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Subject: May 2002 ECMgt.com: Netflix Analyzed via the Value Framework
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May 1, 2002 *4,300 subscribers* Volume 4, Issue 5
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Inside this Issue:

Netflix Analyzed via the Value Framework
by Mitchell Levy, Author, E-Volve-or-Die.com, Author,
the Value Framework™
and Bob Cormia, Faculty Member Foothill Community College and E-Business Consultant


Netflix, a pioneer in Internet DVD rentals, used a clearly defined strategy to achieve its goal to be the largest DVD rental company in the U.S.A. This was accomplished with three key initiatives:

  1. Building a robust Web architecture that supported the ideal selection and fulfillment experience of discerning Internet patrons
  2. Developing key business alliances with content providers in film and television sectors, and with merchandisers of DVD hardware
  3. Leveraging best practice skills in direct and database marketing, and creating a fluid means to blend discovery processes with transaction models into transparent cross-sell and up-sale strategies

Netflix began its quest by blending the consumer's desire to gain access to first run movie content without the traditional 9 to 12 month delay into traditional rental sectors, specifically by building alliances with major film producers. Netflix would offer its subscribers access to first run movies in 90 days, edging out traditional rental brands, and Blockbuster in particular. Using the same strategy, Netflix cut a key deal with HBO to merchandize the most popular seasonal entertainment in DVD format, splitting the additional revenues with producers. Both these deals extended the participant chain in the PTP value framework from original producer to end user, capturing the purchase interest while the affinity for the entertainment was the highest.

Another significant move was to strategically time the extension of its brand from film to precut CD-ROM and DVD-ROM music, blending a Napster-like discovery of music content with high fidelity and legal ownership. Even more significant was Netflix timing its alliance with broadband provider AOL-Time Warner to integrate its own customer base with other users of hybrid digital and DVD formats that were being targeted by AOL. This deal leveraged the Netflix expertise for proprietary predictive data mining technologies in entertainment. Extending movie and music labels into the household through hybrid physical and digital media caused explosive growth in profits by extending revenues into value added archival media.

Not surprisingly, Netflix recognized the opportunity of smaller artists to self-publish in DVDR format, leveraging the heuristic search engine technology that recognized musical patterns in database formats. Netflix extended their competency one last step by creating a publishing format for "books on disk" using natural text to speech technology. More critical was their ability to condense full length news print material to snippets using RDF technology, delivering business and technology news content in condensed formats, again not only through its weekly subscription model, but also in hybrid digital / DVD delivery format.

The process of building brand, technology, and user base was carefully if not cautiously timed, as the lessons of over zealous Internet mergers, such as, Excite@home and AT&T, were rushed well ahead of user awareness and market development. Netflix became recognized as a leader in pioneering personalized content delivery by building on household brand recognition and trust. This was the cornerstone of their database mining and marketing effort, which blended personalization and data mining technology with entertainment delivery.

Netflix Wins:

  • Netflix wins in 'discovery' and negotiation, and streamlines 'process'
  • Netflix developed multiple modes of transactions, as you can hold and buy a DVD (spot purchase), have them sent weekly (recurring), or put in an advance order to have one arrive as soon as it's released (dynamic).
  • The 'participant' component of the value framework was a key element of success, with the B2B2C value chain including movie labels and television content.

The Winning Strategies (Advertising, Marketing, and Distribution/Delivery):

