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Competition in the Movie 1 Running Head: COMPETITION IN THE MOVIE Case Study: Competition in the Movie Rental Industry in 2008: Netflix and Blockbuster Battle for Market Leadership Emilsen Holguin Excelsior College

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Competition in the Movie Running Head: COMPETITION IN THE MOVIE

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Case Study: Competition in the Movie Rental Industry in 2008: Netflix and Blockbuster Battle for Market Leadership Emilsen Holguin Excelsior College

Competition in the Movie Table of Contents

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I. Overview ..................................................................................................................... 3 II. Diagnosis of Strategic Issues ...................................................................................... 4 III. Application of Techniques of Strategic Analysis ................................................... 4 A. Competitive Forces: The Five-Forces Model of Competition ............................... 4 1. Suppliers ............................................................................................................. 4 2. Buyer Power........................................................................................................ 5 3. Threat of Substitution ......................................................................................... 5 4. Threat of New Entry ........................................................................................... 5 5. Competitive Rivalry ............................................................................................ 5 B. Market Position: Strategic Group Map ................................................................... 6 C. Industry Key Success Factors (KSFs)..................................................................... 7 D. Netflixs Competitive Strategy ............................................................................... 7 E. Netflix SWOT Analysis .......................................................................................... 9 F. Blockbuster SWOT Analysis ................................................................................ 10 G. Financial Ratios .................................................................................................... 11 IV. Analysis and Evaluation ....................................................................................... 13 A. The Rental Movie Industry and Netflixs Position ............................................... 13 B. Inside Netflix ........................................................................................................ 14 C. Inside Blockbuster ................................................................................................ 15 V. Recommendations ..................................................................................................... 17 A. For Netflix............................................................................................................. 17 B. For Blockbuster..................................................................................................... 18 VI. New Developments: 2010 Update ........................................................................ 19 Reference .......................................................................................................................... 21

List of Figures Figure 1. Strategic Group Map Application for Selected Movie Rental Services .............. 6 Figure 2. Netflix SWOT Analysis ...................................................................................... 9 Figure 3. Blockbuster SWOT Analysis ............................................................................ 10 Figure 4. Comparative chart: Operating profit ................................................................. 12

List of Tables Table 1. Comparative table: Financial Ratios (December 2007)...................................... 11 Table 2. Comparative table: Financial Ratios (December 2009)...................................... 20

Competition in the Movie Case Study: Competition in the Movie Rental Industry in 2008: Netflix and Blockbuster Battle for Market Leadership I. Overview Since founded in 1999, Netflix has grown to become the worlds largest online

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movie rental service. In the beginning of 2007, Netflix surpassed 6.3 million subscribers. With a catalog that includes more than 100,000 titles, Netflix is leading the movie rental market (Thompson, Strickland & Gamble, 2009). Netflixs subscription-based business model was a disruptive innovation in the movie rental business. By using the internet, Netflix focused on providing convenient and affordable prices for an entertainment industry that was already highly popular. Based on a product that consumers already loved, Netflixs business model was profitable because it improved the consumers rental experience. The company aimed to become the bestcost provider. As part of its competitive advantages, Netflix has an intuitive website (easy to use), personalized movie recommendations, and excellent customer service. Netflix has been rated No. 1 in online retail customer satisfaction by Neilsen Online for the past 3 years and for nine consecutive periods by Forsee/FGI Research (Netflix, 2009). Netflixs strategy for success has included providing a comprehensive selection of movies; an easy way to choose movies, fast delivery, a no-late-fees policy and a convenient drop-it-in-the-mail return system. These strategies ensured a competitive advantage to Netflix and threatened to make the traditional video store obsolete. A combination of its business model and strategic approach carry out the mission of the company: Our appeal and success are built on providing the most expansive selection of DVDs; an easy way to choose movies; and fast, free delivery (Briki Media, LLC, 2007).

Competition in the Movie II. Diagnosis of Strategic Issues Netflixs main competitor, Blockbuster, was losing the battle until 2007, when a resurgent Blockbuster started to take over market share and forced Netflix to reduce subscription prices. This reaction raised a red flag and caused a drop in Netflixs stock price. In addition to Blockbuster, other competitors are increasing their presence in the

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market (i.e., Redbox) and new technology innovations (i.e. VOD and DVR) are changing the business environment. Netflixs business model was a disruptive technology, but its competitors strategies for damage control and recovering market share are starting to affect Netflixs competitive advantage. The market conditions for Netflix have changed and the company needs to adjust and react to new developments. III. Application of Techniques of Strategic Analysis A. Competitive Forces: The Five-Forces Model of Competition 1. Suppliers Netflix acquires its content from movie studios and movie distributors. Although they offer a unique product and there is no chance of substitution, the relationship between Netflix and its suppliers is symbiotic. They need each other. Movie studios and movie distributors make their revenue by selling its content to the largest number possible of viewers. Netflix acquires content by buying DVDs, paying on a fee-perDVD basis, paying a fee to license content and signing revenue-sharing agreements (Thompson et al., 2009, p. C104).

