Bond University

Entrepreneurship and Innovation ENFB-104_153

Group Project: Analysis of the Innovative Strategy of a Firm

Professor:

Baden U’Ren

Students:

Martin Byström

Conrad Quick

Danny Korakali

Oleksii Mykhailiuk

Year 2015

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Executive Summary

Through disruptive innovation Netflix has soared to the peaks of the entertainment industry,
which has resulted in originally significant competitors i.e., Blockbuster, filing for bankruptcy
not long after a huge growth in consumer access to the internet. Their unique value proposition
statement appealed to consumers and fundamentally challenged traditional retailer’s business
models, pricing and product delivery.

By adopting, perhaps unwittingly, a Stewardship Theory style of staff control through their
“Freedom and Responsibility” culture, Netflix has attracted and retained only the highest
performers. Staff need very little encouragement to work autonomously and heuristically, often
putting together groups from different departments to “socialise” new ideas innovatively.

Their main success factors lies in their visionary management, ground breaking talent
management policies and their efficient use of advanced algorithms that constantly offer
consumers relevant content. However, based on the analysis several gaps and
inconsistencies has been identified through the utilisation of the McKinsey 7S framework.

The ongoing innovation that Netflix has demonstrated is their industry disruptive streaming
services, distinctive talent management approach, rapid global expansion and their dual
strategy where they act as a low cost entertainment streaming provider while at the same time
providing high quality original content.

This will continue to act as an enabler for them to continue growth on their current trajectory
for another one to two years while Netflix completes their global expansion plan. This growth
may be unsustainable because within 2 years Netflix will be established in all intended
countries and their main focus will then be on generating profits globally from their own
material and content from 2017 onwards.

The challenge for Netflix in future will be to create new opportunities and market sectors that
will enable them to maintain status quo as an innovative market leader that continues to attract
highly desirable T-Shaped employees but also investors and collaborators alike.

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Introduction

This paper will investigate the Netflix innovative strategies using McKinsey’s 7S framework.
Using this framework, an analysis will be conducted to find gaps an inconsistencies and we
will, based on the analysis, suggest ways in which Netflix can improve. This paper will also
discuss the major contributors to the firm´s innovative success.

As we believe that Netflix DVD rental business “Qwikster” is not suitable to assess for this
project we will focus on the part of the company that is related to the streaming service.

Company overview

Marc Randolph and Reed Hastings founded Netflix in 1997 in California, USA. It first started
as a mail order company delivering DVD’s and their first business model consisted of a
traditional pay per view model but was later changed in favour of a monthly subscription with
unlimited rentals. Netflix built its reputation on having a flat fee model with no late fees, postage
fees or due dates.

In 2007, Netflix introduced the possibility to stream content, consisting of movies, TV series
and documentaries through their website. This allowed customers direct access to their
content instead of waiting 24 hours to receive a DVD via the post. Netflix has streamed a total
of 10 billion hours of content from its libraries in the first quarter of 2015 (Frommer, 2015). Up
to 30% of the traffic in this US during peak hours can be related to Netflix (Appendix 1).

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Netflix was embroiled in controversy when the company decided to split up the DVD rental
service and online streaming service into two different subscriptions. This led to customers
having to pay a higher price if using both services and was not popular.

In 2010, Netflix launched its streamed service internationally when entering the Canadian
market. The service is now available in over 60 countries and their reach spreads out over five
different continents. Since 2012 Netflix has produced its own shows and movies, with famous
titles such as the hugely popular “House of Cards” and “Orange is the New Black”.

Netflix’s total amount of subscribers is, as of October 2015, 69.17 million, including more than
43 million in the US. The turnover for the financial year of 2014 was US$5.5 billion, an increase
of 21% from the year before with an estimated market value of $44.93B as of October, 2015.
Netflix´s main competitors on the streaming market is HBO, Hulu and local players such as
Stan and Presto in Australia.

Strategy

Netflix aims to deliver streamed content at an affordable cost, to consumer’s different platforms
such as smart phones, tablets, computers and smart TV’s. For a monthly fee, customers can
access a large library of movies, series and documentaries, free of commercials (Granados,
2015).

