A REVIEW ON HOW NETFLIX DESTROYED BLOCKBUSTER

SUBMITTED BY: Amit Bhomle Ananya Tiwari Ankita Sarawgi Haritima Wadhwani Harsh Golani Harshad Lunavat

Overview: During the period of 2010-11 Blockbuster has been on decline and filed for bankruptcy. It is interesting to study how Netflix overshadowed a media empire like Blockbuster, which developed and evolved with time by eradicating local video rental shops. Blockbuster became the mega giant of video rentals and immediately stomped out mom & pop video stores everywhere. Funny that Netflix sort of did the same to them. But instead of totally taking it up, they decided to fight back and launched their own rental service very similar to how Netflix does thing. Basically, both require a monthly membership fee where you can automatically stream a selection of movies, documentaries and TV shows from your computer and/or any compatible devices or place an order for mail-in movies. Netflix finished up a stupendous quarter, earning $0.59 per share -- topping Wall Street targets by a nickel. The retailer gained a record 1.7 million new subscribers and closed out the threemonth period with almost 14 million customers. Revenue for that quarter neared $500 million and represented a 25% year-over-year growth. Churn rate dropped, gross margin grew, and the company projects a stronger second quarter.

EXHIBIT 1

EXHIBIT 2

HOW NETFLIX STARTED AND MADE IT BIG The genesis of Netflix came in 1997 when the CEO of Netflix Mr. Reed Hastings got this late fee, about $40, for Apollo 13. He was embarrassed about it. That was back in the VHS days, and it got him thinking that there's a big market out there. So he started to investigate the idea of how to create a movie-rental business by mail. He didn't know about DVDs, and then a friend told him they were coming. He ran out to Tower Records in Santa Cruz, Calif., and mailed CDs to himself, just a disc in an envelope. It was a long 24 hours until the mail arrived back at his house, and he ripped them open and they were all in great shape. That was the big excitement point. Early on, the first concept they launched was rental by mail, but it wasn't subscription based, so it worked more like Blockbuster. Some people liked it, but it wasn't very popular. Reeds thought, God, this whole thing could go down, and we said, Lets try the more radical subscription idea. They knew it wouldn't be terrible, but they didn't know if it would be great. They launched the service on Sept. 23, 1999, and could tell within a month that they had a renewal rate. It was a free trial, but only 20% didn't go from the free trial to the paid. They're up to 90% renewal now.

THE NETFLIX MODEL The widespread acceptance of DVD format was a presumption and risk for Netflix business model. Users could search through the collection and select the desired title. The DVD was mailed to the customer using the USPS service. Earlier, Netflix used the per rental charge model as other companies plus the shipping charges. However Netflix soon realized that it was spending $100 to $200 for a customer to make one $4 rental. As a solution, Netflix started the prepaid subscription based model. The new model allowed greater customer retention, turned the long delivery time to an advantage and most importantly allowed Netflix to offer unlimited DVDs per month. The new all you can eat model was an attractive alternative to the traditional per-day fee structure with late fees. A diagram of this system can be seen in Exhibit 1. The next hurdle Netflix faced was high demand for hit and new movies and the user frustration with the movie unavailability. The recommendation system was developed which makes suggestions of movies that are available and might be of interest based on preference and history. The success of the recommendation system decreased the demand for newer releases to 20% of the total demand compared to the 70% for the traditional video rentals. A positive network effect was generated from the large customer-generated rating system. As a start-up company, Netflix did not have any business relationship with major studios. Netflix mainly acquired titles from smaller studios at a minimal discount. Sarandos who had excellent relationships with the studios and was veteran in the DVD rental industry was successful in forming revenue-sharing agreements with the major studios. The average wait time when there was just one warehouse in Sunnyvale was about 1 week. The one day delivery model was very useful. Today, Netflix has 44 distribution centers across the country, which can deliver to more than 90% of 6.6 million subscribers within a single business day. Using optimized processes, Netflixs employees could open and re-stuff an average of 800 DVDs per hour, allowing the entire distribution center network to ship over 1.6 million DVDs per day. The efficient and minimalistic work processes are part of their overall competitiveness.