  • The alliances with Best Buy were critical to launching their portal, as new DVD users were the most likely consumers to try a new rental service.
  • Blockbuster, which lacked a click and mortar strategy, could not compete with ease of selection, delivery, and opportunity to up-sell to a purchase.
  • Internet selection was more than a convenient shopping tool. It allowed personalized presentation based on user preferences and data mining technology.
  • Using the post office infrastructure for delivery provided an inexpensive and reliable shipping method for Netflix, and added convenience for the customer.
  • Transaction models that included recurring monthly delivery, with the opportunity of a "spot buy" with no pressure, created a "passive shopping" model.
  • Relationships with film producers created a model for direct distribution of first run movies much sooner than current rentals. This helped Netflix edge out other rental brands, and additional revenues for film producers.
  • Theatres became a preferred method of advertising the Netflix service, and added revenue to a film from avid movie patrons, rather than cannibalizing ticket sales.
  • Netflix built a strong base for broadband delivery in selected markets, and possibly direct view on subscription model, becoming a true "Netflix" brand.
  • Database mining and direct email marketing was based on a much better view of the customer, and predictive trends based on aggregate rental and purchase trends.
  • Customers enjoyed the privacy of ordering films in genre that they might not order in a physical setting, including gay and lesbian and adult film material.
  • Sample trailers burned on CD with built in order codes allowed customers to effortlessly preorder videos. Trailers were targeted based on user preferences.
  • Netflix extended DVD material to repackage first run television, especially HBO, which extended revenues for content producers, and virtually wiped out VHS.
  • Netflix built relationships with music labels to extend their brand into music and custom-burned CDs, bringing final resolution to the Napster phenomenon.
  • Careful analysis of hybrid buying patterns showed that kiosks in retail outlets, partnering with BestBuy, allowed for in store selection of films with a value added service of physical browsing but having delayed home delivery.


Strategy Evolved
Having successfully launched a new Internet service and brand, the vision of Netflix was to offer both personalized and standard content through broadband or physical medium, and evolve from movies to music and then to syndicate text content. This strategy leveraged the value proposition of convenience and selection with the natural extension from film to music and then books as entertainment. Launching "books on disk" as a subscription model was coupled with personalizing and encapsulating news content in technology and other fields where consumers wanted to stay current in a field, had little time to read, but had time to listen.

Alliances with ebooks were important here as well. Staying ahead of the competition proved to be a difficult task, as pure play music on disk and ebook entrants made extension of the Netflix brand particularly risky. Similar to Amazon.com, Netflix would need to focus on the core competency of convenience, efficiency, performance,reliability, and personalization to continue to bolster their brand. Finding new revenue streams was key. Using the Value Framework™ to analyze strategy, the key to company growth was a focus on all aspects of PTP, and careful growth into other areas of "household entertainment".

Netflix Evolution:

  • Streaming and downloadable movie and film content: Using a combination of broadband and multicast backbone infrastructure, Netflix provided files for storage or single play. Downloadable movie trailers linked to direct ordering the problematic issue of consumer storage continued to lag behind file content size. However, movie trailers can capture consumer intereste and promote DVD rental, increasing the total number of movies rented and revenue as well.
  • Distribution of online trailers: This can also be a cost that studios bear, but use of the Netflix brand adds value to a third party Internet distribution channel. Netflix will recapture the customer after they have viewed the film live in a theatre.
  • Partnerships: Negotiating contracts with movie studios was key to owning a content channel, if only to lessen the delay from the debut of a first-run film to its availability in DVD format. For some users willing to pay a premium, this was even a preferred consumer format once copyright technology was enhanced.
  • Adult and mature content: Since the entire system of ordering and fulfillment was private from end-to-end, a significant fraction of consumers who watched adult, gay and lesbian films migrated to the service. Content was always kept tasteful to ensure that the Netflix brand was never confused with a pure-play adult channel.
  • Serve Businesses: Training videos, inspirational videos and other business-oriented videos were added to the stock of material, and a business category was created that also included technical training and online educational material.
  • E-learning for schools: Many teachers realized that renting DVDs for class lessons, or renting to own the more successful material, was both a cost-effective and more efficient method of staying current with instructional and educational material.
  • Foreign markets: Both non-US markets and domestic appetites for foreign film were served by a larger inventory. Given the ability of DVDs to play in multilingual format, this was both a natural extension and growth focus. Asia Pacific and European markets added significant growth revenues to Netflix.

Strategy Managed
Launching an Internet brand is difficult enough, but as Netflix deployed their new service, both the Web and the physical competition shifted to adjust to their presence.

On debut, a number of daily challenges and other issues surfaced and were dealt with effectively. Additional reality checks followed with fine-tuning of operations to help keep Netflix ahead of the competition and on track with the long-term vision of personalized content sent through hybrid broadband and physical media.

