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Bond University

Entrepreneurship and Innovation ENFB-104_153

Group Project: Analysis of the Innovative Strategy of a Firm

Professor:

Baden U’Ren

Students:

Martin Byström

Conrad Quick

Danny Korakali

Oleksii Mykhailiuk

Year 2015

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Executive Summary

Through disruptive innovation Netflix has soared to the peaks of the entertainment industry,

which has resulted in originally significant competitors i.e., Blockbuster, filing for bankruptcy

not long after a huge growth in consumer access to the internet. Their unique value proposition

statement appealed to consumers and fundamentally challenged traditional retailer’s business

models, pricing and product delivery.

By adopting, perhaps unwittingly, a Stewardship Theory style of staff control through their

“Freedom and Responsibility” culture, Netflix has attracted and retained only the highest

performers. Staff need very little encouragement to work autonomously and heuristically, often

putting together groups from different departments to “socialise” new ideas innovatively.

Their main success factors lies in their visionary management, ground breaking talent

management policies and their efficient use of advanced algorithms that constantly offer

consumers relevant content. However, based on the analysis several gaps and

inconsistencies has been identified through the utilisation of the McKinsey 7S framework.

The ongoing innovation that Netflix has demonstrated is their industry disruptive streaming

services, distinctive talent management approach, rapid global expansion and their dual

strategy where they act as a low cost entertainment streaming provider while at the same time

providing high quality original content.

This will continue to act as an enabler for them to continue growth on their current trajectory

for another one to two years while Netflix completes their global expansion plan. This growth

may be unsustainable because within 2 years Netflix will be established in all intended

countries and their main focus will then be on generating profits globally from their own

material and content from 2017 onwards.

The challenge for Netflix in future will be to create new opportunities and market sectors that

will enable them to maintain status quo as an innovative market leader that continues to attract

highly desirable T-Shaped employees but also investors and collaborators alike.

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Introduction

This paper will investigate the Netflix innovative strategies using McKinsey’s 7S framework.

Using this framework, an analysis will be conducted to find gaps an inconsistencies and we

will, based on the analysis, suggest ways in which Netflix can improve. This paper will also

discuss the major contributors to the firm´s innovative success.

As we believe that Netflix DVD rental business “Qwikster” is not suitable to assess for this

project we will focus on the part of the company that is related to the streaming service.

Company overview

Marc Randolph and Reed Hastings founded Netflix in 1997 in California, USA. It first started

as a mail order company delivering DVD’s and their first business model consisted of a

traditional pay per view model but was later changed in favour of a monthly subscription with

unlimited rentals. Netflix built its reputation on having a flat fee model with no late fees, postage

fees or due dates.

In 2007, Netflix introduced the possibility to stream content, consisting of movies, TV series

and documentaries through their website. This allowed customers direct access to their

content instead of waiting 24 hours to receive a DVD via the post. Netflix has streamed a total

of 10 billion hours of content from its libraries in the first quarter of 2015 (Frommer, 2015). Up

to 30% of the traffic in this US during peak hours can be related to Netflix (Appendix 1).

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Netflix was embroiled in controversy when the company decided to split up the DVD rental

service and online streaming service into two different subscriptions. This led to customers

having to pay a higher price if using both services and was not popular.

In 2010, Netflix launched its streamed service internationally when entering the Canadian

market. The service is now available in over 60 countries and their reach spreads out over five

different continents. Since 2012 Netflix has produced its own shows and movies, with famous

titles such as the hugely popular “House of Cards” and “Orange is the New Black”.

Netflix’s total amount of subscribers is, as of October 2015, 69.17 million, including more than

43 million in the US. The turnover for the financial year of 2014 was US$5.5 billion, an increase

of 21% from the year before with an estimated market value of $44.93B as of October, 2015.

Netflix´s main competitors on the streaming market is HBO, Hulu and local players such as

Stan and Presto in Australia.

Strategy

Netflix aims to deliver streamed content at an affordable cost, to consumer’s different platforms

such as smart phones, tablets, computers and smart TV’s. For a monthly fee, customers can

access a large library of movies, series and documentaries, free of commercials (Granados,

2015).

