MBUS 807 NETFLIX CASE OMAR MEDINA

To: Reed Hastings, Founder and CEO From: Omar Medina Consulting RE: Growth strategy/Penetrationof the video-on-demand (VOD) market Netflixs competitive environment is becoming hostile; a strategy for entering the video-on-demand (VOD) market must be selected in order to achieve growth targets. This strategy must address issues related to user connectivity, content limitations and initial target market. It is recommended(Exhibit 1) that Netflix develop, and integrate, a VOD platform for its core offering. Netflixs current subscriber base is built on early adopters; these individuals, with free VOD access, will support and help market the VOD platform. Partnerships must be established to expand connectivity options (Exhibit 2) to overcome a key barrier. Strengthening relationships with studios and TV networks is a primary focusin order to obtain digital distribution rights. As a content risk management measure, Red Envelop Entertainment willcontinue to aggressively pursue high quality content for acquisition. Several alternatives (Exhibit 1) were evaluatedand ranked against key decision criteria. Customer satisfaction (quality of the experience)is the most important element to Netflixs business. Netflix has one channel for customers, their website. With high customer acquisition costs, a positive experience is necessary to reduce churn rates. High customer satisfaction will increase revenue growthby adding and retaining subscribers. As a public company,Netflix faces scrutiny by the investor community and growth targets must be achieved. Value innovation has the ability to differentiate Netflix from the competition. This is evident by the success of the recommendation system. A new strategy must add value for subscribers while reducing costs for Netflix. Leveraging Netflixs biggest success, the recommendation system, will provide manybenefits for the company and its customers. The movie rental market is highly commoditized and competition is fierce (Exhibit 3). Netflix, a child of the dot-com era, has been able to differentiate itself through innovation related to service, versus product. This differentiation has resulted in outstanding growth (Exhibit 4).Growth rates are declining to more sustainable levels but measures can be taken to reduce the rate of decline and possibly reverse the trend. Having the most attractive pricing structure, largest movie selection and the most convenient delivery channel will lead to success. Netflixs most valuable asset is its proprietary recommendation system which becomes more valuable with each rental; this asset is a product of pure innovation which has set Netflix apart fromthe industry. The evolution of home entertainment, from Betamax to VHS to DVD and now Blu-ray, reflects the need to stay ahead of the curve, and the need for innovation. A new value curve was created with the Netflix model and its proprietary recommendation system makes imitation extremely difficult;however, stagnation results in a companys demise. Competitive advantages are lost whena value curve converges with that of the industry. An industry transition from DVDs to Blurays is inevitable and would be costly. VOD is regarded as the future of home entertainment, although technological barriers are evident, these barriers will be overcome given the three laws of technology (Exhibit 5). Initial investment costs in VOD will be substantial but are critical to continued growth. The internet provides an opportunity for global expansion but Netflixs current business model is logistically complex. Many of Netflixs weaknesses are related to the current business model.By capitalizing on opportunities (Exhibit 6) Netflix can eliminate many weaknesses, increase strengths and reduce threat levels. Netflix has a strong innovative culture which must be leveraged to enhance value for customers. Certain areas of the implementation (Exhibit 7& Exhibit 8) deserve particular attention. To increase customer satisfaction a problem resolution platform must be integrated with the website;this will be of particular importance when the VOD platform is ready for market. The VOD platform should be offered to existing subscribers free of charge and a new pricing package should be developed for VOD access only. There will be many challenges to obtaining digital distribution rights and a lawyer specializing in this area must be hired. Netflix should expand its content to include TV shows,and eventually, HD content and rentals options for new releases. To do this Ted Sarandos (CCO) must expand his team.Canada the UK and Australia should be the first three targets for global expansion due to the similarities in culture. Netflix must continue to build its inventory of digital content in order to expand its reach across global boarders. Distribution centers, a major cost center, will eventually be closed throughout the US and the VOD platform will be Netflixs sole business model; this will result in substantial long-term cost savings.

