Netflix Analysis Industry Drivers

The intent of this analysis is to discuss the key industry drivers that are creating opportunities and threats for Netflix (NASDAQ: NFLX), in addition to defining the future of the mail-based and online movie rental subscription service. Competition from Video-On-Demand (VOD) services offered by cable television companies including Time Warner Cable, Comcast and others, combined with kiosk delivery network Redbox and the vertical integration of Blockbuster are fundamentally reordering the industry today

(Netflix Investor Relations, 2013). Competition continues to accelerate as each of these competitors invest in research & development (R&D) to increase the performance and reliability of their individual services.

Of the myriad of economic factors that impact their business, Netflix senior management is most concerned and tracks through weekly reporting the level of consumer spending on entertainment in aggregate and for DVID, game and video rental specifically (Netflix Investor Relations, 2013). Additional external factors include time spent on leisure and sports and percentage of services including the proportion of a given weeks' time is spent online (Netflix Investor Relations, 2013). These factors are the most significant in their impact on Netflix subscription and rental demand according to an analysis of their annual reports and filings with the Securities and Exchange commission in 2012 (Netflix Investor Relations, 2013). Netflix also reports that by their own estimation, 49.2% of all movies rented today are delivered via kiosk, followed by subscription-based rentals (26.5%) and brick-and-mortar stores (24.3%) (Netflix Investor Relations, 2013). Cost, convenience and technology are the core components of the company's value proposition today (MacCormack, Murray, Wagner, 2013) and the future growth of the business is going to be highly reliant on how effective the recommendation system performs over time to support a more unique and memorable customer experience of using their service (Papadimitriou, Symeonidis, Manolopoulos, 2012).

II. Five Forces Analysis

Using the Five Forces Model as the framework to complete this section of the analysis illustrates how the high level of competitive rivalry in this industry, in addition to the formidable challenges Netflix has to continually growing profitably. Figure 1 illustrates the structure of the Five Forces Model as designed by Dr. Michael Porter of Harvard University (Porter, 2008). This model has proven to be highly effective in determining the level of competitive rivalry within and between industries. Analyzing Netflix's market position by taking into account the relative influence of each of the five forces further underscores how rapidly changing the nature of competition is in this industry today as well.

Figure 1: The Five Forces That Shape Industry Competition Source:

Source: (Porter, 2008)

Beginning with the Threat of New Entrants, Netflix's greatest competitive strength on this dimension of the model is their customer loyalty (MacCormack, Murray, Wagner, 2013). Kiosk-based delivery models have proven to be formidable new market entrants, as evidenced by the success of Redbox and the market share they have attained, which is significant according to Netflix' own measures of market activity as reported in their financial statements and disclosures to the U.S. Security and Exchange Commission (SEC) in their Form 10K and other filings (Netflix Investor Relations, 2013). Brick-and-mortar-based competitors have higher operating expenses and often must include real estate capital expense (CAPEX) costs as part of their distribution networks and value chains (MacCormack, Murray, Wagner, 2013). The CAPEX-heavy competitors Netflix first faced when they started the business proved to be too slow to react to the disruptive change of video rental business models and chose to vertically integrate, as Blockbuster and others have done (Netflix Investor Relations, 2013). Vertically-integrated, capital-intensive competitors have failed however to create significant barriers to entry to this industry. As a result the Threat of New Market Entry is considered to be Medium to High.

To date Netflix has experienced steady revenue growth mainly as a result of its management of their subscription revenues, which have become an annuity that is financing other parts of the business (Netflix Investor Relations, 2013). It is also an indication of how powerful Buyer Power is as a factor in the Five Forces Model. The many efforts Netflix has made to introduce new programming, launch bundling programs, create more effective programming and online delivery systems including multi-screen consumption of video content are all aimed at earning customer loyalty (MacCormack, Murray, Wagner, 2013). The recommendation system is designed to match preferences while also promoting for additional rentals, thereby becoming and upsell and cross-sell platform on its own as well (Papadimitriou, Symeonidis, Manolopoulos, 2012). Buyers...

