Renting and Netflix Essay

The purpose of this strategic plan is the thorough evaluation of the firm Netflix, Inc. in order to develop strategies that will maintain their position as the industry leader in the online movie rental business. An internal audit of the firm has been completed to reveal the history that has led them to the forefront of the industry, as well as the core competencies that continue to drive their business model. In the third quarter of 2009 CEO Reed Hastings stated the company goals are to, “grow revenue, subscribers and earnings while expanding into streaming content” (Knowledge at Wharton, 2009).

An external audit of the industry in which Netflix operates reveals that the movie rental industry is moving primarily to streaming content consumption online. Netflix faces the strategic issues of developing a streaming content library and the rising cost of postage, which will render their current business model less competitive in the future. This strategic plan will allow Netflix to have a seamless transition from the industry leader in mail-order DVD rentals, to the industry leader in streaming content, as the market they operate in trends in this direction.

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This strategic plan recommends that Netflix make a long term commitment to the growth of their streaming content library. This growth will be achieved by acquiring Hulu, LLC, the reinvestment of decreased postage expenses into streaming content acquisition, and the use of more flexible revenue sharing contracts with studios. The implementation of these strategies will allow Netflix to achieve their overall goal of growing their streaming content library by 7,500 new titles each year for the next 10 years. This will position Netflix with a competitive advantage over all rivals in streaming content as the industry makes the shift to this form of content consumption. Internal Analysis

Company Background
Netflix has been the world’s largest online movie rental service for over a decade (Netflix.com/MediaCenter, 2009). The company was founded in 1997 by Reed Hastings and Marc Randolph who had previously worked together at Pure Software. Hastings was inspired to start Netflix when he realized he owed an absurd amount of late fees on a rental of the movie Apollo 13; he
immediately thought that renting movies should be similar to a gym membership where the customer pays a flat rate monthly and can rent and return movies at their convenience (Netflix.com, 2009). After conceiving this idea in 1997, Hastings and Randolph launched the Netflix website in April of 1998, out of Scotts Valley, California.

Netflix has acquired an extensive movie collection, and at of the beginning of their 2009 fiscal year had a library of 100,000 hardcopy titles and has attracted approximately 10 million subscribers since its inception. On average, Netflix is shipping 1.9 million DVDs daily and just this past spring, shipped its 2 billionth title (Netflix.com/mediarelations, 2009). There are several subscription options available, each allowing the customer to rent a certain number of DVDs at a time, a certain number per month, and more recently allots them a certain amount of time to watch instantly online. Although the company holds the title as the largest online movie rental service, they have seen a shift in consumer trends and are adding online movie watching to existing in-home rentals (Netflix.com/about, 2009). Current CEO and Chairman Reed Hastings ensures that his company reflects his own personal values (Netflix.com/MediaCenter, 2009). Before starting Netflix, Hastings served in the Peace Corps, and has since gone on to serve positions as the President of the California State Board of Education, and as a board member for several non-profits. Most recently, Hastings was appointed to the Microsoft Board of Directors. In addition, Time Magazine named him one of 2005’s “Time 100” most influential global citizens. Netflix was created from an unpleasant customer experience Hastings had with renting movies; this experience has been the driving force behind Netflix desire to please customers. Hastings’ reputation for involvement with the community and industry at large has helped him gain a strong understanding of how to succeed in business and develop strong relationships with customers. With a repertoire like this, it is no wonder Netflix has scored an American Customer Satisfaction Index score of 86; the average is 75 (Netflix.com, 2009). The frustration Hastings experienced with in-store movie rentals, late fees and due dates led him to develop Netflix, a company that has a strong reputation of customer satisfaction. Hastings developed a business model based on customer satisfaction including no due dates, no
late fees, no shipping and handling fees and next to no aggravation for the customer. The Netflix mission states: “Our appeal and success are built on providing the most expansive collection of DVDs; an easy way to choose movies; and fast, free delivery” (http://ir.netflix.com, 2009). The mission is straight-forward and clear cut in defining the goals of Netflix in a way in which customers can understand. By referring to the customer satisfaction ratings, number of subscribers and awards for Hastings, Netflix has been successful in carrying out their mission. Product Segments

