In the late 1990s Reed Hastings recognized that there was a problem with the video rental business. After paying a hefty $40 rental fee, essentially twice the price of a new movie, he recognized that there was a business model waiting to be developed. Fast forward 9 years later and in 2006 Netflix was the dominant player in the online rental business with just under a million subscribers and profits over $370M.
Their path to success can largely be attributed to the recognition of needs, and the fulfillment of them in a way that considered technological trends as a source for growth and new opportunities. In 1997 (when Netflix was founded) the video rental business was mostly fragmented with local chains and one giant – Blockbuster Inc. Blockbuster had over 5,000 locations that allowed 70% of customers to walk in their doors in 10 min or less. Customers flocked to them because of their large selection of recent hits. Netflix recognized that a few gaps in Blockbuster’s business model: (a) late fees, (b) convenience, and (c) value. After tweaking the payment model, Hastings eliminated late fees, thus reducing consumer hesitancy to act. After expanding the distribution network, they made it possible for any American with internet access (~ 71% in 2010) to have immediate access to hit movies. By switching to an unlimited rental business, users have the opportunity to capture value that far exceeds that of Blockbuster.
Beyond those cornerstones of value, Netflix also offered consumers an easy way to find videos they would enjoy. Their proprietary algorithm served up recommendations that not only were highly rated (.75 star higher rating than new releases), but also available. The algorithm learned about consumer preferences and was able to provide more accurate recommendations the more consumers used it. This, along with the video queues provided an additional incentive for users to maintain their subscriptions and lowered switching costs for Netflix.
Recognizing that Netflix’s primary sources of value could come under fire from the up and coming Video On Demand technology, Hastings considered if/how Netflix should enter that market. Ignoring costs and the difficulty getting studios on board (large issues, I know), Netflix looked to user trends and desires and saw that an online delivery model provided even more convenience than the current disk-based one. Users could decide what they wanted to watch in the moment rather predicting what they would want view a few days later and do so without having to deal with returning disks or waiting for the next movie to arrive. It was then clear that Netflix should enter the VOD market and we now know that they did so by offering up the service at no added cost. This allowed them to drive traffic to the offering with their existing large user-base. This ‘add-on’ also allowed them to capitalize on one of their greatest assets – their recommendation engine. Competitors simply could not compete with the convenience and value embedded in their model and Blockbuster, the former king of video, was eventually forced into bankruptcy in 2010. This, of course, doesn’t mean Netflix can stop innovating and pushing the envelope (pardon the pun) forward. New(er) entrants in the video market such as Redbox, iTunes, and Hulu each provide home/mobile entertainment opportunities with which Netflix must compete. As consumers expect more features/convenience for a lower price, they will have to continue finding ways to add value and lower costs. This will likely come from exclusive partnerships with studios, improving algorithms, and improved quality.
Note: This is an analysis of the Netflix HBR Case Study