NET SALES OPERATING EXPENSES OPERATING EXPENSE(AS A % OF SALES) NET INCOME # OF EMPLOYEES PROFIT MARGIN

NETFLIX 16,670,000,000 3,984, 130, 000 24% 1, 000, 200, 000 2000 35%

BLOCKBUSTER 4,062,400, 000 2,533,000,000 62% -558, 000, 000 38,400 53%

TABLE NO 1. Netflixs operating cost in relation to revenues is less than half that of their competition Blockbuster In addition, Netflix collaborated with USPS, to further reduce the turnover time and cost. Netflix received a standard discount for presorting the mail by zip code. As Netflix became known as the de facto source for independent and foreign movies, the smaller studios were interested in partnering with Netflix to market their movies. In 2006, Netflix started to acquire rights for some independent movies through its Red Envelope Entertainment subsidiary. Another growing concern for Netflix was the high attrition rate (churn rate), which grew from 3.6% in 2002 to 6.3% in 2006. SAME MARKET BUT A DIFFERENT APPROACH Although, Blockbuster and Netflix competed in the same video rental market they did different jobs for consumers. Blockbuster made its core business the idea of a movie night. They assumed that most movie rentals were impulse decisions for people who want to watch a movie right now. These were usually new releases and so this is a majority of what Blockbuster stocks. Netflix on the other hand has evolved to view movie watching as a regular part of daily entertainment. They appeal to the customers who do not see movie night as an event but instead as an ordinary form of entertainment like watching television. The ability to hold movies longer and the convenience of receiving/returning through mail is perfect option for this type of consumer. So, Blockbuster and Netflix cater to two different types of movie renters. Blockbuster customer would probably watch fewer movies but the ones they do watch would be new releases rented impulsively. A Netflix customer would watch movies more frequently. They would also be more interested in lesser-known films and would plan out their rentals in advance. Blockbuster and Netflix have differing business models and their operations strategies reflect it. As stated above, Blockbuster focuses on the movie night crowd who want a new release movie right away. So, they operate in a brick and mortar way where customers come into the store and leave with a movie. Their business model is to allow consumers to make an impulse decision to rent a movie and get it right away. To accomplish this they have an operations strategy of actual stores located heavily across the United States and stocked with mostly mainstream titles. Netflix on the other hand has created a business model around the idea that

consumers want convenience and selection more than they want to be able to make an impulse decision. They then created an operations strategy to accomplish this. Monthly fees instead of rentals, mail delivery instead of pickup, and a wide choice of movies instead of just new releases are all a part of their operations strategy. EASE OF ACCESS TO INTERNET AND DIGITAL MEDIA AND ITS EFFECT ON NETFLIX With the rise in availability of broadband Internet and Internet connectible devices, the video on demand business model has gained prominence. VOD is a pay per view ability to access any multimedia content to an individual Web browser or TV set based on user requests. VOD systems either stream content through a set-top box, a computer or other device, allowing viewing in real time, or download it to a device such as a computer, digital video recorder or portable media player for viewing at any time. In a press release, CEO Reed Hastings referenced one of the main factors to its success. He said, "It is clear that our performance, and the overall appeal of the Netflix service, is being driven by subscribers watching instantly. On that score, we reached a milestone in the quarter as more than half of all members -- 55% and growing -- enjoyed movies and TV episodes streamed from Netflix over the Internet." 55% of Netflix subscribers have watched more than 15 minutes of content streamed to their computer or Netflix-supported device. And the number of those devices continues to grow. The retailer has only recently added the Nintendo Wii and its 30 million American users to the fray, but its service is also compatible with the Xbox 360, PlayStation 3, TiVo, and decks from Panasonic, Insignia, and Seagate. Also, Netflix aims to add support to Apple, Android, and Windows 7 mobile devices. It's the at-home streaming aspect that's Netflix's bread and butter. Already two steps behind the tastes of the home viewer, Blockbuster stumbled so late to the video streaming game that Netflix had already commanded the service with dependability and name recognition -- giving it a lead that Blockbuster could never reach. Especially when the latter brings back late fees and sets up rental kiosks using SD cards rather than discs.