MBUS 807 NETFLIX CASE OMAR MEDINA

EXHIBIT 1 ALTERNATIVE ANALYSIS DECISION CRITERIA Achieve growth Value innovation targets/global (product, service expansion and delivery)

Customer satisfaction (Value, Convenience, Selection) ALTERNATIVES 1. Licensing agreements with cable providers (recommendation system & VOD offering) 50% Cable providers will realize most of the benefits from increased satisfaction, not Netflix customers.

Leverage proprietary recommendation system for Netflixs benefit 10% SCORE

25%

15%

Short-term growth Current customers The targets could be will not gain any recommendation achieved but value from this system will benefit negotiations with strategy; Netflixs cable providers cable providers will value curve will eliminating increase converge with that Netflixs main complexity, of the industry. differentiator; their particularly with competitive global expansion. advantage. 10/25 5/15 5/10 The internet is Long term costs will Expanding the global, once the decrease as the offering will result infrastructure is in mail order business in more place Netflix will be is phased out & the customers, movie able to access most VOD platform selection & global markets becomes the brand. increased ensuring short & Value for customers accuracy for the long term growth will be tremendous recommendation targets are in both the short & system. achieved. long term. 40pts

2. Integrate VOD feature into core offering product line expansion

20/50 Netflix will gain the full benefit of increased customer satisfaction which will grow with video content expansion.

90pts 45/50 20/25 15/15 10/10 3. Create a stand- This will not have This will help Netflix Although Netflix will More customers alone VOD a major impact on achieve growth have full control will drive platform existing targets & provide a over product, increased customers or their platform for global service & delivery recommendation level of expansion. there will be no accuracy but satisfaction. additional value for adoption rates will existing customers. suffer with a stand-alone VOD platform. 67 pts 30/50 20/25 7/10 10/15 4. Maintain current This will not have Adapting to market A lack of innovation Leverage of their strategy of DVD a major impact on changes & & added value will greatest assets is mail-order existing technological have a deteriorating not apparent, the business& start customers or their advances is critical effect on the status-quo building a Blu-ray level of for survival & business. continues. inventory satisfaction. growth. 25/50 5/25 0/15 0/10 30 pts

MBUS 807 NETFLIX CASE OMAR MEDINA

EXHIBIT 2 PARTNERSHIPS Partner Cisco Product Development & manufacturing of TV set top boxes for sale through Netflix & other retail outlets. Development & manufacturing of a Bluetooth solution for wireless streaming. Development & manufacturing of optimal computer (PC & MAC) adapters for TV for sale through retail channels, Netflix or free of charge with a one-year subscription. Incorporate access to Netflix through video game consoles (Xbox, PlayStation & Wii). Develop applications for download which will facilitate streaming. The IPhone is scheduled to be released in June of 2007. Incorporate access to Netflix through all of LGs HDTVs and Blu-ray players. Relationships with both studios and TV networks must be strong to obtain the digital distribution rights for quality content.

Hauppauge Microsoft, Sony & Nintendo Smart phone manufacturers LG Studios & TV networks

EXHIBIT 3 COMPETITION Wal-Mart & Best Buy Blockbuster Google TV Networks Digital file ownership Set-top box companies Stand-alone VOD Cable and Satellite Companies Major retailers are stocking and selling DVDs. Dominant industry player with a large network of stores; in talks to purchase MovieLink from major studios. Entered the online video segment through the acquisition of YouTube. CBS & ABC have started streaming content through their websites Many sites are offering this service which allows customers to pay & download content to multiple devices. MovieBeam acquired by MovieGallery offers streaming straight to your TV. Vongo (Starz subscription cable channel) & CinemaNow (Lionsgate, Microsoft & Cisco) able to rent or burn videos online. Have started to offer VOD service with both a paid offering & a free offering.