Netflix does not use a Freemium Model, which is widely used among competitors and other

streaming services such as Spotify. Instead, all content is free of advertisements. This has

had a major impact on TV networks, who have now started to decrease the amount of

advertisement during prime time shows (McAlone, 2015).

Netflix has opted for a dual strategy in order to attract as many customers as possible. Their

first strategy is to offer one of the markets most affordable service. Compared to its

competitors, Netflix price is one of the lowest on the market. Their second strategy is to move

from being a distributor of content to offer original content that is exclusive to Netflix (Shah,

2015).

Following this strategy, Netflix has produced a lot of own content as a way to create an air of

exclusivity, plus the desire and loyalty from its customer base. As the Netflix CEO, Reed

Hastings, explains: “We don’t and can’t compete on breadth with Comcast, Sky, Amazon,

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Apple, Microsoft, Sony, or Google. For us to be hugely successful we have to be a focused

passion brand. Starbucks, not 7-Eleven. Southwest, not United. HBO, not Dish.”

It is also a way to make Netflix less dependable on the TV networks. Studies have shown that

Netflix, together with HBO, has the highest-ranking shows in the industry (McAlone, 2015).

Netflix has also made strategic alliances with different studios in order to cut out the TV

networks (Smith, 2015).

Offering licensed content is expensive and does not offer any extra value compared to

competitors unless it exclusive. Consumer trends have shown the customers are usually

willing to pay more for exclusive material. This strategy is further enhanced, as Netflix will

invest US$5B in 2016 and the majority of the money will be used to produce up to 475 hours

of original content (Garrahan, 2015).

The benefits of own content is that it gives perpetual exclusivity, which means it can be

delivered in any country for as long a period as required. This is not always possible with

bought content and can be experienced when travelling to different countries, as the content

will not be the same everywhere. The bargaining power is definitely lower when having to

license other provider’s material.

Structure

Netflix has been commended for pioneering innovations in the area of human resource

management (McCord, 2014). The organisation has a functional organisation structure, which

is notably flat. The worldwide operations of Netflix are run by a senior management that is

segmented into different functional departments rather than by customer segment or region.

The departments are each headed by Chief Officers that report directly to the Chief Executive

Officer. In this regard, the top level management is considered as having a centralised

structure. The organisational structure below shows the top level management structure.

In an industry that is rapidly advancing, coupled with high competition, Netflix has developed

an efficient working relationship among its different functional teams. “Highly aligned, loosely

coupled” is a motto within the company. It suggests that employee should spend as little time

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as possible coordinating between the departments and silos. Instead, trust is valued higher

than previewing and pre-approving proposals. The reason for this is to continue to be a fast

and flexible company. However, it does not include the alignment on objectives and strategy,

as this is still coordinated between different departments (Amaral, 2015).

A Streaming and Partnerships Team is responsible for global partnerships with consumer

electronics companies, Internet Service Providers and multi-channel video programming

distributors that enable Netflix to deliver movies and TV shows across a full range of devices

and platforms. They work in collaboration with the Product Team who which design, build and

optimise the Netflix experience (Netflix, 2015).

Systems

Netflix has five main systems that the organisation runs on a day to day basis. They are

acquisition, packaging, exhibition, distribution and sales.

Netflix content acquisitions are through the following agreements: direct purchase from studios

and distributors, revenue sharing programs and licence agreements. Streaming titles are

generally licensed for a fixed term. The process of acquisition requires high negotiation skills

in entering sound deals and at the same time extensive monitoring of customers viewing

preferences.

Netflix has, through its website, been able to feature the base actions of the company and for

subscribers such as: subscription account sign up; personalised merchandising; inventory

optimisation; streaming content and payment. Netflix’s merchandising technology creates a

powerful method of catalogue browsing and is believed to be directly tied to the company’s

success. Because of the extensive use big data and powerful algorithms Netflix is able to offer

a quick and personalized way of finding content for subscribers based on their viewing

preferences. The technology also provides information about each title such as, factual data,

trailers and editorial information, recommendations and information gathering by the service

for each subscriber.

Netflix utilises various models to promote their service. Online advertising, TV and radio

advertising, direct mail and third party promotions are some of their many marketing strategies

to gain subscribers. Electronic partners also help promote the service (Handmer, 2015).

