Company resources and competitive position

Netflix

Financial ratio analysis can shed insight into the operations of a company. Ratio analysis typically focuses on liquidity, solvency, profit margins, operating efficiency and returns as key metrics from which the analyst can draw conclusions about the firm's success. The financial ratios for Netflix for the past three years are contained in Appendix a. These ratios are focused on activity, leverage and profitability. In general, Netflix has seen improvements in profitability and leverage in the past year, but saw its level of activity decline in that same period.

Financial Ratio Analysis

Based on this analysis, Netflix has been a successful company in the past few years. Most of the financial metrics have improved in that time, and although the performance was not unanimously good, Netflix appears to have a strong position in the market. The company has seen its margins improve over the course of the past two years. This improvement is across the board -- gross, operating and net margins have all improved. This indicates that most of the improvement probably occurred at the top line, which indicates that Netflix has improved its pricing power over either sellers or buyers. That the top line improvements have trickled down to the net margin indicates that Netflix has grown its operations without an undue expansion in the company's cost structure.

In general, the company's returns are also strong. The firm's ROE increased sharply in 2009 and 2010, but this can be explained by the increase in the use of debt, as evidenced by the debt-to-equity ratio. The lower the amount of equity in the capital structure, the better the ROE will be, all other things being equal. More encouraging, then, is the improvement in the ROA and ROI over this same period of time. The leverage that the firm undertook in 2009 was partially paid down in 2010. The current level is perhaps high for a firm as young as Netflix, but the fact that the company has paid down some of the debt it took out (at least on a percentage basis) is encouraging. It is also possible that Netflix adopted this capital structure to take advantage of the low rates available at present. If this is the case, perhaps the firm is in a good position to adjust its capital structure back to a more equity-oriented one once the interest rates begin to climb. For now, the debt-to-equity ratio is more something to watch than something about which to be alarmed.

The main trouble point for Netflix in terms of its financial ratios is with respect to its activity levels. The company saw its inventory turnover decrease in 2010 from previous levels, and this expanded inventory levels to 48.66 days from 36.8 days in 2009. Expanding inventory levels can be a warning sign that the company's level of activity is slowing. Ideally, Netflix would recognize this reality and make adjustments to its inventory levels in order to bring the inventory turnover back to historic levels. It the inventory levels represent a temporary deviation from the norm, then there is no reason to be concerned. However, it is worth mentioning that Netflix would not want to see a trend of increasing inventory levels in particular, as movie rental inventory can become stale and in general diminishes in value over time. Turnover must be kept high, by moving out extra copies of slow moving titles, and getting the existing inventories out to paying consumers.

Netflix does not record accounts receivable on its balance sheet. This makes it impossible to calculate its average collection period. Thus, no judgment can be made with respect to the firm's ability to turn over its accounts receivable.

Cost Advantages

Cost advantages typically arise from economies of scale, which gives a firm improved pricing power over suppliers. This pricing power can be applied to reducing the prices for consumers as a means of gaining market share. At this point in its life cycle, Netflix should have a cost advantage over its primary competitor, Blockbuster, in the video rental business, given its size. When Netflix started, this was not the case, but Blockbuster failed to leverage its pricing power to undercut Netflix, and the latter firm eventually prevailed with a superior business model.

However, Netflix may not have a cost advantage over companies that act as substitutes, such as media vendors Amazon and Wal-Mart. Compared with those firms, Netflix does not have a cost advantage because it lacks the economies of scale over those competitors. Those competitors are at present substitutes for Netflix, but there is the risk that they could become direct competitors. As such, Netflix may wish to become larger in order to improve its buying power in order to become a cost leader in the video industry.

SWOT Analysis

Netflix has among its strengths a large installed base of users, which represents a captive audience. This gives the company economies of scale in purchasing, including distribution services. Netflix also has a strong brand name, having established itself as a leader in online video rentals. In addition, Netflix has been able to build strong relationships with the media industry during the course of its operation, and this gives it access to virtually all important media properties. A key weakness for Netflix is its lack of international representation. This results in constrained growth opportunities. In addition, Netflix is reliant on the video rental business and has no diversification. This was a problem for the company that Netflix eventually displaced, Blockbuster, and could be a problem for Netflix as well given a technology shift.

International expansion represents a significant opportunity for Netflix, since this business model has thus far not been emulated internationally. In addition, there is opportunity for Netflix to grow by moving into shorter content, more suitable for smartphones and other portable devices. In addition, Netflix can also move into music or other media product lines in order to diversify itself. Technological change represents a major threat to Netflix, because it is a one-business company. In addition, Netflix could face competition from larger retailers, should they choose to emulate the Netflix business model. Lastly, Netflix has a high degree of leverage at present. If it becomes overleveraged in its quest for growth, the company could have solvency issues in the future.