Netflix Business Model and SWOT Analysis (2005)

Introduction

Netflix operates under a fundamentally different business model than those that traditionally prevailed in consumer video delivery. The prevailing model, exemplified by companies like Hollywood Video and Blockbuster, relied on retail storefronts across the country where consumers would go to select and rent a video. Customers maintained a store membership and checked out videos for a rental fee, typically for a fixed period of time — though Blockbuster later instituted a more open-ended return policy.

The Netflix model instead provides rental videos through the mail, emphasizing consumer convenience and a longer rental period. The consumer pays a monthly fee and can rent as many videos as the monthly period allows, with the quantity determined by how quickly the consumer watches and returns each set. The premium plan allowed three videos out at a time.

Industry Conditions

The video rental industry had been in a state of flux for some time. The videotape rental business had reached a saturation point — consumers were renting fewer and fewer tapes — precisely when DVD began to replace VHS. Companies with brick-and-mortar rental operations faced a large and costly inventory to maintain, typically carrying a substantial collection of videotapes on shelves even as they transitioned to DVD for all new releases.

Many consumers had developed the habit of renting a video on the weekend or at other times, making the industry a long-running success and causing many of these companies to be viewed as cash cows. The shift to DVD offered a new attraction to consumers: superior picture quality that more closely approximated the theatrical experience, along with bonus material included on most discs. As with the music industry, this shift to a new technology created a number of fresh selling points and drove increased sales and rentals as a result.

However, the industry was also widely viewed as having a limited future, because the corner video store faced the same structural challenge as many other brick-and-mortar retailers in the digital age. Analysts foresaw a future in which going to a physical store to rent a film would become a niche market, appealing mainly to enthusiasts seeking hard-to-find titles not suited to mass-market distribution. Even for those customers, alternative delivery methods — purchasing DVDs (which were becoming cheaper), video-on-demand from cable and satellite providers, and downloading films over the Internet — were expected to become preferable.

Given this anticipated trajectory, Netflix was well positioned to capture a large market share as the industry model evolved. Netflix operated as both a mail-order and an online business. Consumers maintained a list of desired films with the company, and titles were mailed as they became available. Once viewed and returned, the next set from the list was dispatched. The list could be updated online or by mail. Convenience was the central value proposition, reinforced by prepaid return postage — no charge for mailing in either direction. There were drawbacks, of course: consumers could not obtain the very latest release on demand as they could at Blockbuster, which often offered availability guarantees and allowed customers to select alternative titles in the store. Netflix customers could not make an immediate substitution, nor could they browse physical shelves to discover what was available.

The primary competitive forces in the industry had not changed greatly over the years, centering on choice, convenience, cost, and policies regarding late fees. As part of the convenience factor, store placement had long been a critical consideration, requiring chains to operate numerous outlets in order to reach more customers close to where they lived.

SWOT Analysis of Netflix

Netflix already held a strong position in the market, placing it ahead of any new competitor attempting to enter the same space with online ordering and mail-order delivery. The company had built broad name recognition through widespread advertising — including television commercials, in-theater advertising, online campaigns, and direct mail. It was also developing a rapidly growing consumer base. Its service was convenient, a primary concern for modern consumers, and comparatively inexpensive, another clear advantage. While the monthly subscription model required a degree of commitment — encouraging renters to maximize usage in order to justify the cost — the system nonetheless appeared to be performing well. Additional selling points that had broadened the service's appeal included the guarantee of no late fees and no postage charges for either direction of mailing.

Netflix reported sales of $506.2 million for 2004, representing one-year sales growth of 86%. The company also achieved one-year net income growth of 232.3% and employed 940 people, with employee headcount having grown 65.8% in the preceding year (Netflix, Inc. par. 1).

As noted above, one significant weakness is Netflix's inability to satisfy consumers who want a specific film immediately. Consumers who prefer to browse — wandering the aisles of a store to discover what looks appealing — are also poorly served by the delivery model. Netflix offers greater convenience for the casual renter and for those who simply do not want to make a trip to a store, but for customers who enjoy browsing and making spontaneous selections, the business model is less compelling.

As the industry continues to evolve, Netflix is positioned to benefit from several emerging opportunities. As digital downloading becomes more viable — meaning that broadband becomes more widespread and download times decrease to practical levels — Netflix's existing online infrastructure can be adapted to deliver films digitally. Downloading offers even greater convenience and immediacy, and should attract additional consumers, including those who currently want service on demand and prefer to browse and select in real time. Netflix needed to prepare for this transition proactively. The company also retained the opportunity to expand its reach by growing its customer base. With 30 distribution centers at the time, the company needed to evaluate whether its growth trajectory justified additional centers, which could improve delivery speed and enable expanded services such as guaranteed next-day delivery.

Threats to the existing business model already existed in the form of alternative delivery channels. While widespread digital downloading remained a future prospect, cable and satellite video-on-demand services were already available. At the time, such services offered only a limited selection of titles each month, but the potential existed to expand that selection to the point of functionally replicating video rental — with the significant advantage of immediacy. Netflix might still hold a price advantage in such a scenario, but this would remain to be demonstrated.

Work Cited

"Netflix, Inc." Hoover's Online (2005). <http://www.hoovers.com/netflix/--ID__100752--/free-co-factsheet.xhtml>.