Skill Builder
Format APA Volume of 4 pages (1100 words) Description For Skill Builder assignments, focus on thoughts and reasoning . This is a Socratic exercise – an opportunity for you to think and express your thoughts. Question #1: This question asks you to define business. Based on (1) your personal life experience, (2) personal business experience, (3) your formal and informal education, and (4) the videos and materials assigned this week; what is business and why does it exist? Why do people participate in business (engage in commerce, transactions, exchange)? This is NOT a question looking for you to provide a “right or wrong” answer (or copy a definition via a Google search), but rather an opportunity for you to reflect on what you (and others) think about business. Before we can have a conversation about strategic management, we need to discuss the context in which strategic management exists: BUSINESS. Question #2: What are the five most pressing issues facing businesses in America today; and what can be done to prevent, resolve, or lessen the impact of these issues on individual companies? This is NOT a question looking for you to provide a “right or wrong” answer, but rather an opportunity for you to reflect on what you (and others) think about business in general, and about the “things” individual businesses face every day. This is an opportunity for you to describe your thoughts, and again, an opportunity to begin our semester-long conversation about strategic management by first framing the context. Question #3: What three factors MOST influence the success of a business (list in order of priority and explain)? These are often referred to as Key Success Factors (KSFs), or Key Performance Indicators (KPIs)? This question is intended for you to THINK & REFLECT about what drives performance in companies. Try to avoid cowardice here (or worse, impudence) with the ridiculously unacceptable answer of “it depends.” The question is written to provide you an opportunity to DEMONSTRATE that you are engaged and interested and thinking. The answer of “it depends” simply demonstrates the opposite (apathy and disengagement). If you are an “it depends” person, then answer this question (and similar Socratic questions) with a specific example of a business or industry (or compare several companies or industries in your answer). Question #4: Summarize and expand on Chapter #1 of the textbook (Art & Science of Strategic Management), and explain why you think strategic management is more an art than a science (or argue the opposite)? Use your own words and take a position. Question #5: This week there were videos (and readings) covering somewhat disparate topics in business and strategic management. Which of these videos most resonated with you in regards to understanding business and strategic management (and why – why did they catch your eye – why did they resonate with you – why do you believe the video(s) were relevant/important)? I’ll Complete! Question #6: In the past two weeks you have read the following from the book, Playing To Win: The introduction, Chapter 1 about choice, chapter 2 about aspirations, and chapter 3 about where to play. Provide a summary of these readings and concisely describe what the authors are trying to sell (what is their message – what is their perspective). Reflect on the readings and critique (i.e. share some insight). Do you agree or disagree with their perspective? Do you believe their model and approach is valuable (and why)? Question #7: Based on your own personal experience, education (including the videos and materials assigned this week), and knowledge, how would you best define firm performance (aka company or organization performance)? What does “firm performance” mean? What measure/metric should be used to measure firm performance? This week we introduce two new concepts — Triple Bottom Line and Balanced Scorecard — how do these ideas influence how YOU feel we best define/measure firm performance, and why. Question #8: Summarize and expand on Chapter #2 of the textbook (Leading Strategically), and describe what YOU think about the role and responsibilities of the CEO (I’m curious as to how you feel Emotional Intelligence plays into the art of being a CEO – is it important, and why or why not)? Question #9: Summarize and expand on Chapter #3 of the textbook (External Analysis), and explain why you think Porter or PESTEL is important (think about it: Porter is an economist, so he looks at the world of business by examining industries; so do you think his five forces model makes sense, or serves as a fundamental platform for CEOs to use to analyze their firm’s strategic position)? Question #10: Briefly summarize the Netflix case/company from YOUR perspective (not your team’s perspective). What are the key issues, what are key success factors in this industry, what really matters to this company? Describe how you believe technology businesses differ from non-technology businesses, and the impact of technology issues on the Netflix Company. PROVING THE SKEPTICS Sayan Chatterjee, Wayne Barry, and Alexander Hopkins wrote this case solely to provide material for class discussion. The authors This document is authorized for use only by Debra Robinson (ladydcbr@aol.com). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 17 “Sizing Up Netflix’s International Subscriber Growth Potential,” op. cit. 18 Ibid. 20 B. Stelter, “Netflix Stock Soars 16% on Huge Subscriber Growth,” CNN Money, January 23, 2014, accessed February 22, 22 M. McGrath, “Amazon and Hulu Could Slow Netflix Growth in 2014, Morgan Stanley Says,” January 7, 2014, accessed 27 “Netflix Ends 2013 with 33.4 million US Streaming Subscribers,” accessed March 9, 2014, http://cir.ca/news/netflix-biggerthan-cable-tv-2. This document is authorized for use only by Debra Robinson (ladydcbr@aol.com). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 30 Shah, op. cit. 48 L. Downes, “Rereading the Tea Leaves in the Netflix Comcast Deal,” CNET, March 6, 2014, accessed February 22, 2015, 49 Aune, op. cit. 50 “Netflix Open Connect,” Netflix, accessed February 22, 2014, https://signup.netflix.com/openconnect.