NETFLIX SWOT ANALYSIS Strengths -Few employees, low overhead costs -Predictable revenue via monthly subscriptions -Efficient/minimalistic supply chain Weaknesses -High DVD attrition rates ~4.2% -Small Library -Availability of new releases Opportunities -Continue to utilize Word Of Mouth Marketing via referral systems -Partnerships with production agencies -Video On Demand Threats -Competition, existing and new offering VOD capabilities -Blockbuster Total Access

WHERE DID BLOCKBUSTER GO WRONG AND NETFLIX STRIKE IT RIGHT? In response to Netflix's proposition of convenience, Blockbuster announced that they will let people return videos whenever they like, with no penalty for lateness. What this did is further increase their capital costs, which were already drastically higher than Netflixs given their need for physical locations. This of course did little to improve business as customer defections continued and revenues dropped. Because of Blockbusters high capital costs, the decrease in revenue caused profits to tumble into the red, the company closed store locations which made it even more inconvenient for customers to rent movies, further driving them into the arms of Netflix. The real hit to their business came in 2007 when Netflix launched a download version of their service and soon after, iTunes began distributing movies to its portable devices and Apple TV. Blockbuster continued to see itself as a provider of movie and game rentals rather than a distributor of entertainment. By locking itself into this narrow view, they ignored the innovations happening around them and believed that people wanted to come into the store and talk to their staff, get recommendations, and make their choice, but of course this was not the case. The internet provided all the recommendations they needed and the convenience of renting with a few mouse clicks became impossible to beat. To further compound their problems, the recession as well as growing concerns about the environment took hold, so people were less and less willing to spend money on gas and make two trips to rent a movie. Realizing that Netflix and iTunes were serious threats to their business, Blockbuster began opening automated kiosks in grocery stores and other locations to increase convenience, as well as creating an on demand service that would stream movies to portable devices, PVR's and computers. But all this was too little too late, and the crutch of servicing its large debt load and high capital costs proved too much in the face of their entrenched and thriving competitors. Netflix's image may have taken a hit with recent class action suits alleging privacy invasion and a scheme to restrain trade, but the service remains very popular. Even with titles from Warner Bros., Fox, and Universal being held 28 days after release, it's unlikely customers will cancel their subscriptions over the matter. If anything, it'll only hurt the studios. As the digital age evolves, Netflix has become a household name for online video and television streaming and has almost eliminated the way we used to rent DVDs. Driving to stores like blockbusters to pick up a CD has become a matter of past and people prefer hassle free downloading or ordering online. Thus, Netflix has evolved with the time. SECRETS OF NETFLIXs SUCCESS

Target a specific niche: CEO of Netflix diagnosed what the problem was and targeted specifically that, he analyzed and understood the latent need of customers and designed a service based on that. They targeted a specific problem of penalties on video rentals.

Flexibility: They named the company Netflix, not DVDs by Mail because they knew that eventually they would deliver movies directly over the Internet. DVDs will be around a long time, but they were building for the day when Blockbuster was not. Never underestimate the competition: Netflix erroneously concluded that Blockbuster (BBI, Fortune 500) probably wasn't going to launch a competitive effort when they hadn't by 2003. Then, in 2004, they did. They thought, Well, BBI won't put much money behind it. Till 2008 years they had invested more than $500 million against Netflix. No shortcuts: Occasionally great wealth is created in a short amount of time, but it's through a lot of luck in those situations. You just have to think of building an organization as a lot of work. It may or may not turn into great wealth.

WHAT BLOCKBUSTER COULD HAVE AND SHOULD HAVE DONE.

Purchased Netflix in 2000, this may not have been necessary if blockbuster had simply repositioned itself and modified its strategy Opened kiosks much earlier and began closing stores, this would have reduced capital costs and improved convenience Emulated Netflixs early model of subscriptions and distribution through mail Entered the on demand space much earlier, before Netflix and iTunes took over the market