Netflix, Inc. product line business scope is derived from a single product offering that is delivered to the consumer through three channels of distribution. Netflix sells the monthly subscription plans to end-user consumers. The plans range in price from $4.99 to $47.99 based on the number of DVD rentals allowed per month and the amount of movies a consumer may have in their possession at one time (Netflix.com, 2009). Netflix distributes the allowed number of DVD’s to consumers through a mail order system which utilizes regionalized distribution centers and the United States Postal Service. Netflix also distributes Blu-ray DVD’s to consumers through the Blu-ray monthly add on which gives consumers access to this type of DVD format for prices ranging from an additional $1 to $9 per month (Netflix.com, 2009). The third distribution channel Netflix offers is streaming content. Currently over 17,000 choices of streaming content are available to subscribers, which are included in the monthly subscription plan (Netflix.com, 2009). Although these are three distinct distribution channels, they are grouped together under one monthly subscription plan, for which the consumer pays a singular fee and represents where Netflix derives “substantially all of our revenues” (Netflix 10K, 2009). This monthly subscription plan segment has had compound annual growth of 64% in subscriptions since the founding of Netflix in 1999 (Netflix.com, 2009). Geographic Markets

Netflix currently ships throughout the United States. Although Netflix is headquartered in California, they have 58 distribution centers and 100 shipping points strategically located across the country (Netflix.com, 2009). This streamed lined distribution allows Netflix to claim that 97% of
their consumers receive their movie in about one business day after Netflix has confirmed the reception of their outstanding movie (Netflix.com, 2009). Internal Audit

The examination of Netflix current business strategy is crucial to the evaluation of the firm’s future prospects. An internal audit has been used to assess the performance of Netflix and its value chain activities. This allows for an understanding of Netflix core competencies and a categorization of them into strengths for the firm, as well as, the identification of potential weaknesses. Strengths

Netflix main strength is superior customer convenience. They are able to provide value to the consumer through the elimination of late fees, return dates, and checkout lines. Redbox, a competitor of Netflix, has a limited selection of DVD’s in their kiosks and they charge a fee each day a movie is rented. Netflix allows their customers to keep movies as long as they want and they have over 100,000 DVD titles available (Netflix.com/about, 2009). Netflix has strategically placed distribution centers throughout the United States so they are able to advertise delivery of DVDs in around one business day (Marketlineinfo.com, 2009). Combining these competitive advantages creates a company that has been ranked number one in “eight consecutive surveys, in Foresee Result’s independent survey of e-commerce customer satisfaction” (Marketlineinfo.com, 2009). Netflix provides an opportunity for a one month free trial, and prices plans depending on your movie needs. The monthly subscription plans range in price from $4.99 per month to $47.99 per month (Netflix.com, 2009). This range allows Netflix’s customers to choose their plan depending on the amount of streaming content and DVD quantity they want monthly. Value is created for the consumer because of the choice and availability of the product, for less time money and effort for the consumer. Netflix has developed a user friendly website that is partnered with Cinematch technology. Cinematch is software used by Netflix in order to help the customer find selections that match their demographic information and renting trends, which saves them time and gives them recommendations that match their movie renting desires. It organizes movie selections into different categories creating a superior movie renting
service for the consumer (CNet news, 2009). Netflix is expanding their selection of streaming content, of which they currently have 17,000 movie and TV choices (Marketlineinfo.com, 2009). Customers are able to stream movies directly from Netflix website and watch them instantly. In 2008, they expanded the means to stream content directly from the website. Now customers are able to stream “content to their TVs through Blu-ray players, stand alone set top boxes, TiVo DVRs, Xbox video game consoles, and soon, directly through Internet-connected TVs” (Marketlineinfo.com, 2009). The turnaround time for consumers to watch a movie and the ability to watch it on their computer provide the consumer with instant gratification. Netflix is able to provide two ways to watch a movie for one low price. Although technology is advancing each day, Netflix expects both their streaming content as well as their DVD-by-mail rentals to increase (Marketlineinfo.com, 2009).

Financially, Netflix three major strengths are: a solid current ratio, a decreasing subscriber acquisition cost and a surging stock price. Netflix current ratio is an important measure considering that Netflix spends in excess of $300 million on postage for the past three years and is expected to spend $600 million in 2010 (Knowledge at Wharton, 2009). This cost is only increasing into the future as postage and packaging expenses rose 23% between 2007 and 2008 (Netflix 10k, 2009). Current ratio is an indicator of short term financial status and with a current ratio of 1.67 in 2008 (Netflix 10k, 2009), Netflix displays its ability to cover the exposure to the postage and packaging price hikes, in the short term future. (See Appendix VIII)

Another major strength for Netflix is a decreasing subscriber acquisition cost. Netflix defines subscriber acquisition cost (SAC) as total marketing expense divided by total gross subscriber additions (Netflix 10k, 2009). SAC is used by Netflix to assess how proficient current marketing programs are in gaining new customers. For the years of 2006, 2007, and 2008 the subscriber acquisition costs were respectively $42.94, $40.86 and $29.12 (Netflix 10k, 2009). The drastic change from year 2007 to 2008 can be credited to new marketing schemes including a large reliance on the
customer’s word of mouth. By cutting total marketing costs, Netflix was able to reduce the price of its most popular subscription plans by a dollar into 2008. These new marketing schemes, including word of mouth, were efficient as revenue increased by 13.2% from years 2007 to 2008 (Netflix 10k, 2009).