Online advertising is an important channel that consists of: search listing, banner adds, text

links, permission based emails and an affiliated program whereby web-banner ads are

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available on a self-assisted basis. There are also cooperative advertising programs with

studios under the terms in which Netflix receives economic considerations in exchange for

features and studio’s movies in the promotional advertisement.

Staff

Netflix staff’s main strengths lay in their Finance (David Wells, 2015) and Computer

Engineering (Neil Hunt, 2012) Departments, but have had weaknesses in their PR (Jonathan

Friedland, 2012) and Marketing (Meghan Kelly, 2012) Departments. These weaknesses in

leadership have been addressed and the company continues to grow today.

The staff are highly skilled and well-educated, coming from universities such as Stanford and

Yale. They are generally well compensated with staff salaries, on average, deemed to be

amongst the highest in America, averaging $180,000 per year (Michael Zennie, 2015).

Netflix aims to treat staff well, as demonstrated with their innovative unlimited maternity and

paternity leave staffing policy. Introduced in April 2015, in their first year after having a child

or adopting staff are able to take unlimited leave. Netflix also has a “Freedom and

Responsibility Culture”, where staff are encouraged to decide on how much personal leave

they take each year (Hastings, 2012). This Stewardship Theory type of leadership is a style

that supports innovation, which acts as a great enabler of heuristic innovation for the company.

Netflix targets high performing staff only, and adequate performing staff see their employment

agreements terminated and are given severance packages. The “Keeper Test” that Netflix

Managers use is to ask themselves “Which of my people, if they told me they were leaving,

for a similar job with a peer company, would I fight hard to keep at Netflix?” The policy states

that the ones that they wouldn’t fight for should get a generous severance package now (Patty

McCord, 2014).

With Netflix having passed through their “Crisis of Autonomy” in 2012, after the cancellation

of their “Qwickster” (DVD by mail service) part of the business and the CMO resigning, they

moved upwards through the Adolescence Stage to the Prime Stage of the Corporate Lifecycle

(Adizes, 2015).

Netflix has been described as one of the leading organisations who has “reinvented HR”

according to Sheryl Sandberg, the Chief Operating Officer of Facebook (McCord, 2014).

Netflix has been recognised for the innovation in human resource management, now known

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as talent management. Talent management has shaped the culture and motivated the

performance at Netflix. Netflix has pioneered talent management ideas such as the concept

that workers should be allowed to take whatever vacation times they feel is appropriate. The

talent department has invented a whole new approach to traditional human resource

management. This approach to talent and culture has compelled the company to achieve high

performance results. Below are the five key principles (McCord, 2014):

Hire, reward and tolerate only “Fully Formed Adults”

Tell the truth about performance

Managers own the job of creating great teams

Leaders own the job of creating the company culture

Good Talent Managers think like business people and innovators first and like HR

people last

Style

Now in the Prime Stage of the Corporate Lifecycle, Netflix is producing their own programs,

after starting in 1997 to just offer online movie rentals, which is highly “entreprenheuristic” and

shows shared values dedicated to a collectivist culture of systemic innovation and a resource

based view.

The “Freedom and Responsibility Culture” of Netflix is a style to create this demonstrated

systemic innovation, which relates back to an organisation wide dominant logic of

proactiveness, competitiveness, autonomy, innovativeness and risk taking. This culture is a

well styled tool for Netflix to maintain staff control and encompasses Stewardship Theory,

minimising agency costs in this non-process driven business model.

By hiring the right people and providing the right environment, Netflix has achieved a well-

balanced AGES Framework (Architecture, Governance, Entrepreneurship, Stewardship

approach) that provides them with a sustainable competitive advantage through ongoing

innovative strategies such as these. The management style incorporates psychological and

situational factors, such as empowerment, involvement orientation and a collectivistic culture.

Skills

Netflix entrusts that the majority of the staff they hire will act in the best interests of the

company, so much so that they have made it policy. Netflix moved from standard performance

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reviews to social performance software in the infancy stages, and then progressed to face to

face 360 degree feedback as a result of transcending the “Crisis of Autonomy”.

Instead of conducting old fashioned, regular performance reviews, Netflix implemented the

new face to face performance management strategy to reduce any skill gaps or weaknesses

by addressing any issues with a sense of urgency (McDuling, 2015).