Competition in the Movie 2. Buyer Power Netflix sells its subscriptions to those who prefer online-only browsing and mailbox delivery. By July 2008, Netflix had 8.4 million subscribers (Thompson et al., 2009, p. C102). Individually Netflixs customers have little buyer power; however, with no fees for canceling the subscription, there is virtually no cost for switching to other provider. 3. Threat of Substitution Netflix competes for customers by offering almost any kind of movie broadcasting, movie rental or movie distributor. Netflixs subscribers easily find ways to watch movies. They can watch movies from cable companies, online services, movie theaters, DVD vending kiosks and rental stores. The substitution of Netflix subscription is viable and easy. 4. Threat of New Entry Netflixs economy of scale and distribution systems place a high barrier for new entries to this market. New entries to the online rental movie

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business would face high costs and require state-of-the-art technologies to compete effectively. 5. Competitive Rivalry In 2007, the movie rental business accounted for a $9.5 billion market in the United States. Movies can be rented in-stores ($5.8 billions), via mail (2.0 billions), on-demand (1.3 billions) and vending machines (400 millions). The main movie rental competitors for Netflix are Blockbuster

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and Redbox. Netflixs competitors offer the same products for almost the same price. (Thompson et al., 2009, p. C99). The five-forces model of competition for the movie rental industry shows that supplier power, buyer power, and the threat of new entries do not represent a strong force against a companys market position. However, the threat of substitution and the threat of competitive rivalry can affect a companys ability to make sustainable profit in the movie rental business. B. Market Position: Strategic Group Map Industry competitors - Netflix, Blockbuster, Movie Gallery and Redbox - are evaluated here in terms of added value (instant movies, personalized recommendations, number of queues, etc) and market coverage (online, stores and vending machines). The size of the circle is representative of market share relative to others in the industry.

Figure 1. Strategic Group Map Application for Selected Movie Rental Services

Competition in the Movie The strategic group map (Figure 1) illustrates that the closest rival for Netflix is Blockbuster. Also, it reveals that although Netflixs customers receive more value for their money, Netflix has less coverage because it limits its coverage to internet users. Blockbuster has a strategic advantage by offering rental movies through stores, internet and vending machines, but its customers receive less value for their money.

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The strategic map also reveals the presence of a new player in the business game: Redbox. Although the company is relatively new (first market test launched in 2004 in Denver, CO), the company is growing its market share rapidly. The Redbox business model is focused on fully automated kiosks that holds approximately 630 DVDs and are placed in strategic locations (such us major groceries stores, pharmacies and restaurants) (Redbox, 2009). C. Industry Key Success Factors (KSFs) The key success factors that affect movie rental players the most are: overall low costs market coverage large selection of movies updated catalog (new releases in stock) ability to provide fast and convenient service customer-centered approach state-of-the-art technology and distribution systems D. Netflixs Competitive Strategy Netflix applies a best-cost provider competitive strategy. Movies are an affordable entertainment that almost everyone loves. Netflix offers a large range of subscription

Competition in the Movie plans to meet their consumers needs and added convenience to offer customers more value for the money. A Netflix customer has a broad selection of subscriptions plans starting at $5.99 up to $47.99 from two movies per month to unlimited numbers of movies anytime (Thompson et al., 2009, p. C101). Movies are delivered and returned by

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mail. Netflix has no due dates or late fees. Subscribers can watch instant movies on the internet, all for a fixed price. Netflix adds value in many ways. It provides each account with as many as five separate rental queues (with ratings-based parental controls), offering separate viewing choices to individual family members. Based on ones ratings, the Netflix system learns ones taste and offers personalized lists of recommendations. Users can invite each other to join a friends list, so they can see each other's rental queues and make additional viewing suggestions (Netflix, 2009).

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E. Netflix SWOT Analysis

Figure 2. Netflix SWOT Analysis

As shown in Figure 2, Netflix has a long list of strengths and opportunities. This puts the company in an advantageous position to continue gaining market share. Netflixs customers are used to state-of-the-art technology and they probably welcome novelty in delivering formats such as VOD. However, the company needs to move fast to keep up with technology and innovations.