Critical infrastructure had to be managed to keep customer service and expectations at "Internet levels" congruent with Amazon.com. Most importantly, Netflix managed their strategy to evolve from an effective solution for video rentals, to music, and finally to syndicated text content delivered in digital formats. Netflix extended the value chain marginally from the original producer of the content to the end user with only Netflix in between.

Managing the operations infrastructure, and more importantly, data mining of customer information, was key to a successful business. Product development was also critical to growth and evolution. In conjunction with HBO, Netflix introduced DVD formats for first run television series within 90 days of season endings, capturing interest while it was strongest, and replacing "repeats". This allowed forward continual development on new series and segments, often short run series, as distribution of DVDs proved more appealing to consumers than waiting to see a missed or enjoyed episode.

All through this, Netflix managed the three components of their business namely, Producer, Content, and Consumer, in a fluid synergy that created additional and extended value for first run content. Netflix also created formats for small producers that lacked access to networks, and promoted them through Napster-like discovery and search algorithms.

The adaptive Netflix focus:

  • Reliability: A focus on reliability of operations was essential to building an "experience brand" like Amazon.com did. With so many users accessing the Website, and the Internet architecture being a delivery platform itself, a focus on building and maintaining a robust architecture was a key metric.
  • Compatibility: Netflix needed to keep presentation formats accessible to users of AOL and other portal presence, a key business alliance, and for all kinds of browsers, including PDAs, where movie selections became more frequent.
  • New features: Customized direct email-personalized based on what the user has rented in the past-helped consumers know what new movies were available.
  • Distribution center: Dealing with the challenges of a huge distribution center and logistics with the USPS were the most important factor in developing economies of scale. Managing shipping costs in particular affected bottom line profits.
  • Pricing packages: Instead of forcing all customers to rent only three DVDs simultaneously, Netflix would create tiers based on usage levels ranging from $13 a month for two simultaneous movies to $40 a month for eight. This helped build adoption by hardcore movie buffs as well as casual users.
  • Call center: In the physical world, unanticipated situations would arise all the time for video rental firms. People might return movies in the wrong envelope, product might get lost in the mail etc. A well-staffed call center could intercede in these problems, and double as a phone order service for purchasing DVDs as well.
  • Database marketing as a vehicle to understand individual customers, aggregate and predictive behaviors, and direct email marketing to consumers was critical to creating personalized messaging in a growing permission marketing audience.
  • New content formats grew beyond film. As a strategic turning point for Netflix, the relationship with the consumer became a relationship with the household, where entertainment in digital formats was the common denominator.
  • Music and ebooks became the next target, as the former was useful for delivery of legal "single track" audio, and ebooks were custom built from syndicated content. Each represented natural extensions of video content where convenience was a driver in selection, formatting, delivery, and predictive trends based on global user data.

Strategy Deployed
The initial strategy of Netflix was to take the convenience of renting movies to the next level using the Internet as a selection tool, and adding convenience to delivery and return. Netflix addressed multiple "pain points" common in the physical space, including lack of inventory, pressure of time in both selection and logistics, and having to return films to avoid late fees. Additionally, Netflix offered a much richer selection experience, using Internet technologies to add reviews, personalization, and "consensus" selection; where the pressure to pick the right film is removed. In strategy deployed Netflix first addressed consumer needs by identifying where the current system was and where it was lacking.

Problem issues vs. Netflix solutions:

  • Late fees: A lawsuit has been filed against Blockbuster for the amount they charge in late fees. These late fees often exceed the cost of purchasing the movie. Obviously customers were displeased with their monopolistic strategy and were willing to shift to an entirely new experience of video rental.
  • Due dates: Rushing to drop movies off just in time to avoid late fees was an all too common experience with physical presence rentals. Often consumers would return movies they haven't yet had the chance to watch just to avoid being late. Eliminating due dates would be a unique feature of the Netflix strategy.
  • Delivery Mechanism: Going out of the way to a video store on a Friday evening to pick up two or more movies for the weekend wasn't a pleasant activity. Renting films earlier only added to late charges. Consumers were looking for a more convenient selection and delivery mechanism.
  • Return Mechanism: Drop off boxes were a significant improvement over returning movies at the counter, but usually required driving further on an already rushed Monday morning. Why not let customers mail movies back?
  • Netflix could absorb the cost of pre-paid return envelopes since many films were purchased. Long term contracts with USPS allowed for economies of scale.
  • Volume users: In most businesses, volume users pay less and less the more they buy, but not so with movie rentals. The more movies that were rented, the more consumers paid.
  • Netflix addressed the issue of volume users with a flat monthly fee.
  • Movie studios wanted you to watch more movies without being at a significant disadvantage in loss of revenue.
  • Netflix increased purchases of film content through the preferred DVD medium, adding more profits to successful films.
  • Real estate costs are a significant cost in video rental.
  • By having a central warehouse and office Netflix reduced real estate costs associated with running hundred of stores, including high costs associated with utilities and labor.
  • Netflix could outsource much of the DVD warehousing and shipping logistics, building carefully the infrastructure as the market grew with brand awareness.
  • Selection of videos is limited to "stock on hand" or currency of titles. Browsing through a store is easy for retail, but people's tastes in entertainment are varied, and not easily categorized for personal selection or inventory of obscure films.
  • The centralized location reduced the inventory, increased earnings per DVD and also provided a large selection of obscure works.

Netflix Marketing Strategies:

  • Marketing was key in the early adoption and success of Netflix. By getting the word out through major portals, Yahoo, MSN, and AOL, and through its relationship with BestBuy, consumers were deluged with information about the Netflix service.
  • Free trials addressed the skeptics of a radically new service, and resulted in high conversion rates to continuing customers. The recurring transaction model helped consumers adopt the discipline of selecting films each week but without pressure.
  • Ordering through a centralized and regional warehouse mechanism created efficiencies similar to what Amazon developed. Mail order catalog systems would be difficult for movies, but using the Internet let people both order and pay online.
  • Customization and personalization allowed Netflix users to save lists of preferred movies. As they became available, those films were delivered based on priority.
  • Partnerships were a key strategic focus for Netflix. It was clear that paying upfront and buying movies at market cost would tie up both cash and inventory. Alliances with movie studios would give them a share of profits and equity, and a new distribution channel for film content throughout the product lifecycle.


About the Authors:

Mitchell Levy, is President and CEO of ECnow.com (http://ecnow.com), an e-commerce management consulting company helping start-up, medium and large enterprises transition its employees, partners and customers to the Internet age through strategy, marketing, and off-the-shelf and customized on-line and on-ground training. He is the author of E-Volve-or-Die.com (http://e-volve-or-die.com), author of the Value Framework (http://ecnow.com/value), Executive Producer of VMS3.info (http://VMS3.info), an on-line E-Commerce Management (ECM) eZine, Chair of comdex.biz at Comdex Fall and the Founder and Program Consultant of the premier San Jose State E-Commerce Management Certificate Program (http://ecmtraining.com/sjsu), Chairman of the Pay-per-Performance PR Agency Media Attention Now TM (http://ecnow.com/mediaattention), the on-line learning content production company Transition Learning (http://transitionlearning.com) and the CEO Networking organization CEOnetworking (http://ceonetworking.com). Mitchell was at Sun Microsystems for 9 years, the last 4 of which he managed the e-commerce component of Sun's $3.5 billion supply chain. Mitchell is a popular speaker, lecturing on ECM issues throughout the U.S. and around the world.

Read more about Mr. Levy: http://ecnow.com/ml_bio.htm
Public speaking appearances I've given: http://ecnow.com/speaking.htm
Read about ECnow.com's media coverage: http://ecnow.com/media

Bob Cormia, is an Internet technologist and e-business consultant. Working at SuperBusiness NET, Bob developed strategic positioning, product definition, and account management. Bob developed the e-commerce curriculum at Foothill College while working as a market analyst for G2R, specializing in IT strategy development for Fortune 5000 enterprises. Bob joined eCongo.com in Fall 1998, developing corporate strategy, product development, and launching FreeCommerce on the Internet. In March 2000, Bob joined Calkey.com as an advisor in training and education development in using UML (Unified Modeling Language). In Fall 2001, Bob will join Foothill College as a full-time instructor in the Computer Technology Information Systems division, where he will teach e-commerce, Web strategy, Internet projects, and XML.

Lindsey Cross contributed to this article.


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