It can be clearly shown that Netflix boasts it’s highly sophisticated culture through its job

advertisements on its own website: “The most valuable skill of any Netflix employee is the

ability to deliver exceptional results, where objective measurements of success carry more

weight than any other. In order to attract deep talent, we pay very well. Solving hard problems

requires highly talented people, and we compensate appropriately. We expect a lot. Our

culture is unique and we live by our values, so it’s worth learning more about Netflix” (Netflix,

2015).

Employees are often asked to take on additional responsibilities and perform at an increased

pace without close personal supervision. They are asked to make key decisions quickly and

autonomously and to manage aggressive deadlines. These skills are minimum and mandatory

requirements to fit into the “Freedom and Responsibility” culture at Netflix.

Shared Values

The companies shared values are its culture, vision and mission. These three aspects

permeate through company and help the employees understand their purpose, direction and

leadership goals. Netflix mission is as follows “We promise our customers stellar service, our

suppliers a valuable partner, our investors the prospects of sustained profitable growth, and

our employees the allure of huge impact.”

Netflix does not have a well-defined vision but the CEO expressed the following four points at

a conference in 2001 (Farfan, no date)

• Becoming the best global entertainment distribution service

• Licensing entertainment content around the world

• Creating markets that are accessible to film makers

• Helping content creators around the world to find a global audience

Netflix has applied the four soft S’s in the McKinsey’s 7S Framework very well, which would

suggest are the major contributors to the firm's innovative success.

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Key Success Factors

Netflix has become a market leader because of a combination of several innovative strategies

and staffing policies, as well as an intuitive and user friendly service. Through the challenges

that Netflix have faced over the years, principles of the Effectuation Strategy can be noted in

several aspects in their rise to the Prime Stage of Adizes Corporate Lifecycle (Adizes, 2015).

When Netflix was started, both founders vision was to offer the possibility to stream content

from its website (Kim, 2011). However, they were aware that with the internet infrastructure at

the time it would not be possible due to limited bandwidth, which reduces internet streaming

fluidity. Therefore, they started with what was possible at that time, which was renting DVD’s

online. This is known as “Bird in the Hand” theory under the 5 Principles of Effectuation. They

could have waited until internet speeds were adequate for streaming, but instead they started

with what was possible with at that time. This strategy, combined with their vision of how the

market will transform, is one of the contributing factors to their innovative success. Netflix

disrupted the market in such a way that their main competitor, Blockbuster, had to file for

bankruptcy in 2010.

According to Netflix CEO Reed Hastings, they have created a culture of innovation within the

company. This platform allows Netflix not just to come up with a great idea, but being

consistent in its effort to innovate (Kim, 2011). A “Crazy Quilt” example of this is the fact that

Netflix invested a lot of time and money on its content providers, focusing on building strong

relationships that would became an integral and invaluable part of the business when they

moved over to the streaming service in 2007. Relationship building is one of the most highly

regarded skills of certain key staff members of Netflix.

Furthermore, Netflix acknowledge that their employees are their most valuable resources.

Examples, such as unlimited vacation or maternity leave suggest that Netflix puts a lot of trust

in its employees. According to Adams Equity Theory (1963), staff will put in as much as they

feel they get in return from a workplace. This would imply that employees feeling valued by

the company would perform as highly as possible, with feelings of trust in the workplace

culture, reducing pressure and acting as an innovation enabler. Sam Stern, a Senior Customer

Analyst at Forrester Research sums it up adequately “If you trust and empower people and

give them a chance to rise to the higher expectations, the vast majority of people are able to

do so”.

Netflix uses algorithms efficiently in order to track their customers viewing habits. This Big

Data strategy helps Netflix understand its customers and can therefore predict their behaviour

(Marr, 2015). With this sort of analysis, Netflix measures its customer’s viewing habits, which

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help them remain of interest to their customers by suggesting content that is relevant and of

interest. By constantly improving and innovating these different algorithms, Netflix remain

exceptionally competitive despite their library not always being up to date with the latest

releases.

When Netflix decides to create a new show, it does not use the same concept as traditional

studios. While a studio requires a pilot to be made first for assessment, showed to focus

groups and finally after some bureaucracy signed off by the management, Netflix has

streamlined this time consuming process. If they like what they hear while the creator is

pitching his or hers idea, they tend to order 13 episodes directly. This was the case for “Orange

is the new black” that turned out to be a big success (Price, 2015).