Assignment type : Other types
INSTRUCTIONS:
do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain
names and other identifying information to protect confidentiality.
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Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-11-18
In 1997, Reed Hastings and Mark Randolph founded Netflix, a rent-by-mail service in which customers
ordered movies online to be delivered to their homes.2
By enabling the receipt and return of movie rentals
through the U.S Postal Service, Netflix provided an alternative to physically going to a video rental store.
Netflix focused on DVDs as opposed to VHS videotape cassettes, which, at the time, were the dominant
media for home videos. Just as DVDs were first being released to the U.S. market in March 1997, Hastings
recognized that the cost of shipping a DVD would be low enough for a viable rent-by-mail business model.3
Early adopters of DVDs comprised the primary Netflix customer base, and, as the popularity of DVDs
grew, so did the popularity of Netflix.
Netflix further differentiated itself in September 1999, by transitioning to a subscription service. Instead of
charging for each rental and imposing late fees (similar to traditional video rental businesses), Netflix
offered unlimited rentals with no due dates under a single monthly subscription.4
SHIFT TOWARD STREAMING
Netflix enjoyed fantastic growth in its first decade. Then, in 2007, with 7.5 million members by year-end,
Netflix launched its streaming service to allow subscribers to instantly watch videos on their computers.
Only 1,000 movie titles were initially available for streaming. However, Netflix worked aggressively to
increase its streaming library and improve the viewing experience. New competitors emerged with “payper-view”
models in which the user purchased video content for download and then had a specified time
frame to view it. Still, Netflix focused on convenience and simplicity. For example, Netflix created an
application that subscribers could download to monitor their connection speed and thereby optimize
resolution and minimize streaming interruptions.5
In 2011, management decided to segment its DVD business, which had been in decline, and focus primarily
on instant streaming and original content. This strategic shift was troubled in the short term, as it negatively
affected Netflix’s revenues, customer base, and management. The US$106
a month plan for both unlimited
streaming and DVD-by-mail services was replaced by two separate plans for each service, priced at $8
each, resulting in an uproar from customers and a flood of negative media attention.7
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In the third quarter of 2011, Netflix lost 810,000 of its 23.8 million subscribers; this loss was a dramatic
downturn, as Netflix had grown by at least one million subscribers in each of the previous seven quarters,
including almost 3.5 million new subscribers in the first quarter of 2011. The resulting decrease in revenues
and the public relations issues led to changes to top company management, and a significant decline in
Netflix’s stock price — from $220 per share to $50 per share.8 However, Netflix took on the skeptics in the
marketplace head-on by investing in a strategy of attracting more subscribers, and pursuing new content
and international growth. As a result of this strategy, by the end of 2013, domestic streaming accounted for
$2.8 billion of Netflix’s revenue and international streaming accounted for $0.7 billion. The shrinking
domestic DVD market represented revenue of $0.9 billion.9
New Content and International Growth
The demand for rent-by-mail continued to decline, and Netflix strategically deemphasized this segment by
reducing the number of distribution centres from a high of 58 to only 39 nationwide in late 2013.10 In
addition, Netflix shifted its target market from movie aficionados to streaming customers more interested
in blockbuster movies and popular television (TV) programming. Netflix also began to invest in original
and exclusive content, notably House of Cards and Arrested Development.
11 By employing this strategy,
Netflix reduced its distribution costs but incurred a substantial increase in content costs. However, because
there was very little variable cost in streaming content worldwide, the cost per user could be lowered,
provided that Netflix could continue attracting more subscribers. The cornerstone of executing this strategy
was international expansion.
Netflix worked hard to add subscribers beyond the U.S. market and had recently pursued the European
market more aggressively, specifically Germany and France.12 The company had also been looking to
capitalize on new technology as it came to market. For example, Netflix recently invested in 4K Ultra HD,
in partnership with Sony, LG, Vizio, and Samsung.13
Net Neutrality Ruling and the Impact on Netflix
As of early 2014, the company’s strategy seemed to be working, as Netflix continued to increase its paid
subscribers. Moreover, to confound the skeptics, it had also reduced the cost per subscriber. Hastings, the
chief executive officer of Netflix, had managed to prove the skeptics wrong. However, in early January
2015, a new development led to significant problems. A U.S. appeals court overturned a lower court ruling
supporting the concept of net neutrality, as proposed by the U.S. Federal Communications Commission.
Thus, companies such as Netflix would need to pay a higher cost to Internet service providers, such as
Comcast or Verizon, for the tremendous amount of bandwidth that Netflix’s subscribers needed for quality
viewing of streamed content. Again, skeptics challenged Netflix’s ability to keep its user costs down to
justify its sky-high stock price. Could Netflix once again prove the skeptics wrong?
MARKET SIZE
Because of its focus on streaming subscriptions, Netflix’s market size was largely limited to the broadband
market. Netflix had successfully penetrated the U.S. market, which accounted for nearly 30 per cent of U.S.
