Chapter 4 Netflix in Two Acts The Making of an E commerce Giant and the Uncertain Future of Atoms to Bits 4 1 Introduction Co founder and CEO Reed Hastings during 2011 went from on top of the world to a business press punching bag Netflix was a dot com an internet pure play without a storefront and with a miniscule customer base when compared with competition Blockbuster and Wal Mart Hastings wished he waited another 2 4 years before turning into a public Big competitors ended up failing great but then Hasting s made some company decisions that no one liked o 10 dollar bundle turned into 2 separate 8 dollar plans for DVD by mail and internet streaming 60 price hike for customers o Announced it was going to split into 2 distinct services with 2 separate websites made service harder to use o How does Netflix make the transition from DVD by mail business to Studying Netflix allows us to see how technology helps firms craft and reinforce a competitive advantage streaming Key Takeaways o Analysts and managers have struggled to realize that dot com start up Netflix could actually create sustainable competitive advantage beating back challenges from Wal Mart and Blockbuster among others o Data disclosure required by public companies may have attracted these larger rivals to the firm s market o Netflix operates via a DVD subscription and video streaming model These started as a single subscription but are now viewed as two separate services Although sometimes referred to as rental the model is really a substitute good for conventional use based media rental o Fear of clinging to a sure to shrink DVD by mail business model prompted Netflix management to split and reprice its services However the price increase a poorly handled rebranding effort and a process that would have made the firm s services more difficult to use all contributed to the firm s first major customer contraction and satisfaction decrease 4 2 Act One Netflix Leverages Tech and Timing to Create Killer Assets in DVD by Mail Building a great brand especially one online starts with offering exceptional value to the customer Advertising builds awareness but brands are built through customer experience Netflix has staggering selection Long tail firms can make money by offering a near limitless selection refers to the demand for less popular items that aren t offered by traditional brick and mortar shops o Selection attracts customers o The internet allows large selection inventory efficiencies that offline firms can t match As geographic constraints go away uptapped markets open up Bollywood films Studios earned a percentage of the subscription revenue for every disk sent out to a Netflix customer in exchange Netflix gets DVDs at a very low cost Fixed costs a cost that does not vary according to production volume Biggest inefficiency matching content with customers use a proprietary recommendation system that the firm calls Cinematch o Each time a customer visits Netflix after sending back a DVD the service asks how you liked the movie rate on a scale of 1 5 stars steers you toward titles preferred by people with tastes that are most like yours o Collaborative filtering a classification of software that monitors trends among customers and uses this data to personalize an individual customer s experience has created data advantage that is valuable more ratings make the system even smarter o Switching cost if you leave Netflix another site won t have the same data on you can t make as good as recommendations Churn rate the rate at which customers leave a product service Crowdsourcing the act of taking a job traditionally performed by a designated agent usually an employee and outsourcing it to an undefined generally large group of people in the form of an open call Netflix Prize Netflix has 58 distribution centers Economies of scale the more profitable firm will be the one with more Netflix has the largest selection the largest network of distribution centers customers and the largest customer base Key Takeaways o Durable brands are built through customer experience and technology lies at the center of the Netflix top satisfaction ratings and hence the firm s best in class brand strength o Physical retailers are limited by shelf space and geography This limitation means that expansion requires building stocking and staffing operations in a new location o Internet retailers serve a larger geographic area with comparably smaller infrastructure and staff This fact suggests that Internet businesses are more scalable Firms providing digital products and services are potentially far more scalable since physical inventory costs go away o The ability to serve large geographic areas through lower cost inventory means Internet firms can provide access to the long tail of products potentially earning profits from less popular titles that are unprofitable for physical retailers to offer o Netflix technology revitalizes latent studio assets Revenue sharing allows Netflix to provide studios with a costless opportunity to earn money from back catalog titles content that would otherwise not justify further marketing expense or retailer shelf space o The strategically aligned use of technology by this early mover has allowed Netflix to gain competitive advantage through the powerful resources of brand data and switching costs and scale o Collaborative filtering technology has been continually refined but even if this technology is copied the true exploitable resource created and leveraged through this technology is the data asset o Technology leveraged across the firm s extensive distribution network offers an operational advantage that allows the firm to reach nearly all of its customers with one day turnaround 4 3 Act Two Netflix and the Shift from Mailing Atoms to Streaming Bits Atoms to bits the idea that many media products are sold in containers physical products or atoms for bits the one s and zero s that make up a video file song or layout of a book As the Internet offers fast wireless delivery to TVs music players book readers and other devices the atoms of the container are not necessary Physical inventory is eliminated offering great cost savings Amazon from printed books to kindle Apple from physical CDs to iTunes Eliminates a huge chunk of costs associated with shipping and handling Can Hastings recast Netflix for the day that DVDs disappear or will the atoms to bit shift decimate his firm s hard earned competitive advantage and
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