EXHIBIT4 - GROWTH ANALYSIS Year Revenue Revenue (% growth) Subscriptions Subscriptions (% growth) 1999 4854 730% 107 2000 35894 639% 292 173% 2001 74255 107% 456 56% 2001 150818 103% 857 88% 2003 270410 79% 1487 74% 2004 500611 85% 2610 76% 2005 682213 36% 4179 60% 2006 996660 46% 6316 51%

Willy Shih, Stephen Kaufman, David Spinola, Netflix, (Harvard Business School 04/27/2009)

MBUS 807 NETFLIX CASE OMAR MEDINA

EXIHIBIT52 - THE THREE LAWS OF TECHNOLOGY 1. Moores Law: Formulated by Gordon Moore of Intel in the early 1970s: The processing power of a microchip doubles every 18 months. Corollary: computers become faster - &the price of a given level of computing power halves - every 18 months. 2. Gilders Law: Proposed by George Gilder, prolific author & prophet of the new technology age: The total bandwidth of communication systems triples every 12 months. New developments seem to confirm that bandwidth availability will continue to expand at a rate that supports Gilders Law. 3. Metcalfes Law: Attributed to Robert Metcalfe, originator of Ethernet & founder of 3COM: The value of a network is proportional to the square of the number of nodes; so, as a network grows, the value of being connected to it grows exponentially, while the cost per user remains the same or even reduces.

EXHIBIT 6 SWOT Strengths y Leader in online DVD movie rental market y Strong brand recognition y Tremendous growth y Proprietary recommendation system y Subscription based service y No late fees y 44 distribution centers across the US y 70,000 different titles (selection) y Reduced overhead expenses y Economies of scale y User friendly website y Strong customer service culture y Relationships with studios y Employees & company culture Opportunities y VOD service (company funds have been allocated for investment in infrastructure) y Content acquisition through Red Envelop Entertainment y Strengthen relationship with studios & develop relationships with TV networks y Domestic & international expansion y Partnerships & alliances Weaknesses y No physical stores for customers y Inventory management across distribution centers - forecasting demand y Dependency on USPS y Bottlenecks resulting from returns by mail y Time lag from order to delivery y Subscription service not economical for occasional movie watchers y Public company with full disclosure y Target market limited to individuals with internet access & a DVD player

Threats y Network of traditional brick & mortar movie rental stores y Increased competition in various segments (VOD, DVD retail & rental outlets, pay-perview, cable & satellite companies) y Piracy or peer-to-peer movie sharing over the internet y Next generation technologies y Digital distribution rights y High churn rate

Jim Pinto, The 3 laws of technology,http://www.jimpinto.com/writings/3laws.html

MBUS 807 NETFLIX CASE OMAR MEDINA

EXHIBIT 7 SHORT-TERM GANTT

Q1 Task 1 - Announce plans for VOD platform 2 - Develop & integrate problem resolution platform 2.1 - Develop & integrate VOD platform 2.2 - Hire lawyer specializing in digital distribution rights 2.3 - Source & build partnerships to enable connectivity 2.4 - Aggressively acquire digital content for distribution 2.5 - Pre-launch advertising blitz 3 - Roll out VOD platform 3.1 - Post-launch advertising campaign (free trial offer) Start Jan-07 Jan-07 Jan-07 Jan-07 Jan-07 Jan-07 Oct-07 Jan-08 Oct-05 End Jan-07 Jun-07 Dec-07 Dec-05 Dec-07 Dec-05 Dec-07 Jan-08 Dec-05 Responsibility R. Hastings IT IT HR Operations T. Sarandos Marketing All bus. units Marketing Q2 Q3 Q4 Q1 Q2 Q3 Q4

2007

2008

EXHIBIT 8 LONG-TERM GANTT

1 Task 1 - Acquire digital content (current & new markets) 1.1 - Build employee base for new target markets 1.2 - Expand VOD platform to Canada, UK & Australia 1.3 - Reduce DVD inventories 1.4 - Close distribution centers & sell DVD inventories 2 - Expand VOD platform to Europe, Asia & India 3 - Expand to all other markets Start Jan-09 Jan-11 Jun-11 Jan-14 Jan-17 Jun-18 Jan-20 End Dec-24 May-11 Dec-13 Dec-16 Dec-18 Dec-19 Dec-24 Responsibility Content unit HR All bus. units Operations Operations All bus. units All bus. units 2 3 4 5 6 7 8

2009 - 2024 (1 period = 2 years)