricing strategy was good to initially enter the market, but once Netflix began to seriously take on Blockbuster, and DVD usage increased, it was allowed to make drastic and unique pricing changes that led to a significant increase in market share and even more important, brand awareness. The initial plan was not sustainable as consumers couldn’t justify using the internet if driving to their local store offered the same price and convenience. The shipping and handling fees combined with the added time to receive the video was stifling Netflix from expanding and appealing to the masses.
Netflix’s initial operating strategy laid the foundation for the major factors that led to the company’s success. Eliminating payroll and real estate expenses, which consisted of a significant percentage of Blockbuster’s operating expenses, was the key innovation to the Netflix business model. The inexpensive delivery costs didn’t even put a dent in the difference operations incurred between an online business and a traditional store front business.
The major downside to the Netflix model was a significant impediment in gaining more market share earlier on. Delivery time was highly regional, offering superb and timely delivery to the Northern California and North Pacific market, while the rest of the country suffered long wait times for delivery. This factor likely caused many East Coast customers to cancel as they were unable to justify using the service over running to a local video store.
Other unique attributes that Netflix offered were a large library of independent and lesser known movie titles. Netflix was able to form relationships with these distributers as they were desperately seeking distribution chains. Netflix used this extensive library to encourage video renters to expand their viewing options when new releases were in short supply by introducing them through their recommendation service. The way the recommendation service and website operated left a lot of gaps in the companies’ services though. New releases had long wait lines and as independent films were highlighted on the companies website even they began to have wait times. The inability to receive new releases, which consisted of 70% of Blockbuster’s rentals, made many customers leaves the service (Shih, et als., 2007).
As the company’s reach and brand awareness expanded, alongside the increase in DVD usage, significant changes were made to tweak the operating the pricing strategies of the business. The first major pricing strategy that Netflix made, which was significant and unique to the industry, was to eliminate late fees. Although the company first reduced subscription fees, and this may have attracted more consumers, nothing grabbed their attention more than eliminating late fees. This greatly appealed to frequent movie renters, as well as occasional renters. As Netflix changed the playing field of the industry, and as alternative and new competitors entered the market (cable services video on demand, internet video downloading), Netflix continued to refine their subscription plans to more competitive rates.
The refinement of the companies operations further improved their customer service. The two major improvements came in the way of quicker delivery times and an improvement in their website and recommendation service. By implementing distribution centers across the country, it allowed a larger market to enjoy next day delivery, that formerly only benefited the West Coast. As the company expanded and grew they were able to make a partnership directly with USPS to ensure fast delivery while continually improving their internal operations.
The most significant operational change was the improvement in the Netflix web service. As more people joined the recommendation service was able to improve, but more importantly, implementing a barrier on the website that only allowed videos in stock to be recommended greatly reduced video wait times for new releases and now popular independent films. Consumer “queues” helped Netflix estimate demand for movies with more precisions and alerted them to upcoming shortages or excess inventory of individual films.
The last operational barrier that still left Blockbuster with a competitive advantage was their relationships and revenue sharing contracts with major movie studios. Netflix improved their inventory of new releases by cherry picking an expert in the industry and modeling the plan that Blockbuster enjoyed with major film studios. By the time this plan came to fruition, Netflix had gained the recognition and market share that merited the films studios attention. The revenue sharing that Blockbuster shared with these film studios was so threatening to the industry in 2002, before Netflix was considered a major player; independent rental stores were filing antitrust lawsuits against the media giant (Anderson Forest, 2002).
As far as Video on demand, there is a plethora of considerations that Netflix must keep in mind when deciding how they will approach this technology. First, they need to decide if this is a market they should definitely be investing in. Will the cost of acquiring content be justified by the revenue generated? Netflix must first discover, as best as physically possible, if this is a technology that people want and if this market is a market they should definitely be in. They also need to consider if consumers are willing to invest in additional technology or if the future of VOD lies solely in the hands of cable and satellite companies that already provide electronics to the consumer. Another consideration in entering the market is how video on demand will affect their core business plan of video rentals. Will video on demand cannibalize this industry? If so, will the revenue obtained through video on demand services meet or exceed that of the DVD rental service? Or will they be able to coexist. Also, will the expansion of video on demand promote piracy thus indirectly affecting the future of the company? This is another indirect and long term consideration which could potentially cripple the company.
If these issues pass the litmus test, the next factor to be determined is how Netflix should approach the market. If they decide to forgo a partnership with the cable companies to seek higher margins, will one of their competitors steal the market through a partnership? If they decide to forgo the advertising revenue that internet VOD services are implementing will they be exiting a potentially lucrative business proposition that the internet markets will capture? The CEO of Netflix stated that the two roadblocks to VOD being more widespread was a lack of technology to stream online content through the internet to the television and content availability. Netflix pretty much decided this was a matter outside of their area of expertise and to be left to others, however, do they stand to lose market leadership to the company that does innovate these products and subsequently takes Netflix’s market share? Perhaps this is an area Netflix should be investing more R+D into or at the very least keeping on top of.
I believe that it would be in the best interest of Netflix to procure, adopt, and test VOD services to their thousand of subscriber. For starters, while the cost in acquisition of content may increase, the company will be saving costs of subscriptions as well as fulfillment costs, which were $532,621 and $93,439 million in 2006 respectively (Shih, et als., 2007, p.14). Furthermore, I believe that initially, until the industry is fleshed out, Netflix should approach this endeavor much the way they did their rental services, and start out with independent and older films which have lower acquisition costs. Implementing VOD will provide the customer with more content and a better experience and Netflix can utilize its storage of data to suggest customers to films the same way it does with its rental service. The impact of acquiring the rights to the films will be mitigated by the savings in USPS, processing operations, and other fulfillment costs including the costs of physical DVD replacement, loss, etc…. Having already spent $50 million on research and development of video on demand technology, it would be almost a waste to not test the waters with this introductory service. Another idea is to get the subscriber introduced and subsequently hooked on the product, then consider implementing advertising or additional fees as the quality of the content improves. As the market leader in DVD rental services, Netflix’s enjoys the ability to toy around with various pricing and operating strategies as the technology is in its infancy.
References
Anderson Forest, S (2002, June 12). Blockbuster CEO’s Days in Court. BusinessWeek. Retrieved March 16, 2010, from http://www.businessweek.com/bwdaily/dnflash/jun2002/nf20020618_5409.htm
Browder, S. (1999, March 8). Blockbuster Finally Gets It Right. BusinessWeek. Retrieved March 16, 2010, from http://www.businessweek.com/archives/1999/b3619089.arc.htm
Chamberlain, E. H. (1962). The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value, 8th Edition (Harvard Economic Studies) (8th Ed ed.). Cambridge: Harvard University Press.
Landler, M. (1996, March 29). Big Executive at Wal-Mart Taking Reins At Blockbuster. The New York Times. Retrieved March 16, 2010, from http://www.nytimes.com/1996/03/29/business/big-executive-at-wal-mart-taking-reins-at-blockbuster.html?pagewanted=1
The Media Business – Blockbuster Closes at Its Offering Price. (1999, August 12). The New York Times.. Retrieved March 16, 2010, from http://www.nytimes.com/1999/08/12/business/the-media-business-blockbuster-closes-at-its-offering-price.html?pagewanted=1
Shih, W., Kaufman, S. and Spinola, D. (November 19, 2007). Netflix. Harvard Business Review Case Study.