Competition in the Movie F. Blockbuster SWOT Analysis

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Figure 3. Blockbuster SWOT Analysis

Although Blockbuster has a good list of strengths and opportunities (as shown in Figure 3), its challenges are greater because the company is losing reputation and is already behind in using technologies and distribution systems. For a company that is in recovery mode, conditions such as slowing numbers of movie DVD rentals and an economic slowdown can be highly detrimental.

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G. Financial Ratios Ratios Working capital Debt to Equity Long term debt to Equity Return on Assets Assets turnover Operating Profit Netflix 203.9 0.50 0.008 0.10 1.862 0.075 Blockbuster 30.7 1.96 1.015 -0.031 2.027 0.007

Table 1. Comparative table: Financial Ratios (December 2007)

The financial ratios above are based on financial data from 2007 fiscal year (Thompson et al., 2009, p. C106, C110). Netflix is highly liquid and has more than enough solvency to cover expenses. Netflixs debt-to-equity ratio is only 0.50 which shows that the company is creditworthy and has a strong balance sheet. This is confirmed with its very low (0.008) long term debt to equity ratio. The company shows considerable capacity to borrow additional funds if needed. In addition, Netflix generates $1.862 sales for each dollar of assets. From Blockbusters perspective, its working capital is very low (only 30.7). This can represent a significant challenge to cover its operating expenses. In addition, Blockbusters debt to equity ratio (1.96) indicates excessive debt and a weak balance sheet. High long-term debt equity undermines the companys capacity to borrow

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additional funds. Blockbuster generates $2.027 sales for each dollar of assets, which is a good indicator; unfortunately, its operating profit is very low. The chart below compares operating profit ratios for Netflix and Blockbuster from 2002 to 2007. The operating profit margin or return on sales shows the profitability of current operations (not including interest charges and income taxes). The operating profit ratio is best used to compare a companys results over time to reveal trends. The chart shows a rapid decline in Blockbusters operating profits from 2002 to 2004, followed by a recovering curve until 2006. At the time of this analysis, Blockbusters operating profit trend was falling in negative direction. In contrast, Netflixs trend over time is upward. According to the 2007 notes in Netflix Annual Report, its flatten out of operating profit during that period was primarily the result of an increase in personalrelated costs due to the growth in headcount and expenses related to the development of solutions for the Internet-based delivery of content (Netflix, 2007, p. 47).Comparative chart: Operating profit0.1 0.05 0 Operating profit -0.05 -0.1 -0.15 -0.2 -0.25 -0.3 -0.35 Year 2002 2004 2005 2006 2007 Blockbuster Netflix

Figure 4. Comparative chart: Operating profit

Competition in the Movie IV. Analysis and Evaluation A. The Rental Movie Industry and Netflixs Position The five-force model of competition shows that in the rental business the main

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threats are substitution and competition. A movie rental business competes with any kind of movie broadcasting business (cable, theaters, movie rentals, streaming videos, etc). A company that wants to succeed in the movie rental industry must apply strategies to keep customer satisfaction high and to promote consumer loyalty. In the Strategic Group Map (Figure 1), the competition for market share with Blockbuster is evident. Although Movie Gallery and Redbox together have a significant presence in the market, they do not represent a direct threat to Netflix. In contrast, Blockbuster has a large market share and has a wide geographic coverage. If Blockbuster implements strategies to add value to its customers, Netflix can face a significant challenge that could harm the direction of the company. Success in the rental movie industry depends on seven factors. Netflix is especially good on most of the key success factors for the movie rental business: overall low cost (an upward trend on operating profits), large selection of movies (with a catalog of more than 100,000 titles), updated catalog (Netflix offers new releases the same day they are available in the market), ability to provide fast and convenient service (Online instant movies and mail delivery),

Competition in the Movie customer centered approach (Netflix policies are customer friendly. its intuitive website allows customers to make all transactions; in addition, Netflix offers phone help available 24 hours a day) and

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state-of-the-art technology and distribution systems (Netflix system learns to customer taste and personalize recommendations. Movies arrive within one business day).

Netflixs market coverage is limited to internet users.