Internet traffic in late 2013.14 In 2010, Netflix began its international expansion, first in Canada, followed
by Latin America and Europe, including the United Kingdom, Ireland, Sweden, Norway, Finland, and
Denmark. In two years, it gained six million additional subscribers.15 Given this success rate, international
expansion was a future strategy to pursue to increase Netflix’s market size.
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Broadband access continued to expand within the United States and other developed countries, which
increased the potential market for Netflix. Approximately 88 million U.S. households had high-speed
Internet, and Netflix had captured more than 36 per cent of the market with 33 million subscriber
households.16 As of 2011, approximately 10 million Canadian households had access to broadband, and
independent analysts believed that, over time, it could capture five million subscribers, or 30 to 40 per cent
of the Canadian market. Analysts also expected that Netflix could model its business in Europe after its
success in the U.S. market.17 With 38 million European households having Internet access, Netflix could
capture 12 million subscribers, or 30 per cent of the European market.18 The broadband subscriber base of
58 million in Latin America was growing at a constant rate, and analysts expected Netflix to secure seven
million to eight million household subscribers in this market.19 Within these markets, the size of the total
target market represented 57 million households, of which Netflix had already secured 77 per cent.20
COMPETITION
Netflix
Netflix competed with various websites and cable and broadcast networks, both for viewership and for
exclusive content from suppliers. Netflix considered HBO to be its strongest competitor for content, as
HBO had secured long-term exclusive content deals with such major suppliers as Universal and Fox.21
HBO’s global presence and long-standing image in the entertainment business made it a very strong
competitor. Hulu Plus, a joint venture of FOX, ABC, and NBC, was also a competitor for content. With
respect to the number of subscriptions, the popularity of Netflix’s original content and its stable number of
subscriptions (only approximately 3 per cent were projected to discontinue in 2014) indicated that, thus far,
other streaming-video companies were not threatening Netflix’s market space.22 However, these web-based
competitors were rapidly gaining subscribers, portending a major future concern for Netflix.
Because of the higher costs of producing original content and improving online streaming, to remain
competitive, Netflix needed to be cautious with its costs. Because it was perceived to be a low-cost
alternative or substitute to its competitors, Netflix could not pass all these costs down to its customers. Also,
Netflix had very narrow profit margins, as it was neither the creator nor the transporter of the content. Its
problems would be further compounded if content creators decided to stream directly and eliminate Netflix
from the value chain.23
HBO GO
HBO offered unlimited streaming of all its shows, movies, and other content as a free service to its
subscribers via HBO Go,24 which had, by far, the industry’s highest-quality movies and original
programming. Due to HBO’s reputation and high-quality streaming, its subscribers might not feel the need
to switch to other streaming services. However, because HBO could not be subscribed to as a stand-alone
service, Netflix might gain disaffected cable users that wanted to avoid paying cable or satellite TV bundle
fees. A recent study indicated that online video providers, such as Netflix and Hulu, were gaining market
share over premium cable providers such as HBO. According to this study, the number of subscribers of
streaming video-on-demand services (27 per cent, up 4 per cent in the previous 18 months) was now almost
equal to subscribers of premium cable TV (32 per cent, down 6 per cent in the previous 18 months) (see
Exhibit 1).25 HBO lost 15 per cent of its customer base in a few months in 2013, and, by year-end, had 29.2
million subscribers.26 By comparison, Netflix reported 33.4 million U.S. streaming subscribers in the fourth
quarter of 2013, up 23.2 per cent from the beginning of the year (27.1 million).27 Netflix expected to add
2.25 million U.S. subscribers and 1.6 million international subscribers by the beginning of 2014.28 In the
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long run, Netflix expected to gain two to three times more U.S. subscribers than HBO, or 60 million to 90
million U.S. subscribers.
Amazon Prime
Amazon offered unlimited instant streaming of the wide selection of commercial-free TV shows and movies
accessible with an Amazon Prime membership. At $99 per year, Amazon Prime was priced almost the same
as Netflix’s streaming-only subscription ($95.88 per year), and included free two-day shipping and Kindle
book rentals.29 If Amazon customers (who were in the millions) found that Amazon Prime was good enough
for them, then Netflix might never be able to gain traction with those viewers. Although Amazon Prime
received only a 2 per cent share of streamed TV programming in 2013, its growth was close to 55 per cent,
representing a potentially serious concern for Netflix.30
Hulu
Hulu, a web-based video provider, offered access to a wide variety of TV shows, movies, and other content
for free via an ad-supported platform. Viewers could access more recent content by subscribing to Hulu
Plus at $7.99 per month.31 Hulu Plus offered much more current TV content than Netflix; however, Hulu
Plus programs included many commercials. There was also a subscription from Hulu for $11.99 per month
that had no commercials. Further, because Hulu Plus was a joint venture of such major TV networks as
FOX, ABC, and NBC, these networks were more likely to promote the programs offered by Hulu Plus to
their broad viewership. These network providers were also content creators and preferred to give their
content to Hulu.32 Netflix, recognizing this barrier in terms of its ability to secure content, lobbied
vigorously with the content creators before the launch of any show. Netflix also invested huge resources in
working with partners, finalizing contracts, and promptly receiving all the digital files. Nick Nelson, the
creative services manager for Netflix USA, aptly described his strategy, stating, “to remain competitive, it
was very important to be on top of everything and anticipate the launch dates.”33
Satellite/Cable TV
Cable and satellite TV had traditionally been the main source of at-home entertainment, but Internet-based
entertainment such as Netflix had increasingly advanced in this market. In the long term, whether Netflix
would be a substitute or supplement to traditional TV would depend on the choices made by both Netflix
and its viewers. Netflix would be a substitute product for viewers unwilling to pay the high cost of bundled
cable or satellite subscriptions.34 For a modest monthly fee, Netflix was a convenient and flexible source of
entertainment that offered streaming of a broad selection of less current movies, documentaries, and TV
shows. However, Netflix did not offer many traditional cable TV shows and, for the series it did carry, new
episodes were typically not available for at least a year after first being aired. Netflix also did not offer live
sports or news. Overall, Netflix could serve only as a supplement to consumers who desired one platform
for current TV shows, live sports, and news.