Buyer Power is the most powerful of the five forces in the industry as a result.
Supplier Power is also high as the content producers an dictate who gets what movies, television shows, short films and documentaries. Studios, networks and distributors often change licensing agreements over time depending on the relative popularity of a given genre or specific show. Netflix senior management lists licensing agreements in their list of risks in the Form 10Q filed with the SEC to report potential shortfalls to revenue operations (Netflix Investor Relations, 2013). Supplier power is also changing the nature of technology investment in the industry, where streaming video patents look to qualify licenses based on the requested move from a subscriber (MacCormack, Murray, Wagner, 2013).

The Threat of Substitution, due to the ubiquity of technologies, is also high. From tablet PCs running the Apple iOS and Google Android operating systems to the latest wide-screen smartphones, the threat of substitution is only gated by the delivery technologies and licensing structures of content providers (Netflix Investor Relations, 2013). Netflix lists the rapid evolution of form factors as a significant opportunity for their business in their Form 10K and other documents, in addition to defining their overall strategy for transforming this into a revenue opportunity. The Threat of Substation however is high and driven by a high level of Buyer Power in the industry as well. As with enterprise software and many other areas of Web-based software delivery today, a high priority is being placed on mobility platform development. This continues to drive the Threat of Substitution as well. Video streaming is the most disruptive of technologies in this area and one that Netflix must continue to monitor in order to stay competitive.

With all of these factors taken into account, the Competitive Rivalry of this industry is considered High. As there is a disruptive shift in the value chain itself and the delivery technologies as well. It is clear that this industry will continue to see commoditization and heavy price competition. Only by having a disruptive, highly innovative platform will Netflix be able to emerge a market leader and manage to continually grow against the rapid ascent of kiosk-based systems including Redbox (Netflix Investor Relations, 2013).

III. Changes to the Industry Structure and Competitive Environment

The industry today is at a stable maturity to declining maturity level with medium levels of revenue volatility, capital intensity and barriers to entry. Thankfully for all participants, the regulation level of the industry today is light and industry globalization level is low. The competitive level of the industry, concentration level and speed of technology change are all very high (Netflix Investor Relations, 2013). All of these macro-level factors indicate that the industry is facing the threat of consolidation, and Netflix senior management clearly sees the potential to use disruptive innovation to further accelerate their growth in a very competitive market (MacCormack, Murray, Wagner, 2013).

Shifts in consumer spending, time spent on leisure and sports and the percentage of time and services conducted online continue to shift, the industry structure will also face a corresponding restructuring and shift as well. The CAPEX-level investments of competitors who are vertically integrated are going to eventually prove to be too expensive to maintain just for video rentals and games. Eventually CAPEX-intensive competitors will need to begin to act as industry consolidators on their own; in act this is the best survival strategy of all for Netflix' many competitors who are locked into CAPEX-based business models. They will need to become the consolidators of the industry themselves and begin buying up smaller chains and force the consolidation of the industry through mergers and acquisitions. According to Netflix analysis and reporting in their SEC filings, senior management sees this as inevitable with the largest CAPEX-based competitors taking the lead as industry consolidators (Netflix Investor Relations, 2013).

IV. Existing Rivals Competitive Capabilities Analysis

Netflix faces three dominant competitors including Blockbuster with approximately 17% market share, Redbox which the company estimates has 45.5% market share, and with independents who have 13.3% share according to the company's filings with the SEC (Netflix Investor Relations, 2013). Blockbuster with its CAPEX-intensive cost structure and heavy reliance on retail, has customer been able to gain an advantage in the use of analytics to measure customer churn based on foot traffic in their stores (MacCormack, Murray, Wagner, 2013). Blockbuster is also positioned well to be an industry consolidator, using merger and acquisition (M&A) strategies to further capture more the largest and most profitable independents…