Netflix also finds strength in their surging stock price. On January 23rd 2004, Netflix decided to split their stock when it reached $77.50. Five years later the stock is rising back towards $77.50, as it reached $60.81 on November 18th. The momentum of Netflix stock does not seem to be slowing either; its 52 week change in a percentage was 221.90% (YahooFinance.com, 2009) and is still growing. This momentum and price growth shows that Netflix has strong investor confidence that will allow them to raise capital easily in the future. Weaknesses

Netflix provides various monthly subscription plans, allowing them to cater to a broad market. Over the years, the highest subscription plan price has decreased. The constant demand for lower prices will lead to lower revenue per month per customer. For Netflix, low subscriber retention rates increase their operating costs, so it is important to retain current subscribers. Netflix does not currently have any plans in place that reward customer loyalty. Switching costs are very low for a Netflix customer, so consumers are easily able to switch to rivals. Despite Netflix success among customer satisfaction surveys, they are still vulnerable to “pricing wars” with rival firms, in an effort to provide a more attractive price to consumers.

In terms of streaming content, Netflix must continue to expand their inventory because competitors currently offer comparable content for free. Websites such as Youtube and Hulu, LLC have massive libraries of content available and already have great success in this market (Hulu, LLC, 2009). These sites are able to offer more streamed content to consumers for free, while Netflix charges a fee and provides less streamed content to consumers. Netflix must continue to develop their streaming content operating segment to offer appealing content to consumers that they cannot get elsewhere. External Analysis

An external audit is a necessity to identify opportunities and threats within Netflix environment. After an evaluation of the industry that Netflix operates in, the major opportunity that exists for firms in their industry is streaming content, while the major threat present in their industry is the rising cost of postage. Opportunities

Netflix broke into the movie rental business by providing an original service that attracted consumers based on its convenience and price. The introduction of streaming content is a major opportunity for firms in the movie rental industry. Streaming content is fairly new and the market share has not been captured by any single firm, leaving open the opportunity for firms in this industry to take control of large segments of market share. By acting on the opportunity of streaming content firms in the industry will be able to prepare for the future of content consumption, which will eventually be consumed primarily online.

Threats
Currently, a major threat for the companies in the mail order DVD rental industry is postage risk. Between 2007 and 2008 postage and packaging expenses rose 23%. If firms pass these raised postage prices onto their consumer, it could adversely affect their churn rate, or customer turnover rate, in turn affecting sales. There are low barriers to entry regarding access to streaming content, due to the immense amount of streaming content that is available to potential distributors, making the industry extremely volatile and rivalry among firms very high. This high competition among firms makes it essential to maintain a competitive advantage in terms of subscription plan pricing. Established businesses such as Netflix face the constant competition from new website based businesses such as Hulu, LLC and local digital cable companies. PEST Analysis

Netflix, like other firms in the movie rental industry is subject to political, economic, social and technological macro-environmental factors. Changes to any of the factors in this arena can have a substantial impact the operations and livelihood of movie rental firms. In terms of the
political and legal landscape, firms could be affected by changing laws regarding copyrights of certain types of content, such as movies and television shows that firms rely on to provide to consumers. Any change in copyright law that affects their ability to distribute this content to consumers could drastically affect business because this content can represent large segments of a firm’s product offering. Firms are dependent upon content licenses from studios to distribute content, because they usually do not actually produce any content, and any change in these licenses could cripple their business model (Fritz, 2009). To maintain a competitive advantage, firms are required to price competitively against rivals. Netflix operates in an industry that relies primarily on the disposable income of consumers. If economic growths were to slow and the purchasing power of consumers was negatively affected, firms in this industry would feel the effects of this decreased purchasing power first. Netflix relies on the popularity of movies among consumers in their target market segments. As the average age of the population continues to grow older and movie consumption among the older demographic becomes less popular, business could be negatively affected. Also, if the online consumption of movies became unpopular among large segments of the population, business could be adversely affected as more movies are streamed online. Technologically, as an internet based business Netflix must contend with the constantly evolving internet, as the industry moves toward online consumption. As technological factors lower barriers to entry in terms of streaming content, Netflix faces challenges to its market share from new rivals. The rate of technological change in terms of the internet forces rivals in this industry to constantly update their business model to maintain market share. Five Forces