Finally, cable companies were responding to Netflix’s growth. They matched Netflix’s value proposition
of “entertainment on the go” by launching TV Everywhere (“TV on the go”). Because cable companies had
the money to enter Netflix’s space, they represented one of the biggest threats to the company’s future.
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Other Competitors and Substitutes
Other media-streaming boxes and digital media players were also beginning to occupy Netflix’s market
space, including Apple TV, Roku, TiVo, Google Chromecast, and smart TVs. These devices enabled users
to stream content from Netflix, Hulu Plus, ESPN, HBO Go, and many other sources. Although most of
these devices included the Netflix app, they also provided many more streaming options, some of which
were free. As long as a broadband connection was available, viewers could watch anything that was
available online, which reduced the chance of these viewers getting hooked on Netflix.
Although Netflix had a few substitutes, including theatre, pay-per-view TV, and rental services such as
Redbox, Netflix clearly had the advantage due to its convenience and pricing. Its customers did not need to
step outside for digital entertainment and could easily switch content. Although Netflix had added more
subscribers, this trend might not be easy to continue in this highly competitive environment. Recent TV
programming data showed that other streaming services, including Hulu and Amazon, had a long future
ahead, while Netflix’s declining shares indicated that many viewers were using free trials offered by
Netflix’s competitors.35 However, Netflix continued to lead the overall online downstream market with 32.3
per cent of market share, whereas its competitors, such as Amazon (1.31 per cent), HBO Go (3.4 per cent),
and Hulu (2.4 per cent), had captured only a tiny fraction of this market (see Exhibit 1).36 Netflix could
enjoy its market share advantage, because these numbers had not changed much in the past few years.
TOTAL REVENUES
Utilizing a subscription model, Netflix’s sole source of revenue came from the monthly fees paid by its
subscribers (i.e., its members). The company seemingly had no plans to supplement its revenue sources by
utilizing pay-per-view or ad-supported content, as offered by some of its competitors. The company’s focus
was very clear, “We are about flat-fee unlimited viewing commercial-free.”37 Netflix’s top-line results
directly corresponded to its number of members, and growing its streaming members was vital to the
company’s future success.
Since 2011, the company had three business segments: domestic streaming, international streaming, and
domestic DVD. For the year ended 2013, total revenues were $4.4 billion, compared with $3.6 billion in
2012, and $3.2 billion in 2011. The majority of 2013 revenues were attributable to the domestic streaming
segment at $2.8 billion, an increase of 26 per cent over the previous year. International streaming
represented the smallest portion of 2013 revenues at $0.7 billion, yet the highest percentage growth at 148
per cent. The domestic DVD segment declined to $0.9 billion, representing –20 per cent growth.38
The rapid rise in Netflix’s revenue was consistent with its increase in members. Streaming members totalled
23.5 million, 33.3 million, and 44.4 million at the end of 2011, 2012, and 2013, respectively. Monthly
revenue per streaming member was approximately $7, while monthly revenue per DVD member was
approximately $11.39
Netflix also needed to consider the seasonality of revenue. Historically, the company had seen the highest
membership additions in the first and fourth quarters of the year, which directly corresponded to North
American weather patterns and TV-watching trends.40
Netflix had raised additional sources of funds by issuing debt. As of December 31, 2013, the company had
$500 million in long-term debt outstanding. It also planned to issue an additional $400 million in the first
quarter of 2014, due to the current low-interest rate environment.41
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It remained to be seen whether Netflix could continue to grow its streaming members at the current yearover-year
pace at the current subscription price. Due to its single source of revenue, any factor that could
cause an abrupt number of cancellations would be detrimental to the company.
