Case Study #2 – Netflix, Inc.

: The Disruptor Faces Disruption

1) Describe how Netflix was a “disruptive innovator” with respect to Blockbuster?

a. Explain the scenario of Netflix and Blockbuster from the ~2000-2013 timeframe in your
response

A disruptive innovation creates a new market and value network and, eventually, disrupts an
existing market and value network, displacing established market leaders and alliances. These
changes usually come at the expense of firms in the industry that does not adapt to changes in
demands and they are usually not innovative. As they die out, the firm that is classified as
“disruptive innovations” monopolize on the market share up for grabs. Netflix was very strategic in
that it had entered the market looking for a new solution to an existing market. If they had initially
started out by targeting the competitor’s core market and introduced a similar, larger scaled
solution, Blockbuster’s response would very likely have been a vigorous and perhaps successful
counterattack. Blockbuster’s failure to respond effectively to Netflix put them on the trajectory
towards a total and complete demise.

As for the story of Netflix, it started as an idea fueled by the anger of a $40 Blockbuster late fee
back in 1997 and was based on the premise of ‘no late fees’. In 1999, Netflix brought on board Ted
Sarandos from a fellow Blockbuster competitor and from there, it had scaled the business then to
reach 300,000 subscribers, yet it was still unable to turn a profit. Netflix then gained popularity by
appealing to Blockbuster’s core audience through providing, a wider selection of content with an all-
you-can-watch, on demand, low-price, high-quality, highly convenient approach to the limited scope
of the DVD rental market. As the DVD market grew substantially, it allowed Blockbuster to reach
over 7700 stores nationwide. At one point, Netflix had offered Blockbuster a 49% stake in Netflix
with the bonus of taking the name Blockbuster.com, but Blockbuster made the fatal mistake of
dismissing the entire deal in 2004 in favor of eventually releasing their own attempt at creating a
similar spinoff to Netflix’s services, but quickly failed at that as well. From 2005 through 2013, Netflix
grew from 15 million to 32 million subscribers. During that time, Blockbuster’s customer base was
still at a solid 47 million, but soon the writing was on the wall and most saw this as the beginning of
their inevitable demise. In November 2013, Blockbuster officially announced it would be going out
of business.

2) Describe the disruption that Netflix now faces from the streaming video services such as Hulu?
Unlike the DVD-by-mail delivery model that Netflix originally started under, the digital video
streaming segment was highly competitive and had many limiting factors inhibiting potential
growth. One of the first challenges Netflix faced was the uncertain terms specific owners placed on
their content, which at times came up for discussion at inopportune times causing outages and
delays. This ultimately angers the viewers who can easily and quickly switch companies to better suit
their specific content wants. Another challenge was the fierce competition the Netflix faced with not
only direct competitors in the digital streaming market, but also from services that Netflix relied
upon to provide content to their subscribers. Netflix depended heavily on licensing approval by the
 digital content creator and to host a certain digital content, Netflix must abide by the owner of the
content guidance and terms. Once these terms expired, they had to renew at a disadvantage to host
that content again. An example of this is Hulu, where they are both a direct competitor and a
content owner/provider since the founders of Hulu were a joint venture with Fox, NBC and later
Disney joined the mix. Viewers still wanted to see content from those companies, so Netflix then fell
into a category called a “coopetition” with their competitors in which they had a general agreement
to do business with one another, but at the end of the day, they were still direct competitors with
each other.

Eventually as Netflix began to scale, most of these competitors involved in the “coopetition”
began to see Netflix as a threat and cut back on the deals they had previously negotiated with them.
Netflix and other companies in the digital content market is now looking to create its own original
content. The large downsides to this are the massive investments each much take in creating these
original shows as well as the large amount of risk. In 2016 and earlier, Netflix spent a large amount
on content, but at the most it equaled total revenue for the years. But as competition picked up,
Netflix made an aggressive decision in 2017 where they budgeted $6.0 billion on new content, which
is more than twice their total revenue. This then requires Netflix to keep adding as much subscribers
just to keep their business model sustainable and their heads above water.

3) What are the actions that Netflix should now take given the strategic dilemma they face?
As with any company in a fiercely competitive market with a similar platform and offerings, in order
for them to succeed, they will need to differentiate themselves in order to capture and grow the
largest share of the market. That differentiation for the streaming video market will be in the form
of original content since the other competitors are pulling back on sharing one another’s content in
favor of getting their foot into the door in this fast-growing market.

a. Evaluate the streaming video market today in your response

The streaming video market is very strong and fast-growing industry with a CAGR of 18.9%. Despite
the concern of the growing number of ‘cord cutters’, consumers have shifted their needs to want a
more mobile, flexible option that still gives them the entertainment factor they had from cable but
in an entirely new platform. With its high growth rates means many new entrants are jumping on
board to try and get their piece of the pie. Due to this fierce competition, it requires each to start
being creative through producing their own original content to get an edge, but that comes with a
hefty price tag and a lot of risk.

b. Explain how you as the Netflix CIO would recommend a path forward to Reed Hasting’s

Continuing with the original content recommendation, Netflix has a large database of their
subscribers’ ratings, feedback and content choices. By compiling and utilizing this data is has
obtaining from their existing subscribers, it can start making more strategic decisions on what
content to create and offer to maximize its overall impact. The cost implications of this will be
significant since 2017’s content budget was 2x their revenue, but I feel it’s a worthwhile investment
 to get ahead in this market. With a few successful series under their belt and a solid lineup in the
pipeline, the large investments in content in the long run will give Netflix that positive ROI they have
been striving for. This decision will be key in taking the lead in the market.

4) What other industries can you think of facing similar disruptions? How would you as the CIO for a
company in this industry use past examples such as Blockbuster and Netflix to explain the risks of
not adapting to your CEO / Board of Directors?

Another industry example of a disruptive innovator is Airbnb. It has completely changed both
the hospitality and travel industry by giving the more price sensitive consumers another option for
places to stay than just the typical hotel – thus giving low-value consumers a new opportunity to
travel. They made a business model for low-value customers because Airbnb was not required to
own the property or employ any of the operating staff necessary to service the customer and
provided it via an online platform that allows customers to access these unique properties at any
time. They have created a low-cost solution to a low-value customer bundled with the convenience
of an on-demand application to meet the customers’ unique requirements and needs while
maximizing flexibility.

There have been numerous examples of long-standing companies that have done business
‘their way’ successfully for many years and are both stagnant and resistant to change. Despite the
difficulty of making any full-scale shift in a new and uncertain direction, adapting to your customers
has proven to be the most effective choice a business can make. Customers will always change, but
if the business will not, it will most certainly be left behind. History has proven this point time and
time again. As we’ve seen in the case of Blockbuster, the power is in the hands of the consumers,
and in the streaming video market, consumers want convenience, personalization, and affordability.
For Netflix to meet those needs of their consumers, streaming services and cable networks alike
need to constantly be at the forefront of technology and always be sure to embrace it where its due.