Rivalry Among Firms
Direct competitors threaten Netflix task environment. Exclusive content contracts are a threat to Netflix task environment. Our competitors, such as Blockbuster, brokered these types of deals in 2006 and 2007. This automatically limits the access our company has to certain content (Netflix 10K, 2009). Substitute Products and Services

Digital cable is now required for most homes so many consumers will have a movie selection from their cable network at their fingertips. Services such as “On Demand,” offered by Comcast Cable, could be a substitute for Netflix if they increase their movie inventory to a comparable selection of titles, because it is more convenient and already has placement in the home, at the source of consumption. There is a large market that this would appeal to; some consumers watch less than the typical three movies per month package from Netflix and they will be drawn to the immediate satisfaction they receive when using “On Demand.” This content is also offered from these providers to mobile devices. It is imperative for Netflix to keep up with the constantly changing technology in order to continue their success.

Entry of New Competitors
Netflix must continue to keep the growing popularity of e-commerce as an advantage and increase their inventory of streaming movies as well as increase their HD streaming inventory. If this effort is delayed, more convenient means of renting movies, such as “On Demand,” will take over. This is possible due to the inexpensive entry barriers in the industry related to streaming content due to the immense amount of streaming content that could become available to potential distributors. Bargaining Power of Customers

The movie rental industry is primarily an entertainment industry. In slower economic times where consumers have a lower amount of discretionary income, expenses such as entertainment could be cut out by consumers or their amount of spending on the industry reduced. Additionally, in more prosperous economic times, consumers could spend more money on the industry. This gives consumers a high bargaining power in the movie industry because they can simply choose to spend their entertainment dollars of alternative products or services. Bargaining Power of Suppliers

Netflix is entirely dependent on studios for the content they need to deliver to consumers. Netflix does not currently produce any of their own content, so the bargaining power of the studios who supply the content to Netflix is extremely high. If the suppliers were to discontinue distribution of their
content to Netflix, it could cripple Netflix business model. This gives the suppliers extreme leverage over contract negotiations with Netflix for content acquisition. Competitive Analysis

The only real competition left in the “brick and mortar” segment of the movie rental industry is Blockbuster. Netflix has been competing with Blockbuster since its formation and has continued to move past them to become the industry leader. Blockbuster has historically been an in-store movie rental chain but once Netflix gained popularity, Blockbuster launched an online service in response in 2005. Blockbuster spent $30 million to develop the project only to be sued a year later by Netflix for patent violations (Hoovers.com/blockbuster-inc, 2009). Blockbuster continued to develop the online segment with new subscription plans but was unable to match the success of Netflix.

Currently, Netflix is thriving as Blockbuster is going under. Blockbuster once had 7,100 company and or franchise owned stores in 20 countries and has been closing hundreds of stores as of late (hoovers.com/blockbuster-inc, 2009). In the third quarter of 2009, Blockbuster closed 216 stores and plans on closing about 1,000 stores in total by the end of 2010 (Fritz, 2009). Most recent financial evidence shows that Blockbuster can no longer be seen as a true threat to Netflix. This past quarter alone, Blockbuster reported a 21% drop in revenue and a total net loss of $114.1 million (Blockbuster 10K, 2009). Among other issues, Blockbuster is attributing these issues to the current economic recession, citing that the DVD market has been hit hard and is suffering in general (Fritz, 2009). Netflix, on the other hand, has been exceeding expectations and overall pleasing investors. This past quarter Netflix acquired 510,000 subscribers and predicts up to a million for the next quarter (Associated Press, 2009). While Blockbuster is experiencing a severe drop in revenue, Netflix reported a 24% increase this quarter (Associated Press, 2009). Looking to the future, Netflix is optimistic about gaining subscriptions and continuing to grow. However, there main competition in the future will be from business that have advanced their streaming content offerings, while Blockbuster is looking to close stores and does not see a quick turnaround any time soon.
To ensure future success over Blockbuster, Netflix must continue expansion of online streaming content and bring in new subscribers regularly. Strategic Issues

As a result of a thorough internal analysis of the firm Netflix and an external analysis of the movie rental industry in which it operates, several strategic issues that need to be addressed have been identified. Cost of Shipping Related Expenses