COSTS AND SUPPLIER POWER
User Costs
Netflix started online streaming in January 2008. At that time, its streaming and DVD-by-mail operations
were combined, and subscribers could receive both streaming content and DVDs under a single “hybrid
plan.” In July 2011, Netflix introduced DVD-only plans and separated the combined plans, requiring two
separate subscriptions for viewers who wished to receive both DVDs-by-mail and streaming content.42 The
financials for the streaming and DVD segments were not separated until the 2011 annual report, and even
then, only the fourth quarter of 2011 contained the information by DVD and streaming segments. Therefore,
it was difficult to analyze the impact of the move to streaming on Netflix’s subscriber costs and revenues
per segment before 2012. For this reason, the comparison of Netflix’s subscriber costs and other financials
was based on the consolidated financials in annual reports issued from 2002 through 2013 (see Exhibit 2).
As Netflix transitioned from DVD-by-mail to streaming video, the cost per user steadily declined; in 2008,
the cost per user per year was $97 ($8.08 per month) compared with 2011, when the cost per user per year
was $70 ($5.83 per month). Over the past two years, Netflix had struggled to keep the cost per user low, as
it increased costs associated with licensing, original content, and streaming fees.
Licensing Fees and Original Content
In January 2011, Netflix signed a licence agreement with Disney for $150 million to $200 million a year
for access to streaming rights of seven Disney shows (the estimated cost of the licence fee shown in
parentheses): six seasons of Lost ($45 million), Scrubs ($26 million), Hannah Montana ($18 million),
Desperate Housewives ($12 million), Wizards of Waverly Place ($12 million), High School Musical ($1
million), and Camp Rock ($1 million).43 In early 2014, Netflix announced it would spend $3 billion in 2014,
and an additional $6 billion over the next three years to secure the licensing of new content, and to develop
and continue to produce original-content shows.44 These licensing and original content costs were a
significant increase over the cost of revenues that were reported for 2008 and 2009 ($911 million and $1.1
billion, respectively).
Content Delivery
In addition to the increased costs of licensing and new original content, Netflix needed to pay for content
delivery. These costs were incurred through agreements with third-party backbone Internet providers that
carried Netflix’s streaming data via broadband connections, which then passed to Internet service providers
(ISPs) and then to subscribers. Specifics regarding these costs were opaque. However, a note in Netflix’s
2013 year-end financial reports indicated an increase of $31 million in content delivery costs.45
Netflix also had to manage the impact of the recent U.S. appeals court’s overruling of the principle of net
neutrality: “The open Internet, or Net Neutrality, was a principle that [said] all legal content on the Internet
was equal.” In other words, service providers could not discriminate on the speed at which that content was
delivered based on the company that was delivering the content.46 It was believed that an implication of this
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federal ruling would be that Internet service providers, such as Cox Cable, could now charge a higher rate
to sites that used a higher percentage of bandwidth, such as streaming video providers.
In February 2014, Netflix made a deal with Comcast, the largest ISP in the United States, to allow Comcast
to connect directly to Netflix’s servers and bypass backbone third-party providers (e.g., Cogent). The terms
were not disclosed, but Netflix would pay Comcast to ensure sufficient broadband to stream Netflix’s
content to Comcast’s subscribers (see Exhibit 3). The Netflix-Comcast deal followed Comcast’s
announcement of its intentions to buy Time Warner Cable, the nation’s second-largest ISP, for $45 billion.
If the merger was approved by federal authorities as not being in violation of antitrust laws, then Comcast
would have approximately 30 million (or 33 per cent) of all broadband users, and have a near monopoly in
20 of the top 25 broadband markets.47 The Netflix-Comcast deal also closely followed a long anticipated
federal ruling eliminating net neutrality rules.
Various interpretations of the Netflix-Comcast deal and its broader implications were reported in the media.
There appeared to be two basic theories: 1) Netflix was forced into paying off Comcast, at least partially in
response to the recent federal ruling, which reflected a new trend in which ISPs had increased power to
charge content providers for bandwidth usage, and 2) By bypassing third-party backbone providers and
linking Comcast directly to Netflix’s servers, the deal streamlined network connectivity and costs structure,
reflecting a parallel growth of Netflix’s buyer power and Comcast supplier power. It was widely debated
whether either scenario had anything to do with net neutrality and the implications for the Internet as a
whole.48
In the first scenario, Netflix appeared to have mitigated the possible negative consequences of the recent
federal ruling. Some assumed that, without net neutrality rules, ISPs would create an open market for
bandwidth usage by controlling access between Internet content providers and users, and thus gain the
power to charge both users and content providers. Because Netflix was the largest content provider and
bandwidth customer, and Comcast represented access to the largest pool of broadband users, the NetflixComcast
deal was made under terms unfavourable to Netflix but necessary, given the new network
landscape; furthermore, these terms were perhaps better than what Netflix would receive in a future bidding
war for broadband access.
Ultimately, given the first scenario, the elimination of net neutrality would lead to more Netflix-ISP directaccess
deals. Netflix would need to pay more to maintain a core axiom of its business model — the delivery
of quality streaming to a critical mass of customers. Doing so would drive up Netflix’s costs, which would
likely be passed on to its customers via higher subscription fees. However, Netflix could also benefit from
a reduced threat of entry of new competitors into the streaming market, and from the possible elimination
of existing competitors who were unable or unwilling to pay ISPs for the necessary bandwidth. If ISPs
placed bandwidth limitations on Netflix’s competitors, such as Hulu, then Netflix would then secure an
advantage in a reshaped market. Still, it remained to be seen whether ISPs would have incentives to play
favourites over the long term, or whether they would hold heavy bandwidth users hostage with everincreasing
fees for quality service.