Analysis

Based on an assessment using McKinsey's 7 S model as the framework, there are several

gaps and inconsistencies of Netflix’s innovative strategies that have become apparent and are

identified below, with the following suggestions of ways the company could improve. To give

another dimension to our analysis, a SWOT analysis has been conducted (Appendix 2). We

have structured our analysis based on the hard and soft S’s of McKinsey’s 7S framework,

which makes it clear how much effort is required to change the soft S’s over the hard S’s.

Despite promoting themselves as being an innovative company, with cutting edge strategies

and systems, Netflix does not offer an offline mode, which is not keeping in line with current

trends of their competitors. An offline mode would allow consumers to download material and

then watch it later without being dependent on an internet connection. This might be useful

when in transit or if a customer wants to save its mobile data allowance. Competitors such as

Amazon Prime have already started to offer this feature. Netflix refers to “the paradox of

choice”, stating that if consumers are faced with too many choices, it is likely that they will not

use the service (Venable, 2015). A solution to this problem would be to offer the offline mode

in an optional Premium Service, which would come at a slightly higher cost and can include

access to the most recent releases and most popular content. An example of where Netflix is

trying to address this issue is the partnership in place with Virgin America, where they offer all

Netflix customers free Wi-Fi on board (Netflix Blog, 2015). It’s highly likely that Netflix will

continue increase these strategic partnerships with other airlines and transport service

providers.

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Not only does Netflix not offer basic features such as an offline mode, but have also

implemented system based changes that have affected the users in negative ways. Recently,

Netflix changed its service by only allowing one device per account to be used at the same

time. Because many families use the same account it lead to a controversial argument

amongst consumers that Netflix is becoming too greedy (Salway, 2015). As Netflix will not turn

back on its decision, it would be more suitable if they offered a Premium Service at a slightly

higher cost allowing for up to five simultaneously users per account.

There are several gaps and inconsistencies that might affect Netflix in the future. The first

obvious weakness in their strategy is their high dependency upon internet neutrality because

of the data intensive nature of their service. Internet Service Providers (ISP’s) are not allowed

to block or slow down traffic based on the type of service that is sending the content (Reardon,

2014). However, it has been found that some ISP’s have created a “slow lane” for Netflix and

a “fast lane” for less data demanding websites (Rayburn, 2014). This shows how Netflix is

highly dependent upon third party companies to stream its services. One way of decreasing

these risks is either to launch its own ISP or create strategic partnerships with existing ISP’s

in each country they offer services.

They are also dependent upon, and possibly constrained by, software platforms owners such

iOS, Android or Windows. For instance, if Apple TV streaming services were to be launched

it could give Apple cause to cancel the Netflix App available on the iOS platform in order to

decrease competition, which would cost Netflix market share. This is a challenge that all

competitors in the market have to face and there is no easy solution apart from acquiring a

Telco in every country, incorporating their own software platform to compete against iOS,

Android and Windows, which is not a viable solution.

When Netflix entered the market it had a positive effect on internet piracy. The amount of

illegally downloaded content decreased, which showed that consumers were willing to pay for

a quality streaming service. However, through the years, illegal competitors such as PopCorn

Time has started to have a negative impact on Netflix. Despite being illegal, users now have

the ability to watch the same material without having to pay for it. When the actor Kevin Spacey

visited India last year, journalists told him that the Indian people were huge fans of his latest

series “House of Cards”. However, Netflix is not accessible in India, which would suggest that

millions of people watch theirs shows without paying (Rajani, 2014). There are no simple

solution to this problem because the market is compromised by IT criminals that will try to

make money out of other peoples content.

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Furthermore, the content that Netflix produces is only available on their own platform, while

the competing studios can also sell the redistribution rights both nationally and internationally

to other providers of content. The show “Friends”, despite that the final episode aired over ten

years ago, still generates recurrent revenue for NBC and Warner Bros Studios. The competing

studios have understood that in order to compete with Netflix, they must replicate its process

of creating new content. Once they have adapted this streamlined process, they have the

ability to generate considerably more revenue than Netflix (Price, 2015). This may be

considered a threat to the Netflix strategy and a solution to this could the Premium Service

option, where subscribers pay a higher fee for more highly sought after content and have an

offline storage tool. A change in strategy may be to licence their own content to TV networks

to increase their revenue streams.