Netflix relies on the U.S. Postal Service (USPS) to deliver its DVD’s to consumers. Netflix is faced with the strategic issue that they are dependent on a third party for their shipping needs and must develop a strategy to combat the increasing cost of postage. On Netflix 2008 balance sheet, they listed subscription cost, defined as “postage and packaging costs related to shipping DVDs to subscribers as well as content related expenses,” as 55.8% of the total 66.7% of their cost of revenues (Netflix 10K, 2009). This cost has increased from $0.39 in 2006 to $0.42 in 2008 for each DVD they ship and receive, representing a 7.8% increase in postage in just two years and has attributed to Netflix rise in subscription cost as a percentage of cost of revenues from 53.4% in 2006 to 55.8% in 2008 (Netflix 10K, 2009). Constant price increases or surcharges, such as the $0.17 surcharge proposed by the US Attorney General in December, 2007, could cripple Netflix business model, as Netflix monthly operating income per subscriber could fall by as much as 67%, from $1.05 to $0.35 (Kaufman, 2007). Limited Streaming Content

Netflix currently offers its consumers over “17,000 choices in streaming content,” (Netflix.com, 2009) but must compete with sites such as Hulu, LLC, a joint venture between major studios, NBC Universal, News Corporation and The Walt Disney Company, as well as 190 other content companies (Hulu, LLC, 2009). Currently, these sites are able to offer streaming content free to consumers by generating revenues through advertising sales (Hulu, LLC, 2009). Although Hulu, LLC is currently in the process of developing a paid subscription type site to debut next year, (Cheng, 2009) the founders of this site are the same content providers that Netflix licenses some of its
streaming content from. The competition in the industry with regards to streaming content is extremely competitive and the race to become the industry leader in this market segment represents a potential increase in Netflix content acquisition costs. Content Deals with Studios

In the movie rental industry, companies are completely reliant upon content licensing deals from studios who own the rights to the media. Netflix competitor, Redbox is currently in litigation with studios, Warner Brothers, Fox and Universal over the studios refusal to sell its titles to them until 30 days after their release date for public purchase (Fritz, 2009). Netflix has been threatened with a similar “30 day window” and maintains little control over the studios because they rely on the studios to sell them content (Fritz, 2009). Netflix relies on revenue sharing agreements, where they will share a portion of their revenue from a specific title, for a period of usually 6 to 12 months, to acquire that title from the studio at a substantially lower cost than retail price (Netflix 10K, 2009). The studios are looking for a higher percentage of revenues in the revenue sharing agreements to prevent the implementation of the 30 day window, specifically Warner Brothers who was the first studio to attempt to renegotiate their content deal with Netflix in August, 2009 (Fritz, 2009). Higher revenue sharing deals would greatly increase Netflix content acquisition costs, which they list as a subscription cost on their balance sheet and accounts for 55.8% of their cost of revenues (Netflix 10K, 2009). Strategic Objectives

Through the use of information collected in internal and external audits of the firm Netflix, several strategic objectives have been identified. These objectives are a direct response to the strategic issues that Netflix faces. Cost Stability for Postage

A strategic issue that was identified through an external audit is the increasing cost of postage. In addition to the increasing cost of postage, since 2007 the US Postal Service has threatened to implement a $0.17 surcharge to Netflix for each envelope it sends (Kaufman, 2007). A long term strategic objective that Netflix must set is to attain cost stability for their postage expenses, which will allow Netflix to maintain their
monthly operating income per subscriber. This specific objective will be achieved by Netflix as they continue to grow their streaming content segment. This objective will be measured by the decreasing cost of postage, and the increase in the amount of dollars Netflix can aggressively reinvest with content providers to expand their streaming content library. Netflix will decrease their dependency on the USPS for their shipment needs each year with this time bound objective as consumers make the switch to streaming content. Commitment to Build Streaming Content Library

Netflix faces several strategic issues in terms of their streamed content product segment. They currently charge for a limited amount of content, while competitors offer more content for free. They are also reliant upon revenue sharing agreements with studios to obtain the content. A strategic objective Netflix must implement is to eliminate competitors to gain market share and achieve the ability to get greatly increased amounts of streaming content reliably from the studios each year. To do this Netflix must act aggressively and eliminate rivals. Netflix will have specific vertical integration because they will be able to secure a steady stream of reliable content in the form of television shows and some movies. They will have realistic and aggressive horizontal integration by eliminating rivals in the streamed content industry. Netflix will be able to measure their return on investment by the increase in subscribers they receive as consumers switch to their product. Strategic Choice