Netflix does not use a Freemium Model, which is widely used among competitors and other
streaming services such as Spotify. Instead, all content is free of advertisements. This has
had a major impact on TV networks, who have now started to decrease the amount of
advertisement during prime time shows (McAlone, 2015).

Netflix has opted for a dual strategy in order to attract as many customers as possible. Their
first strategy is to offer one of the markets most affordable service. Compared to its
competitors, Netflix price is one of the lowest on the market. Their second strategy is to move
from being a distributor of content to offer original content that is exclusive to Netflix (Shah,
2015).

Following this strategy, Netflix has produced a lot of own content as a way to create an air of
exclusivity, plus the desire and loyalty from its customer base. As the Netflix CEO, Reed
Hastings, explains: “We don’t and can’t compete on breadth with Comcast, Sky, Amazon,

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Apple, Microsoft, Sony, or Google. For us to be hugely successful we have to be a focused
passion brand. Starbucks, not 7-Eleven. Southwest, not United. HBO, not Dish.”

It is also a way to make Netflix less dependable on the TV networks. Studies have shown that
Netflix, together with HBO, has the highest-ranking shows in the industry (McAlone, 2015).
Netflix has also made strategic alliances with different studios in order to cut out the TV
networks (Smith, 2015).

Offering licensed content is expensive and does not offer any extra value compared to
competitors unless it exclusive. Consumer trends have shown the customers are usually
willing to pay more for exclusive material. This strategy is further enhanced, as Netflix will
invest US$5B in 2016 and the majority of the money will be used to produce up to 475 hours
of original content (Garrahan, 2015).

The benefits of own content is that it gives perpetual exclusivity, which means it can be
delivered in any country for as long a period as required. This is not always possible with
bought content and can be experienced when travelling to different countries, as the content
will not be the same everywhere. The bargaining power is definitely lower when having to
license other provider’s material.

Structure

Netflix has been commended for pioneering innovations in the area of human resource
management (McCord, 2014). The organisation has a functional organisation structure, which
is notably flat. The worldwide operations of Netflix are run by a senior management that is
segmented into different functional departments rather than by customer segment or region.
The departments are each headed by Chief Officers that report directly to the Chief Executive
Officer. In this regard, the top level management is considered as having a centralised
structure. The organisational structure below shows the top level management structure.

In an industry that is rapidly advancing, coupled with high competition, Netflix has developed
an efficient working relationship among its different functional teams. “Highly aligned, loosely
coupled” is a motto within the company. It suggests that employee should spend as little time

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as possible coordinating between the departments and silos. Instead, trust is valued higher
than previewing and pre-approving proposals. The reason for this is to continue to be a fast
and flexible company. However, it does not include the alignment on objectives and strategy,
as this is still coordinated between different departments (Amaral, 2015).

A Streaming and Partnerships Team is responsible for global partnerships with consumer
electronics companies, Internet Service Providers and multi-channel video programming
distributors that enable Netflix to deliver movies and TV shows across a full range of devices
and platforms. They work in collaboration with the Product Team who which design, build and
optimise the Netflix experience (Netflix, 2015).

Systems

Netflix has five main systems that the organisation runs on a day to day basis. They are
acquisition, packaging, exhibition, distribution and sales.

Netflix content acquisitions are through the following agreements: direct purchase from studios
and distributors, revenue sharing programs and licence agreements. Streaming titles are
generally licensed for a fixed term. The process of acquisition requires high negotiation skills
in entering sound deals and at the same time extensive monitoring of customers viewing
preferences.

Netflix has, through its website, been able to feature the base actions of the company and for
subscribers such as: subscription account sign up; personalised merchandising; inventory
optimisation; streaming content and payment. Netflix’s merchandising technology creates a
powerful method of catalogue browsing and is believed to be directly tied to the company’s
success. Because of the extensive use big data and powerful algorithms Netflix is able to offer
a quick and personalized way of finding content for subscribers based on their viewing
preferences. The technology also provides information about each title such as, factual data,
trailers and editorial information, recommendations and information gathering by the service
for each subscriber.

Netflix utilises various models to promote their service. Online advertising, TV and radio
advertising, direct mail and third party promotions are some of their many marketing strategies
to gain subscribers. Electronic partners also help promote the service (Handmer, 2015).
Online advertising is an important channel that consists of: search listing, banner adds, text
links, permission based emails and an affiliated program whereby web-banner ads are

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available on a self-assisted basis. There are also cooperative advertising programs with
studios under the terms in which Netflix receives economic considerations in exchange for
features and studio’s movies in the promotional advertisement.