Netflix plans to rapidly expand to a large number of countries in the near future. A major threat

to this strategy that has been acknowledged is that new host country’s internet infrastructure

may be insufficient. Because their service demands a large amount of data to be tunnelled

across the different broadband networks, it is important that the relevant country’s ISP

infrastructure can manage the large amounts of data that Netflix streaming requires.

Otherwise, this will lead to poor user experiences, which will ultimately affect and reduce the

number of consumers using the service because of constant buffering. When Netflix entered

the Australian market, it almost immediately started using a lot of internet bandwidth, slowing

down internet speeds and leading to bad user experiences for customers. The Australian ISP’s

were forced to heavily invest in their networks in order to maintain adequately running services

(AdhikariI, 2015). Netflix is endeavouring to improve this situation by creating partnerships

with ISP’s across the world to secure sufficient internet bandwidth for their consumer

demands.

Although these weaknesses may remain in place, Netflix’s main strengths lies in the soft S’s

of McKinsey’s 7S framework, which there is staff, skills, style and their shared values. These

soft S strengths are Netflix’s mainstay where we have identified gaps and inconsistencies as

follows.

Netflix promote themselves by stating they are looking for curious and passionate employees

(Smith, 2015), with both pay and benefits well above industry standards. Netflix incorporates

an elitist staff recruiting and retention policy that could create a feeling of job insecurity and

affect some staff member’s capacity for creativity and innovation, due to the stressors of these

prestige and performance requirements. Whilst Netflix has given staff the option of taking as

much leave as they want, it could be seen to go against the ethos of working in an elite,

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performance based culture because of the requirement to always be available. With the

“Keeper Test” in place, consternation and confusion about appropriate amounts of leave to

take in relation to job security resulted (Zillman, 2015). Close consultation conducted by the

HR department may help alleviate this problem by bringing it to the fore, making it an ongoing

agenda for staffing solutions.

Netflix does not disclose their viewing ratings, not even to employees working within a

specifically related project are allowed to take stock of the figures (NathanMcAlone, 2015).

However, not disclosing this kind of information with its staff seems to be a potentially

demotivating factor. By simply sharing this information, it will allow employees to understand

how their work is affecting the company’s goals, direction and strategies.

Despite offering original content, Netflix is dependent upon offering big titles such as the

“Transformers Trilogy” and other blockbusters in order to remain competitive. However, Netflix

have to prolong those agreements from time to time, which can be costly. This would mean

that Netflix library could become inconsistent and therefore less competitive. Netflix recently

parted ways with Epix, which lead to a lot of popular titles disappearing from the library. Those

kind of risks will always exist, regardless of how much original content Netflix produces

(Alexander, 2015). The weaknesses of this style and strategy could be addressed by

increasing the length of their contracts with strategic partners.

Because of their aggressive expansion strategy, Netflix has recently opened offices in Tokyo,

Singapore and Amsterdam in order to reinforce its international market presence and increase

market share. This could potentially increase agency costs, according to Agency Theory,

because they have to monitor, govern and align staff to the shared values of the Netflix

“Freedom and Responsibility” culture. When opening new offices in countries where the

business culture is different to the USA it can also create chaos because new employees are

not accustomed to the Netflix culture and their way of conducting business. This challenge

could be addressed by opening offices in new countries with an ethnocentric staffing strategy

and move towards a polycentric staffing strategy to enhance the Netflix cultural experience in

these local offices.

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Conclusion

This paper has revealed that Netflix is highly innovative company with market disrupting

technology, staffing policies and the ability to generate high levels of consumer demands for

their award winning original content.

However, several gaps and inconsistencies have been revealed with their ongoing strategies,

which will have to be reassessed and aligned once their global expansion plans are complete

in 2017. Focus then will lay in their product development, such as their new offerings and

finding new sources of revenue from their own original content, or licencing their widely

popular shows to other networks. As it stands, Netflix have proven to be a very successful

market leader and innovator, in possession of the skills and shared values to face the

challenges ahead.

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Appendix 1

(Lardinois, 2012)

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Appendix 2

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