According to Internet World Stats, the percentage of penetration of the internet in the North American population in 2009 was 74.2% (an increase of 134% since 2000). This rate indicates that Netflix could reach 74.2% of the American populations, which adds market coverage to Netflixs list of key success factors (Miniwatts Marketing Group, 2009). B. Inside Netflix Netflix has been successful in applying the best-cost strategy. It has been able to offer additional benefits to its customers while controlling its expenses, keeping low levels of debt, and continuing to increase net income. Netflix is a very profitable business that has built on its first mover advantages and created a business model that promotes customer satisfaction and technology innovation. Although it only provides online rental services, the rapid increase of internet users will help the company to convert this weakness into an opportunity. In 2007, Netflixs most significant weakness was the lack of stores and the difficulty for subscribers to have immediate access to movies. Although instant movies were available, the titles were limited and the movies had to be watched on a computer

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screen. In addition, competitors had emulated Netflix online services, making the war for market share more competitive. The biggest threat for Netflix is to overcome the business cycle of its model. Netflixs business model is at its peak, competitors are getting close enough to force Netflix to lower the price of its subscriptions. Netflix needs to take advantage of its opportunities to continue its growing trend and avoid a contraction cycle. Its most attractive opportunity is the growing awareness of video streaming technology and its promising partnerships with gaming console manufacturers to offer video on demands. Netflixs financial ratios confirm the financial health of the company. Large amounts of working capital, low levels of debt, high rates of asset turnover and a positive trend of operating profit makes the company attractive for investors and ensures financial stability. C. Inside Blockbuster The main problem with Blockbuster is the lack of a defined strategic approach. Blockbuster used to set its own price standards until Netflix came aboard. Since 2003, the company has been losing money. In its effort to recover its market share, the company tried to add value to its memberships. This initiated when Blockbuster launched an ad campaign that communicated their value proposition: Get 4 movies by mail and trade them for in-store movies, as often as you like for $20 a month (Steele, 2009, para 1). However, the company did not persist in a clear strategy; instead, customers were surprised by changes to the rental policies and new promotions each time they visited the stores. The policy changes were frequent to the point that store employees delivered

Competition in the Movie negative and confused messages to customers. Employees and customers were puzzled about what the current policy was.

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Blockbuster is subject to the same list of key success factors as Netflix. However, in Blockbusters case, the company is weak in maintaining overall low costs; it has seen a decrease in customers satisfaction and has struggled with efficiency in its distribution systems. In its favor, Blockbuster has a reasonable selection of movies, an updated catalog (although movies are not always in stock), offers convenient access to movies across multiple channels (stores, online and vending machines) and has a global presence. Blockbusters diversified delivery channels is the companys strongest competitive advantage. Blockbuster is the only company to make media entertainment available across multiple channels. The company promotes that the fact that the same customer may choose different ways to access media entertainment on different nights (Blockbuster Corporate, 2009, para 4). A consumer can rent movies at traditional stores, by-mail, vending or digital download. In spite of this advantage, Blockbuster has lost reputation and has dealt with high operating costs that make it a difficult to challenge a strong competitor like Netflix. In addition to its internal difficulties, Blockbusters recovery efforts are being slowed down by the countrys economic recession and a consumer trend to rent fewer DVDs. However, the company counts on its infrastructure to take advantages of opportunities such as a growing market for game rentals, a strategic alliance to deploy Blockbuster-branded DVD vending machines for movies and video games and a video streaming technology. Blockbusters financial ratios reveal a poor financial performance. A low amount of working capital, high levels of debt and negative trends of operating profits make it

Competition in the Movie difficult for the company to attract investors. Its high ratio of long-term debt to equity (1.015) makes it difficult for Blockbuster to find external funding to support its new strategies. V. Recommendations

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A. For Netflix The market environment for Netflix has changed and the company needs to adjust its strategies in order to avoid a contraction cycle. The company enjoys key success factors needed in the movie rental business, but to keep its leading position in the market, Netflix must continue improving customer satisfaction rates and customer retention rates. The following recommendations can help Netflix keep its front running position in the market: Design a marketing campaign to raise awareness of the advantages of video streaming technology, which allow customers to instantly watch TV episodes and movies streamed from Netflix. Increase the number of digital content movies available in its catalog (in 2007, only 12,000 full-length movies and television episodes were available for streaming over the Internet to computer screens.) Take the first movers advantage of digital technology broadcasting. Netflix should aim to download its digital content directly to TV screens. Partnerships with TV and game consoles manufactures can give Netflix a new distinctive competence. Continue to increase its number of titles available and seek to include music digital content.

Competition in the Movie Design annual memberships to reward loyal customers. Netflix should offer a discount price for loyal customers who want to pay for annual subscriptions.

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Design a referral program. Netflix sells gift subscriptions and sends by mail free-trial coupons, but it fails to reward its customers for helping the company in its marketing efforts. A free-month or a special discount in membership prices would motivate customers not to trash those freetrial coupons.