The alternative interpretation was that the Netflix-Comcast deal was a mutually beneficial move toward
greater efficiency. Netflix and Comcast had both been paying Cogent to serve as their backbone provider.
However, Cogent had reportedly failed to meet Netflix’s capacity demands, resulting in Netflix-Comcast
customers experiencing degraded streaming quality. Therefore, while Netflix had the additional costs of
paying Comcast directly, both Netflix and Comcast no longer incurred the costs of paying Cogent and had
greater control over the streaming quality their customers experienced.49
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This deal was not unprecedented: Netflix had begun its effort to bypass backbone providers in June 2012
through its Open Connect program.50 When an ISP signed on to the Open Connect program, a Netflix server
device was installed directly to the ISP’s servers, which essentially regulated the delivery of Netflix’s
content. Netflix incentivized ISPs to install these devices by offering high-definition (HD) and 3D content
only through Open Connect. Overall, the Open Connect program leveraged the Netflix customer base with
ISPs whose customers might defect if higher-quality Netflix streaming was available via another provider.
Several major ISPs signed up for Open Connect, including Frontier, British Telecom, TDC, Clearwire,
GVT, Telus, Bell Canada, Virgin, Cablevision, Google Fiber, and Telmex.
Before the Netflix-Comcast deal, some had speculated that Comcast and Time Warner Cable would
continue to resist Open Connect because they were competitors of Netflix; they argued that Comcast and
Time Warner Cable (or any broadband/TV provider) would want to avoid giving Netflix any advantage
unnecessarily over their own offerings, but at the same time avoid alienating their customers by not
providing quality Netflix streaming.
The interplay between Netflix and ISPs reflected the industry’s uncertainty regarding Netflix’s future
market space and the growing polarity of market power. Regardless of net neutrality, the growing
concentration of broadband and TV market power, and Netflix’s reliance on its competitors to deliver an
advantage suggested that Netflix would continue to be a supplement to traditional TV. However, Netflix’s
market power was also growing and, as the cost of cable TV continued to rise, these ISPs would need to
tread lightly when dealing with Netflix, and avoid provoking customer defection from traditional TV and
toward whatever broadband provider was best suited for streaming Netflix.
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EXHIBIT 1: NORTH AMERICAN MARKET SHARE OF ONLINE DOWNSTREAM TRAFFIC, 2013
Netflix 32.25
YouTube 17.11
HTTP 11.11
BitTorrent 5.57
HBO Go 3.4
MPEG 2.58
Hulu 2.41
iTunes 1.90
SSL 1.89
Flash Video 1.72
Other 21.98
Source: Created by case authors based on MarketingCharts Staff, “Netflix + YouTube = Half of North American Peak
Downstream Traffic,” MarketingCharts, May 5, 2013, accessed March 1, 2014, www.marketingcharts.com/wp/online/netflixyoutube-half-of-north-american-peak-downstream-traffic-29549/;
Erik Gruenwedel, “Amazon Prime Instant Video and Hulu
Plus Lag Considerably HBO,” Home Media Magazine, May 28, 2015, accessed March 25, 2015,
www.homemediamagazine.com/streaming/netflix-grows-streaming-traffic-market-share-35953.
EXHIBIT 2: NETFLIX REVENUES, COST OF REVENUES AND COST PER USER PER YEAR, 2002–
2014
Source: Created by case authors based on Netflix 10-K Annual Report 2010, accessed March 1, 2014,
http://files.shareholder.com/downloads /NFLX/2914336619x0x561754/3715da18-1753-4c3-8ba7-18dd28e50673/NFLX_10K.pdf.
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Page 10 9B16M081
EXHIBIT 3: THE NEW INTERNET, AS ENVISIONED BY NETFLIX CHIEF EXECUTIVE OFFICER REED
HASTINGS
ISP
Source: Created by case authors based on Reed Hastings, “Internet Tolls and the Case for Strong Net Neutrality,” Genius.com,
accessed January 13, 2016, http://genius.com/Reed-hastings-internet-tolls-and-the-case-for-strong-net-neutrality-annotated.
800-988-0886 for additional copies.
Page 11 9B16M081
ENDNOTES
1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Netflix or any of its employees. 2 “Netflix Company TimeLine,” Netflix, 2014, accessed February 22, 2014, https://pr.netflix.com/WebClient/loginPageSales
NetWorksAction.do?contentGroupId=10477&contentGroup=Company+Timeline.
3 A. Abkowit, “How Netflix Got Started,” Fortune, January 28, 2009, accessed January 11, 2016,
http://archive.fortune.com/2009/01/27/news/newsmakers/hastings_netflix.fortune/index.htm; J. Cook, “Five Lessons from the
Netflix Startup Story,” MarketingProfs.com, April 11, 2006, accessed February 22, 2014, www.marketingprofs.com/6/
cooktaylor1.asp, 2006.
