Founded by Reed Hastings in 1997, NetFlix Inc. is the largest online provider of DVD rentals in the U.S., offering monthly prepaid rental services and applying processes of online ﬁlm search engine, ordering and direct mailing of DVDs to subscribers via the United States Postal Service. NetFlix’ innovative business model has to this point served as a competitive advantage helping to detract proﬁts from competitors including Blockbuster Video and traditional “mom and pop” video rental stores. However in order to sustain said advantage NetFlix must develop a strategy to react to the changes in technology and the industry as a whole, most importantly that of online video and Video-on-Demand (VOD) providers.
This case study includes an analysis of NetFlix’ long run objectives, its business model i.e. how the company creates, delivers and captures value, a deep dive into the subscriber model and its use in projecting future cash ﬂow requirements, the value of a new subscriber, and lastly recommendations in regards to changes to the existing business model.
To that end the recommendations that we have developed include a dynamic pricing model by which NetFlix offers subscribers a package of up to 6 DVDs for $25 per month rather than the initial monthly fees of up to $19.95 for renting 4 DVD’s at a time. A revenue sharing pricing model with the Motion Picture
Association of America
(MPAA) through which NetFlix will have the ability to purchase new releases for less than $10 rather than average cost of $17.55 per DVD in exchange for 40% of rental revenue during the ﬁrst 6 months of service.
Additionally an advertising partnership with the MPAA by which Netﬂix would use its platform to advertise studio speciﬁc releases to subscribers based on their movie preferences. We also projected the scenario of a 25% drop in NetFlix
DVD sales and the impact that this would have on the company’s revenue, and lastly analyzed the long tail theory which suggests that customers demand older DVDs releases far more than new releases over the long-term, with the understanding that it is a better decision for a ﬁrm to capitalize on the entire lifetime of a video (even if demand and cost diminishes), rather than place it into an obsolete, unproﬁtable archive. Through analysis of the NetFlix case and supporting data our recommendation is for NetFlix to implement the revenue sharing model as this option produces optimal net present value for each new subscriber at $132.16 as well as corporate value of $985,559.20 after 5 years (Table 3).
1. What is Netﬂix’s long-run objective? How does Netﬂix plan to achieve its long- run objective?
How would you assess Netﬂix’s business model?
Netﬂix, as a leading innovator within the entertainment industry, wants to be able to capitalize on its model and continue to grow in the long term. To achieve this objective, Netﬂix is in need of a capital inﬂow, ideally resulting from an IPO. The challenge for them going public is their ability to stabilize their ﬁnancial model to a
point where they become proﬁtable. Success in this endeavor is dependent in their ability to increase their subscriber retention rate that lowers their sales and marketing expenses ($16.4 million in 1999) while augmenting their forecasted cash ﬂows.
Netﬂix is preparing to address its long term objective by forecasting different client subscription scenarios. An interesting dilemma lies on whether to continue providing the ﬁrst-month free promotion to increase market share acquisition. The downside of this decision would be the cost of losing ﬁrst time customers who would not incentivized to engage with the new business model that Netﬂix is proposing. To assure long term growth, Netﬂix must capture customers beyond the early adopter segment and penetrate the mass market, who is culturally used to brick and mortar retail shopping behaviors shaped by massive competitors such