Staff

Netflix staff’s main strengths lay in their Finance (David Wells, 2015) and Computer
Engineering (Neil Hunt, 2012) Departments, but have had weaknesses in their PR (Jonathan
Friedland, 2012) and Marketing (Meghan Kelly, 2012) Departments. These weaknesses in
leadership have been addressed and the company continues to grow today.

The staff are highly skilled and well-educated, coming from universities such as Stanford and
Yale. They are generally well compensated with staff salaries, on average, deemed to be
amongst the highest in America, averaging $180,000 per year (Michael Zennie, 2015).

Netflix aims to treat staff well, as demonstrated with their innovative unlimited maternity and
paternity leave staffing policy. Introduced in April 2015, in their first year after having a child
or adopting staff are able to take unlimited leave. Netflix also has a “Freedom and
Responsibility Culture”, where staff are encouraged to decide on how much personal leave
they take each year (Hastings, 2012). This Stewardship Theory type of leadership is a style
that supports innovation, which acts as a great enabler of heuristic innovation for the company.

Netflix targets high performing staff only, and adequate performing staff see their employment
agreements terminated and are given severance packages. The “Keeper Test” that Netflix
Managers use is to ask themselves “Which of my people, if they told me they were leaving,
for a similar job with a peer company, would I fight hard to keep at Netflix?” The policy states
that the ones that they wouldn’t fight for should get a generous severance package now (Patty
McCord, 2014).

With Netflix having passed through their “Crisis of Autonomy” in 2012, after the cancellation
of their “Qwickster” (DVD by mail service) part of the business and the CMO resigning, they
moved upwards through the Adolescence Stage to the Prime Stage of the Corporate Lifecycle
(Adizes, 2015).

Netflix has been described as one of the leading organisations who has “reinvented HR”
according to Sheryl Sandberg, the Chief Operating Officer of Facebook (McCord, 2014).
Netflix has been recognised for the innovation in human resource management, now known

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as talent management. Talent management has shaped the culture and motivated the
performance at Netflix. Netflix has pioneered talent management ideas such as the concept
that workers should be allowed to take whatever vacation times they feel is appropriate. The
talent department has invented a whole new approach to traditional human resource
management. This approach to talent and culture has compelled the company to achieve high
performance results. Below are the five key principles (McCord, 2014):
 Hire, reward and tolerate only “Fully Formed Adults”
 Tell the truth about performance
 Managers own the job of creating great teams
 Leaders own the job of creating the company culture
 Good Talent Managers think like business people and innovators first and like HR
people last

Style

Now in the Prime Stage of the Corporate Lifecycle, Netflix is producing their own programs,
after starting in 1997 to just offer online movie rentals, which is highly “entreprenheuristic” and
shows shared values dedicated to a collectivist culture of systemic innovation and a resource
based view.

The “Freedom and Responsibility Culture” of Netflix is a style to create this demonstrated
systemic innovation, which relates back to an organisation wide dominant logic of
proactiveness, competitiveness, autonomy, innovativeness and risk taking. This culture is a
well styled tool for Netflix to maintain staff control and encompasses Stewardship Theory,
minimising agency costs in this non-process driven business model.

By hiring the right people and providing the right environment, Netflix has achieved a well-
balanced AGES Framework (Architecture, Governance, Entrepreneurship, Stewardship
approach) that provides them with a sustainable competitive advantage through ongoing
innovative strategies such as these. The management style incorporates psychological and
situational factors, such as empowerment, involvement orientation and a collectivistic culture.

Skills

Netflix entrusts that the majority of the staff they hire will act in the best interests of the
company, so much so that they have made it policy. Netflix moved from standard performance

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reviews to social performance software in the infancy stages, and then progressed to face to
face 360 degree feedback as a result of transcending the “Crisis of Autonomy”.

Instead of conducting old fashioned, regular performance reviews, Netflix implemented the
new face to face performance management strategy to reduce any skill gaps or weaknesses
by addressing any issues with a sense of urgency (McDuling, 2015).