Overall Strategic Choice
Netflix must make a long term commitment to build their streaming content library. Each year Netflix must aggressively expand their streaming content library, with the ultimate goal of matching their 100,000+ titles that are currently available in mail-order DVD’s. This will allow for a seamless transition as the online movie rental industry moves primarily toward a streaming content consumption model. Netflix must implement these strategies to prepare for a new core competency of streamed content, as their most popular method of content consumption moves from mail-order to streaming. The following three strategies are all tied directly to the overall goal of a long term commitment to streaming content which will allow
Netflix to remain the industry leader. 1) Acquisition of Hulu, LLC: This acquisition will provide value to Netflix in three ways. First it will eliminate a rival firm in the industry, which will increase Netflix market share in the streaming content market. Second, Hulu, LLC currently counts 40 million unique visitors to their website each month as their consumer base. For feasibility, a 5% “migration” rate of Hulu, LLC consumers is required. (See Appendix IV and V) With this 5% migration rate Netflix projects to add 2 million subscribers from Hulu, LLC’s consumer base over 5 years. (See Appendix VI and VII) Lastly, Netflix will maintain their goal of building their streaming content library by acquiring content from 190 leading content providers, such as News Corp., NBC Universal and Disney (Hulu, LLC/about, 2009). This will give Netflix a competitive advantage in television and movie streaming content from these content providers. In addition to the consumers and content that Netflix will acquire, they will also acquire the intangible assets of knowledge from the pioneer company in the streaming content market. Netflix must develop the infrastructure that Hulu, LLC has implemented to ensure that their expanded streaming content library will be able to successfully reach consumers. The Hulu, LLC acquisition will give Netflix access to some of the top employees in the industry, as well as the physical equipment that will allow the implementation of an expanded streaming content library to be successful. 2) Reinvestment of Decreased Postage Expense: Netflix current rising cost of postage and the increase in postage prices that are expected in future years are pushing Netflix mail order product segment to a level where it will no longer be cost effective to ship DVD’s. With Netflix commitment to building their streaming content library, consumers will continue to switch to streaming content consumption (42% of Netflix subscribers streamed content of at least 15 minutes in the third quarter of 2009 (Knowledge at Wharton, 2009)). While this change takes place, Netflix cost of postage will begin to decrease and as a result Netflix cost of subscription cost of revenues will decrease. Netflix must reinvest all of the increased revenues they receive as a result of lowered subscription cost of revenue into streaming content acquisition. 3) More Flexible Revenue Sharing Contracts: Netflix will be receiving increased revenue from the elimination of rival Hulu, LLC and the addition of consumers that would have used their website for
streaming content consumption to their consumer base. The continued growth of revenue from their subscription plans as a result of increased market share must be used to offer more lucrative contracts to content providers whose content Netflix has not secured with the acquisition of Hulu, LLC. Netflix has been threatened by major movie studios with a 30 day window from the time a new title is released on DVD until Netflix could rent it to their subscribers. The studios are looking for increased revenue sharing from Netflix, which Netflix will be able to provide with the increased revenue from the previous two strategies. Strategy Implementation