4 Reed Hastings, “How I Did It: Reed Hastings, Netflix,” Inc., December 1, 2005, accessed February 22, 2014,
www.inc.com/magazine/20051201/qa-hastings.html.
5 Q. Hardy, “Netflix to Stream Live Movies for Free,” Forbes, January 16, 2007, accessed February 22, 2014,
www.forbes.com/2007/01/15/netflix-free-video-streaming-tech-media-cz_qh_0116netflix.html. 6 All currency amounts are shown in U.S. dollars unless otherwise noted.
7 “Netflix Introduces New Plans and Announces Price Changes,” Netflix, accessed February 22, 2014,
http://blog.netflix.com/2011/07/netflix-introduces-new-plans-and.html, 2011. 8 G. Sandoval, “Netflix’s Lost Year: The Inside Story of the Price-Hike Train Wreck,” CNET, July 11, 2012, accessed
February 22, 2014, http://news.cnet.com/8301-1023_3-57468798-93/netflixs-lost-year-the-inside-story-of-the-price-hiketrain-wreck/.
Also see “Netflix Stock Quote & Chart,” accessed November 30, 2011, http://ir.netflix.com/stockquote.cfm and
“Netflix Quarterly Earnings,” http://ir.netflix.com/results.cfm.
9 Netflix 10-K Annual Report 2013, accessed February 24, 2015, http://ir.netflix.com/secfiling.cfm?filingID=1065280-14-
6&CIK=1065280.
10 J. Roettgers, “The Slow but Inevitable Decline of Netflix’s DVD Business,” Gigaom Research, October 21, 2013, accessed
February 22, 2014, https://gigaom.com/2013/10/21/when-will-netflix-kill-its-dvd-subscriptions/. 11 F. Salmon, “Why Netflix Is producing Original Content,” Reuters, June 13, 2013, accessed February 22, 2014,
http://blogs.reuters.com/felix-salmon/2013/06/13/why-netflix-is-producing-original-content/. 12 J. Roettgers, “Netflix Is Eyeing Germany and France for International Expansion,” Gigaom Research, accessed February
22, 2014, http://gigaom.com/2014/01/14/netflix-is-eyeing-germany-and-france-for-international-expansion/. 13 J. Roettgers, “Netflix Bets Big on 4K, Strikes Partnerships with Four TV Vendors,” Gigaom Research, January 6, 2014,
accessed February 22, 2014, http://gigaom.com/2014/01/06/netflix-4k-ultra-hd-3d/; D. Moskowitz, “Amazon Is About to
Intensify Your Living Room With 4K Ultra HD,” The Motley Fool, January 11, 2014, accessed February 22, 2014,
www.fool.com/investing/general/2014/01/11/amazon-is-about-to-intensify-your-living-room.aspx. 14 Trefis Team, “How Big Could Netflix’s U.S. Streaming Business Get”? Forbes, March 7, 2013, accessed February 22,
2014, www.forbes.com/sites/ greatspeculations/2013/03/07/how-big-can-netflixs-u-s-streaming-business-get/. 15 Trefis Team, “Sizing up Netflix’s International Subscriber Growth Potential,” Forbes, March 5, 2013, accessed February
22, 2014, www.forbes.com/sites/greatspeculations/2013/03/05/sizing-up-netflixs-international-subscriber-growth-potential/. 16 “Household Broadband Adoption Climbs to 72.4 Percent,” National Telecommunications and Information Administration,
blog post, June 6, 2013, accessed March 9, 2014, www.ntia.doc.gov/blog/2013/household-broadband-adoption-climbs-724-
percent; J. Rodriguez, “Los Gatos: Netflix, Comcast Ink Deal for Smoother, More Efficient Streaming,” San Jose Mercury
News, February 23, 2014, accessed January 11, 2016, www.mercurynews.com/news/ci_25214035/los-gatos-netflixcomcast-ink-deal-smoother-more.
19 “Number of Fixed Broadband Households and Subscriptions Latin America from 2011 to 2017 (in Millions),” Statista,
2014, accessed March 9, 2014, www.statista.com/statistics/267439/fixed-broadband-households-and-subscriptions-latinamerica.”
2014, http://money.cnn.com/ 2014/01/22/technology/netflix-earnings/. 21 “Netflix View: Internet TV Is Replacing Linear TV,” Netflix, accessed February 22, 2014, http://ir.netflix.com/long-termview.cfm.
February 22, 2014, www.forbes.com/sites/maggiemcgrath/2014/01/07/amazon-and-hulu-could-slow-netflix-growth-in-2014-
morgan-stanley-says/.
23 S. Shah, “Netflix: Wrong Part of the Digital Supply Chain,” Seeking Alpha, February 1, 2013, accessed February 22, 2014,
http://seekingalpha.com/article/1149431-netflix-wrong-part-of-the-digital-supply-chain. 24 HBO Go was the streaming service offered by HBO.