It can be clearly shown that Netflix boasts it’s highly sophisticated culture through its job
advertisements on its own website: “The most valuable skill of any Netflix employee is the
ability to deliver exceptional results, where objective measurements of success carry more
weight than any other. In order to attract deep talent, we pay very well. Solving hard problems
requires highly talented people, and we compensate appropriately. We expect a lot. Our
culture is unique and we live by our values, so it’s worth learning more about Netflix” (Netflix,
2015).

Employees are often asked to take on additional responsibilities and perform at an increased
pace without close personal supervision. They are asked to make key decisions quickly and
autonomously and to manage aggressive deadlines. These skills are minimum and mandatory
requirements to fit into the “Freedom and Responsibility” culture at Netflix.

Shared Values

The companies shared values are its culture, vision and mission. These three aspects
permeate through company and help the employees understand their purpose, direction and
leadership goals. Netflix mission is as follows “We promise our customers stellar service, our
suppliers a valuable partner, our investors the prospects of sustained profitable growth, and
our employees the allure of huge impact.”

Netflix does not have a well-defined vision but the CEO expressed the following four points at
a conference in 2001 (Farfan, no date)

• Becoming the best global entertainment distribution service

• Licensing entertainment content around the world

• Creating markets that are accessible to film makers

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

Netflix has applied the four soft S’s in the McKinsey’s 7S Framework very well, which would
suggest are the major contributors to the firm's innovative success.

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Key Success Factors

Netflix has become a market leader because of a combination of several innovative strategies
and staffing policies, as well as an intuitive and user friendly service. Through the challenges
that Netflix have faced over the years, principles of the Effectuation Strategy can be noted in
several aspects in their rise to the Prime Stage of Adizes Corporate Lifecycle (Adizes, 2015).

When Netflix was started, both founders vision was to offer the possibility to stream content
from its website (Kim, 2011). However, they were aware that with the internet infrastructure at
the time it would not be possible due to limited bandwidth, which reduces internet streaming
fluidity. Therefore, they started with what was possible at that time, which was renting DVD’s
online. This is known as “Bird in the Hand” theory under the 5 Principles of Effectuation. They
could have waited until internet speeds were adequate for streaming, but instead they started
with what was possible with at that time. This strategy, combined with their vision of how the
market will transform, is one of the contributing factors to their innovative success. Netflix
disrupted the market in such a way that their main competitor, Blockbuster, had to file for
bankruptcy in 2010.

According to Netflix CEO Reed Hastings, they have created a culture of innovation within the
company. This platform allows Netflix not just to come up with a great idea, but being
consistent in its effort to innovate (Kim, 2011). A “Crazy Quilt” example of this is the fact that
Netflix invested a lot of time and money on its content providers, focusing on building strong
relationships that would became an integral and invaluable part of the business when they
moved over to the streaming service in 2007. Relationship building is one of the most highly
regarded skills of certain key staff members of Netflix.

Furthermore, Netflix acknowledge that their employees are their most valuable resources.
Examples, such as unlimited vacation or maternity leave suggest that Netflix puts a lot of trust
in its employees. According to Adams Equity Theory (1963), staff will put in as much as they
feel they get in return from a workplace. This would imply that employees feeling valued by
the company would perform as highly as possible, with feelings of trust in the workplace
culture, reducing pressure and acting as an innovation enabler. Sam Stern, a Senior Customer
Analyst at Forrester Research sums it up adequately “If you trust and empower people and
give them a chance to rise to the higher expectations, the vast majority of people are able to
do so”.

Netflix uses algorithms efficiently in order to track their customers viewing habits. This Big
Data strategy helps Netflix understand its customers and can therefore predict their behaviour
(Marr, 2015). With this sort of analysis, Netflix measures its customer’s viewing habits, which

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help them remain of interest to their customers by suggesting content that is relevant and of
interest. By constantly improving and innovating these different algorithms, Netflix remain
exceptionally competitive despite their library not always being up to date with the latest
releases.

When Netflix decides to create a new show, it does not use the same concept as traditional
studios. While a studio requires a pilot to be made first for assessment, showed to focus
groups and finally after some bureaucracy signed off by the management, Netflix has
streamlined this time consuming process. If they like what they hear while the creator is
pitching his or hers idea, they tend to order 13 episodes directly. This was the case for “Orange
is the new black” that turned out to be a big success (Price, 2015).