Overall Goal: Increase streaming content by 7,500 titles per year for the next 10 years. Netflix projects to be renting DVD’s by mail until 2030, however they expect mail order rental figures to begin to decline in the next four to nine years (Wingfield, 2009). Evidence for this decline can be seen in home video sales, mostly from DVD’s, which declined from $15.9 billion in 2007 to $14.5 billion in 2008, as well as movie rentals that remained stagnant over that period at $8.2 billion (Wingfield, 2009). With a successful implementation of this streaming content growth strategy, by 2020 Netflix will have added 75,000 new titles to their existing 17,000 titles for a total of 92,000 streamed content choices. This number is comparable to the 100,000 hard copy DVD titles Netflix currently has available, which made them the industry leader in the mail order segment of the online movie rental business. This 10 year expansion strategy corresponds directly to the beginning of the expected decline in DVD rentals Netflix projects over the next 9 years. As Netflix begins to feel the effects from this decline, they will simultaneously be building their streaming content library. To achieve this overall goal Netflix must use the following implementation procedures for the three content growth strategies outline in the Strategic Choice section. 1) Hulu, LLC Acquisition: The total purchase price of Hulu, LLC would be $29 million. (See Appendix III) Netflix stock price, currently around $60 in November, 2009, up from $28.66 on January 1st, 2009 is a testament to the extreme confidence Netflix investors have in their business model and the prospects of the company. In order to fund this acquisition, Netflix will obtain a loan. Although our stock price is surging, this transaction can be funded
with debt, which not dilute the share price and allow for a continued strong relationship with our shareholders. Netflix will need a $30 million loan at a reasonable 8% rate. Over the life of the loan, the total investment will cost $51.6 million, which will be paid over 15 years. (See Appendix II) The net income from subscribers that migrated from Hulu, LLC is estimated to add $8 million in the first year. As estimated subscribers continue to migrate to Netflix, projected net income will increase by about 35% per year. (See Appendix X) The synergy value of this acquisition to Netflix is an estimated $51 million. (See Appendix X) Hulu, LLC has an estimated 40 million viewers per month. If we attract a mere 5%, the acquisition is worthwhile. (See Appendix V) If Hulu is currently owned by content providers such as NBC/Universal, isn’t it possible that these providers will CUT OFF the content after it is sold to you? Think of Hulu as their own child. They are providing it resources so that it does well. Once Hulu is outside of the family, what incentive will they have to provide it resources? Clearly this has to change and is not considered here. 2) Reinvestment of Increased Revenue from Decrease in Postage Cost: Consumers are moving toward streaming content consumption of Netflix content. Netflix projected postage costs of $600 million in 2010 (Knowledge at Wharton, 2009) represents a peak price that will not continue to rise at the rate it traditionally has. Netflix expects their primary mode of content distribution to be streamed content by 2030, which means that their cost of postage will begin to decrease towards that year until it comes minimal. Netflix currently spent 55.8% of their revenue on the combination of postage and content acquisition mostly due to the over $.42 Netflix currently pays for DVD’s to be shipped to and from consumers (Netflix 10K, 2009). For streaming content delivery Netflix incurs a cost of $.06 for standard definition movies and $.09 high definition movies (Rayburn, 2009). This represents a huge cost reduction for Netflix in terms of delivery to consumers. Netflix will be able to maintain the 55.8% cost of revenue for subscriptions, but will now be able to devote more to content acquisition and less to postage and packing costs. Each year where postage costs decrease, the increase in revenue from the decrease in postage should be put directly into content acquisition. 3) More Flexible Revenue Sharing Contracts: To remain competitive with similar content contracts with studios from their rivals, Netflix must act aggressively in
new negotiations and renegotiations with content providers whose content they have not secured from the Hulu, LLC acquisition. Although the figures of Netflix current contracts with studios are not available, Netflix will renegotiate these contracts to include, up to a 50% increase in revenue sharing which will meet the studios needs and prevent them from implementing the 30 day restriction on the rental of new releases. Netflix will use the income provided by the migrated subscribers from Hulu, LLC for the capital necessary for the increased costs associated with the increase in revenue sharing percentages in these contracts. Netflix will offer lucrative contracts to content providers who they do not currently have signed, such as Time Warner Inc.’s HBO and CBS Corp.’s Showtime to acquire their content. These contracts will be directly responsible for Netflix to meet their goal of 7,500 new titles each year of streaming content. These contracts will also maintain relationships with content providers they already have signed to continue to secure the new content they provide each year.

Evaluation & Control
Forecasted Income Statement
Netflix

Actual

Year

2009

2010

2011

2012

(in millions)

$

$

$

$

Net sales

1,364.70
100%
1,797
100%
2,237
100%
2,799
100%
Cost of Revenues

910.2
66.7%
1198.59
66.7%
1,492.08
66.7%
1,867.21
66.7%
Gross Profit

454.50
33.3%
598.40
33.3%
744.92
33.3%
932.20
33.3%
Operating Expenses:

Technology and Development

89.9
6.7%
120
6.7%
149.88
6.7%
187.56
6.7%
Marketing

199.7
14.6%
262.36
14.6%
326.60
14.6%
408.71
14.6%
General and administrative

49.7
3.6%
64.692
3.6%
80.53
3.6%
100.78
3.6%
Gain on disposal of DVDs

(6.30)
-0.4%
(7.19)
-0.4%
(8.95)
-0.4%
(11.20)
-0.4%
Total operating expenses

332.9
24.4%
438.47
24.4%
546
24.4%
683.06
24.4%
Operating income

121.5
8.9%
159.93
8.9%
199.09
8.9%
249.15
8.9%
Other Income (expense):

Interest expense on lease finance obligations

(2.50)
0.2%
(3.90)
0.2%
(3.90)
0.2%
(3.90)
0.1%
Interest and other income (expense)

12.5
0.9%
12.5
0.9%
12.5
0.9%
12.5
0.9%
Income before income taxes

131.5
9.6%
168.53
9.6%
207.69
9.6%
257.75
9.6%
Provision for income taxes

48.5
3.6%
64.69
3.6%
80.53
3.6%
100.78
3.6%
Net income

83
6.0%
103.84
6.0%
127.16
6.0%
156.97
6.0%

Appendices
I.