25 J. Edwards, “CHART: Netflix Is Slowly Destroying HBO’s Customer Base,” accessed January 11, 2016,
www.businessinsider.com/netflix-hbo-customer-market-share-2014-1. 26 T. Spangler, “Netflix Now Pulls in Almost as Much Revenue as HBO — But HBO Is Far More Profitable,” Variety, February
5, 2014, accessed February 22, 2014, http://variety.com/2014/tv/news/netflix-now-pulls-in-almost-as-much-revenue-as-hbobut-hbo-is-far-more-profitable-1201087683/.
800-988-0886 for additional copies.
Page 12 9B16M081
28 R. Crum, “Netflix Subscriber Gains Lift Sales, Earnings,” MarketWatch, January 22, 2014, accessed February 22, 2014,
www.marketwatch.com/story/netflix-subscriber-gains-lift-sales-earnings-2014-01-22. 29 Amazon.com, “Amazon Prime,” accessed February 22, 2014, www.amazon.com/Amazon-Prime-One-YearMembership/dp/B00DBYBNEE.
31 “About Hulu,” Hulu, accessed February 22, 2014, www.hulu.com/about.
32 Shah, op. cit.
33 T. Dreier, “Streaming Forum: Netflix and Partners Talk Digital Supply Chain,” Streaming Media Europe, June 18, 2013,
accessed February 22, 2013, www.streamingmediaglobal.com/Articles/Editorial/Featured-Articles/Streaming-Forum-Netflixand-Partners-Talk-Digital-Supply-Chain-90286.aspx.
34 M. Lipka, “How to Cut the Cable Cord and Watch TV Now,” Reuters, August 23, 2013, accessed February 22, 2014,
www.reuters.com/article/ 2013/08/23/us-tv-cable-alternatives-idUSBRE97M0XY20130823. 35 E. Protalinski, “NPD: Netflix Accounted for Dominant 89% of TV Show Streaming in Q1 2013, but Lost Share to Hulu and
Amazon Prime,” TNW News, June 4, 2013, accessed March 8, 2013, http://thenextweb.com/insider/2013/06/04/npd-netflixaccounted-for-dominant-89-of-tv-show-streaming-in-q1-2013-but-lost-share-to-hulu-and-amazon-prime/#!x5k.
36 D. Kerr, “Video Streaming Is on the Rise with Netflix Dominating,” CNET, May 14, 2013, accessed March 8, 2013,
http://news.cnet.com/8301-1023_3-57584535-93/video-streaming-is-on-the-rise-with-netflix-dominating/. 37 Netflix, “Netflix View: Internet TV Is Replacing Linear TV,” op. cit.
38 Netflix 10-K Annual Report 2013, op. cit.
39 Ibid.
40 Ibid.
41 Ibid.
42 Netflix 10-K Annual Report 2010, accessed February 22, 2014, http://files.shareholder.com/downloads/NFLX/
2914336619x0x561754/3715da18-1753-4c3-8ba7-18dd28e50673/NFLX_10K.pdf.
43 S. Aune, “How Much Does Netflix Spend on Streaming Content?” TechnoBuffalo, January 18, 2011, accessed February
10, 2011, www.technobuffalo.com/2011/01/18/how-much-does-netflix-spend-on-streaming-content/. 44 M. Sweney, “Netflix to Spend $3bn on TV and Film Content in 2014,” The Guardian, February 15, 2014, accessed
February 22, 2014, www.theguardian.com/media/2014/feb/05/netflix-spend-3-billion-tv-film-content-2014. 45 Netflix 10-K Annual Report 2013, op. cit.
46 R. Yu and M. Snider, “Court Ruling, Comcast Deals Shake up the Landscape for Distributing Content. Here Are Some
Questions to Consider,” USA Today, March 6, 2014, accessed February 22, 2015, www.usatoday.com/story/money/
business/2014/03/05/net-neutrality-recast/5877835/. 47 “Cable Consolidation in America: Turn It Off,” The Economist, March 15, 2014, p. 14, accessed January 11, 2016,
www.economist.com/news/leaders/21598997-american-regulators-should-block-comcasts-proposed-deal-time-warnercable-turn-it.
http://news.cnet.com/8301-1023_3-57619984-93/rereading-the-tea-leaves-in-the-netflix-comcast-deal/; T. Lee, “Comcast’s
Deal with Netflix Makes Network Neutrality Obsolete,” The Washington Post, February 23, 2014, accessed February 22,
2015, www.washingtonpost.com/blogs/the-switch/wp/2014/02/23/comcasts-deal-with-netflix-makes-network-neutralityobsolete/;
D. Rayburn, “Here’s How the Comcast Deal Is Structured, with Data and Numbers,” Streaming Media blog,
February 27, 2014, accessed February 22, 2015, http://blog.streamingmedia.com/2014/02/heres-comcast-netflix-edalstructured-numbers.html.
This document is authorized for use only by Debra Robinson (ladydcbr@aol.com). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or
800-988-0886 for additional copies.