Analysis

Based on an assessment using McKinsey's 7 S model as the framework, there are several
gaps and inconsistencies of Netflix’s innovative strategies that have become apparent and are
identified below, with the following suggestions of ways the company could improve. To give
another dimension to our analysis, a SWOT analysis has been conducted (Appendix 2). We
have structured our analysis based on the hard and soft S’s of McKinsey’s 7S framework,
which makes it clear how much effort is required to change the soft S’s over the hard S’s.

Despite promoting themselves as being an innovative company, with cutting edge strategies
and systems, Netflix does not offer an offline mode, which is not keeping in line with current
trends of their competitors. An offline mode would allow consumers to download material and
then watch it later without being dependent on an internet connection. This might be useful
when in transit or if a customer wants to save its mobile data allowance. Competitors such as
Amazon Prime have already started to offer this feature. Netflix refers to “the paradox of
choice”, stating that if consumers are faced with too many choices, it is likely that they will not
use the service (Venable, 2015). A solution to this problem would be to offer the offline mode
in an optional Premium Service, which would come at a slightly higher cost and can include
access to the most recent releases and most popular content. An example of where Netflix is
trying to address this issue is the partnership in place with Virgin America, where they offer all
Netflix customers free Wi-Fi on board (Netflix Blog, 2015). It’s highly likely that Netflix will
continue increase these strategic partnerships with other airlines and transport service
providers.

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Not only does Netflix not offer basic features such as an offline mode, but have also
implemented system based changes that have affected the users in negative ways. Recently,
Netflix changed its service by only allowing one device per account to be used at the same
time. Because many families use the same account it lead to a controversial argument
amongst consumers that Netflix is becoming too greedy (Salway, 2015). As Netflix will not turn
back on its decision, it would be more suitable if they offered a Premium Service at a slightly
higher cost allowing for up to five simultaneously users per account.

There are several gaps and inconsistencies that might affect Netflix in the future. The first
obvious weakness in their strategy is their high dependency upon internet neutrality because
of the data intensive nature of their service. Internet Service Providers (ISP’s) are not allowed
to block or slow down traffic based on the type of service that is sending the content (Reardon,
2014). However, it has been found that some ISP’s have created a “slow lane” for Netflix and
a “fast lane” for less data demanding websites (Rayburn, 2014). This shows how Netflix is
highly dependent upon third party companies to stream its services. One way of decreasing
these risks is either to launch its own ISP or create strategic partnerships with existing ISP’s
in each country they offer services.

They are also dependent upon, and possibly constrained by, software platforms owners such
iOS, Android or Windows. For instance, if Apple TV streaming services were to be launched
it could give Apple cause to cancel the Netflix App available on the iOS platform in order to
decrease competition, which would cost Netflix market share. This is a challenge that all
competitors in the market have to face and there is no easy solution apart from acquiring a
Telco in every country, incorporating their own software platform to compete against iOS,
Android and Windows, which is not a viable solution.

When Netflix entered the market it had a positive effect on internet piracy. The amount of
illegally downloaded content decreased, which showed that consumers were willing to pay for
a quality streaming service. However, through the years, illegal competitors such as PopCorn
Time has started to have a negative impact on Netflix. Despite being illegal, users now have
the ability to watch the same material without having to pay for it. When the actor Kevin Spacey
visited India last year, journalists told him that the Indian people were huge fans of his latest
series “House of Cards”. However, Netflix is not accessible in India, which would suggest that
millions of people watch theirs shows without paying (Rajani, 2014). There are no simple
solution to this problem because the market is compromised by IT criminals that will try to
make money out of other peoples content.

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Furthermore, the content that Netflix produces is only available on their own platform, while
the competing studios can also sell the redistribution rights both nationally and internationally
to other providers of content. The show “Friends”, despite that the final episode aired over ten
years ago, still generates recurrent revenue for NBC and Warner Bros Studios. The competing
studios have understood that in order to compete with Netflix, they must replicate its process
of creating new content. Once they have adapted this streamlined process, they have the
ability to generate considerably more revenue than Netflix (Price, 2015). This may be
considered a threat to the Netflix strategy and a solution to this could the Premium Service
option, where subscribers pay a higher fee for more highly sought after content and have an
offline storage tool. A change in strategy may be to licence their own content to TV networks
to increase their revenue streams.