II.
Debt Financing for Hulu, LLC Acquisition
Years
15
Rate
8.0%
Loan Amount
$ 30,000,000.00
interest
$ 21,605,220.00
Total Investment
$ 51,605,220.00
Monthly Amounts
$ 286,695.63
Yearly Amounts
$ 3,440,348.00

III.
Hulu Purchase Price
Google Sales
21,795,000,000.00
Hulu Sales
2,700,000.00
Market Cap
187,330,000,000.00
Hulu FMV
23,206,744.67
Sales Multiple
8.595090617
Hulu Purchase Premium 25%
5,801,686.17

Hulu Total Purchase Price
29,008,430.83

IV.
Acquisition Feasibility
Subscribers Migrated
Value of Synergy
2%
$ (34,000,000)
3%
$ (5,000,000)
4%
$ 22,000,000
5%
$ 50,000,000
V.
VI.
HULU Subscriber Momentum
Year
Subscribers
1
200000
2
270000
3
364500
4
492075
5
664301
Total
1990876

VII.

VIII.
Netflix Current Ratio

2008
Current Assets
361,447
Current Liabilities
216,017
Current Ratio
1.67
IX.
Effect of Acquisition in Sales

(Millions)
2009
% of sales
2010
% of sales
2011
% of sales
2012
% of sales
2013
% of sales
2014
% of sales
Hulu Acquisition

135.5
7.54%
214
9.57%
335.4
11.98%
493.5
14.12%
782.8
17.64%
Mail-Rental
1,364
100.00%
1,661
92.46%
2,023
90.43%
2464.01
88.02%
3000.899
85.88%
3654.775
82.36%
Total
1,364

1,797

2,237

2799.41

3494.399

4437.575

Works Cited
Associated Press. (2009, October 22). Netflix third quarter earnings climb 48 percent. Retrieved October 29, 2009, from MSNBC: Cheng, J. (2009, October 23). Hulu to Charge for Content. Retrieved October 25, 2009, from Ars Technica: Cnet news. ©2009 CBS Interactive Inc., 21 Sept. 2009. Web. 02 Oct. 2009. .

Hoovers. (2009, November). Blockbuster Inc. Retrieved November 2009, from Hoovers Online: Hulu, LLC. (2009). Hulu: About Us. Retrieved October 28, 2009, from Kaufman, J. L. (2007, December 6). Post Office Drawback Cited in Dark Forecast for Netflix. Retrieved October 15, 2009, from The New York Times: Knowledge at Wharton. (2009, October 28). Netflix: One Eye on the Present and Another on the Future. Retrieved October 30, 2009, from Fritz, Ben. (2009, August 13). Warner Bros. takes aim at Netflix along with Redbox. Retrieved October 25, 2009, from The Los Angeles Times: Fritz, B. (2009, November 13). Blockbuster loss grows as revenue dives 21%. Retrieved November 14, 2009, from LA Times: Manuel’s Web- My Opinion of Netflix. Manuel Villanueva, 27 Mar. 2008. Web. 4 Oct. 2009. .

Netflix 10K. (2009, November). Netflix, Inc. Retrieved November 2009, from Hoovers Online:

Netflix. © 1997-2009 Netflix, Inc. Web. 04 Nov. 2009. .

“Netflix Inc. Report.” Marketline. 17 June 2009. Web. .

“Netflix ‘Throttling’ the Brakes on Frequent Renters?” FoxNews.com. © 2009
FOX News Network, LLC, 13 Feb. 2006. Web. 20 Oct. 2009. .

“NFLX: Summary for Netflix, Inc.- Yahoo! Finance.” Yahoo! Finance – Business Finance, Stock Market, Quotes, News. 2009. Web. .

Rayburn, D. (2009, March 17). Detailing Netflix’s Streaming Costs: Average Movie Costs Five Cents To Deliver. Retrieved November 29, 2009.

Wingfield, N. (2009, June 23). Netflix Boss Plots Life After the DVD . Retrieved November 29, 2009, from The Wall Street Journal:

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