Increase awareness of the companys social responsibility. Netflix could create special programs (contests or collections of points) to allow schools to receive free subscriptions. These kinds of program are powerful ways to build a company brand and to ensure future loyal customers.

B. For Blockbuster On the other hand, Blockbuster continues working in a recovering mode. Although some of its strategies have been working and the company saw a small recovery in 2006 with a modest profit of 39.2 millions, the boost did not last long and the company went negative again on 2007 (registered a loss of 85.1 million). The conditions for Blockbuster are more challenging because of its weak financial situation and damaged reputation. A priority for Blockbuster must be to become profitable. The company needs to reduce its operating costs and to design an effective distribution system. It can do this by: Building a business model that is sustainable and has the flexibility to adapt to competitive threats without eroding value.

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Identifying appropriate strategies and creating company policies to ensure that employees deliver consistent and reliable information to its customers.

Taking advantage of new technologies to reduce its operating costs and to improve customer service.

Blockbuster should quit fighting Netflix and focus on creating a new niche market. Blockbuster took too long to fight back Netflixs strategies and currently the company does not have financial resources to compete against this giant rival. However, Blockbusters global infrastructure provides the company with unique geographic markets where Netflix is not present. In addition, Blockbuster offers rental of video games, another market where Netflix does not compete and that is growing in numbers. Movie rentals could become the added value for video game rental consumers. Investing efforts and resources to build distinctive competitiveness in markets where Netflix is absent gives Blockbuster a better chance of recovering its competitive advantage. VI. New Developments: 2010 Update In September 2009, Blockbuster announced a major store closing initiative that could result in the elimination of 22% of its current freestanding store bases (Pardy, 2009, para 1). Also, the company continues promoting its "Total Access" program, which has only 1.6 million current subscribers. Redbox has become a major player with more than 19,000 kiosks placed nationwide by the end of 2009. This represents a significant threat to Blockbusters network of kiosks (only 497). Redbox does not have late fees and customers have up to 25 days to return their DVDs. In addition, Redboxs system offers online reservations,

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allowing customers to choose their favorite titles online and pick them up immediately at the preferred Redbox location (Redbox, 2009). By January 2010, Netflixs base of customers was about 10.6 million subscribers and the company was launching a strong marketing campaign to promote its instant movies that could be downloaded directly to TV screens (with the help of several devices such as game consoles, blue ray players and HDTVs.) The table below summarized the main profitability ratios and profit information for Netflix and Blockbuster as of December 31, 2009 (Yahoo! Inc., 2010). Ratios Return on Equity Return on Assets Profit Margin Operating Profit Net Income Netflix 38.66% 20.29% 6.79% 11.01% 107.68 M Blockbuster -119.14% 4.15% -10.70% 3.31% -452.80M

Table 2. Comparative table: Financial Ratios (December 2009)

It is clear that Netflix continues to maintain a strong position in business, while Blockbuster continues to get worse.

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Reference Blockbuster Corporate . (2009, December). Company overview. Retrieved from http://www.blockbuster.com/corporate/news Briki Media, LLC. (2009). Hacking Netflix. Retrieved from http://www.hackingnetflix.com/2009/08/netflix-posted-a-128-page-internalpresentation-on-the-company-culturereference-guide-on-our-freedomresponsibility-culture.html Miniwatts Marketing Group. (2009, September 30). World internet usage statistics. Retrieved from http://www.internetworldstats.com/stats.htm Netflix. (2007, January). 2007 annual report. Retrieved from http://ir.netflix.com/annuals.cfm Netflix. (2009, May 05). Fact sheet. Retrieved from http://files.shareholder.com/downloads/NFLX/823470738x0x295021/422b46fbca67-47a6-be19-36879cf977fe/IR_Fact_Sheet_05_15_09.pdf Pardy, S. (2009, September 16). Blockbuster closing up to 960 stores through 2010. Retrieved from http://www.costar.com/News/Article.aspx?id=CE22237D7F77AE8FED9161447 C2874B Redbox. (2009, December). The History of redbox. Retrieved from http://redboxpressroom.com/factsheets/TheHistoryofRedbox.pdf Steele, D. (2009, July 1). Death by a thousand paper cuts (aka, the blockbuster pricing strategy). Retrieved from http://blog.mindspace.net/?p=186 Thompson, A. A. Jr., Strickland, A. J. III, & Gamble, J. E. (2009). Crafting & Executing Strategy: The Quest for Competitive Advantage: Concepts and Cases, Sixteenth Edition. New York, N.Y.: McGraw-Hill/Irwin Yahoo! Inc. (2010, January). Yahoo! finance, key statistics. Retrieved from http://finance.yahoo.com/