Netflix plans to rapidly expand to a large number of countries in the near future. A major threat
to this strategy that has been acknowledged is that new host country’s internet infrastructure
may be insufficient. Because their service demands a large amount of data to be tunnelled
across the different broadband networks, it is important that the relevant country’s ISP
infrastructure can manage the large amounts of data that Netflix streaming requires.
Otherwise, this will lead to poor user experiences, which will ultimately affect and reduce the
number of consumers using the service because of constant buffering. When Netflix entered
the Australian market, it almost immediately started using a lot of internet bandwidth, slowing
down internet speeds and leading to bad user experiences for customers. The Australian ISP’s
were forced to heavily invest in their networks in order to maintain adequately running services
(AdhikariI, 2015). Netflix is endeavouring to improve this situation by creating partnerships
with ISP’s across the world to secure sufficient internet bandwidth for their consumer
demands.

Although these weaknesses may remain in place, Netflix’s main strengths lies in the soft S’s
of McKinsey’s 7S framework, which there is staff, skills, style and their shared values. These
soft S strengths are Netflix’s mainstay where we have identified gaps and inconsistencies as
follows.

Netflix promote themselves by stating they are looking for curious and passionate employees
(Smith, 2015), with both pay and benefits well above industry standards. Netflix incorporates
an elitist staff recruiting and retention policy that could create a feeling of job insecurity and
affect some staff member’s capacity for creativity and innovation, due to the stressors of these
prestige and performance requirements. Whilst Netflix has given staff the option of taking as
much leave as they want, it could be seen to go against the ethos of working in an elite,

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performance based culture because of the requirement to always be available. With the
“Keeper Test” in place, consternation and confusion about appropriate amounts of leave to
take in relation to job security resulted (Zillman, 2015). Close consultation conducted by the
HR department may help alleviate this problem by bringing it to the fore, making it an ongoing
agenda for staffing solutions.

Netflix does not disclose their viewing ratings, not even to employees working within a
specifically related project are allowed to take stock of the figures (NathanMcAlone, 2015).
However, not disclosing this kind of information with its staff seems to be a potentially
demotivating factor. By simply sharing this information, it will allow employees to understand
how their work is affecting the company’s goals, direction and strategies.

Despite offering original content, Netflix is dependent upon offering big titles such as the
“Transformers Trilogy” and other blockbusters in order to remain competitive. However, Netflix
have to prolong those agreements from time to time, which can be costly. This would mean
that Netflix library could become inconsistent and therefore less competitive. Netflix recently
parted ways with Epix, which lead to a lot of popular titles disappearing from the library. Those
kind of risks will always exist, regardless of how much original content Netflix produces
(Alexander, 2015). The weaknesses of this style and strategy could be addressed by
increasing the length of their contracts with strategic partners.

Because of their aggressive expansion strategy, Netflix has recently opened offices in Tokyo,
Singapore and Amsterdam in order to reinforce its international market presence and increase
market share. This could potentially increase agency costs, according to Agency Theory,
because they have to monitor, govern and align staff to the shared values of the Netflix
“Freedom and Responsibility” culture. When opening new offices in countries where the
business culture is different to the USA it can also create chaos because new employees are
not accustomed to the Netflix culture and their way of conducting business. This challenge
could be addressed by opening offices in new countries with an ethnocentric staffing strategy
and move towards a polycentric staffing strategy to enhance the Netflix cultural experience in
these local offices.

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Conclusion

This paper has revealed that Netflix is highly innovative company with market disrupting
technology, staffing policies and the ability to generate high levels of consumer demands for
their award winning original content.

However, several gaps and inconsistencies have been revealed with their ongoing strategies,
which will have to be reassessed and aligned once their global expansion plans are complete
in 2017. Focus then will lay in their product development, such as their new offerings and
finding new sources of revenue from their own original content, or licencing their widely
popular shows to other networks. As it stands, Netflix have proven to be a very successful
market leader and innovator, in possession of the skills and shared values to face the
challenges ahead.

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Appendix 1

(Lardinois, 2012)

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Appendix 2

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