Netflix

9-113-018
REV: JULY 14, 2017
FRANCOIS BROCHET
SURAJ SRINIVASAN
MICHAEL NORRIS
Netflix: Valuing a New Business Model

Since its 1997 founding, Netflix had built a reputation for innovation and a $3.2 billion business by
offering film rentals on DVD discs through the mail. In 2007, Netflix expanded into streaming media,
the instantaneous delivery of media to computers, set-top boxes, and mobile devices via a broadband
Internet connection.1 By 2011, the company was pursuing streaming as its core business. Underlying
this change in business model was Netflix CEO Reed Hastings’ belief that streaming video offered the
potential for more future growth than DVD rentals. Hastings had been hopeful about the future of
streaming for at least a decade, commenting as early as 2001 that the company hoped to offer streaming
services in the future.2 The shift to streaming created several new wrinkles for Netflix, including
questions about content acquisition, business segmentation, plan pricing, and accounting.
Analysts offered mixed assessments of Netflix’s viability as a company focused on streaming media.
Some argued that the company’s massive subscriber base, customer loyalty, and existing relationships
with the companies that controlled content would allow Netflix to succeed.3 Others, though, pointed
out the business weaknesses that were emerging as Netflix began focusing more on streaming media,
and were concerned about high levels of stock sales by company management.4
In July 2011, Netflix announced the largest price increase in its history, and in September, Netflix
decided to divide its DVD and streaming operations into two separate, independent companies; as a
result of these announcements, the company’s stock lost more than half its value, and almost a million
subscribers canceled their subscriptions within a matter of weeks.5 (Exhibit 1 shows Netflix’s stock
performance. Exhibit 2 shows quarterly subscriber growth.)
At the same time, Netflix was engaged in international expansion. In 2010, Netflix debuted
streaming service (but no DVDs) in Canada, and in 2011, streaming video became available in 43
countries in Latin America and the Caribbean. Netflix planned to begin streaming operations in the
U.K. and Ireland in 2012, further distancing itself from the rental DVD business that had made it
famous. Moving into the streaming video business, however, meant a transition from variable costs to
fixed costs for content. The new business was difficult for investors and analysts to evaluate because
of its newness and the different accounting rules that applied to streaming content. Many analysts
fretted that Netflix’s continued success was in doubt.6
An Industry in Transition
The 2000s was a decade of transition for the home video rental industry, spearheaded by Netflix.
________________________________________________________________________________________________________________
Professors Francois Brochet and Suraj Srinivasan and Research Associate Michael Norris (Global Research Group), prepared this case. This case
was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as
endorsements, sources of primary data, or illustrations of effective or ineffective management.
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This document is authorized for use only in Angeles Romo's MBA 2024 Emprendimientos Tecnologicos (1Q A.R.) at Pontificia Universidad Catolica Chile (PUC-Chile) from Feb 2024 to Jul
2024.
113-018 Netflix: Valuing a New Business Model
Between 2006 and 2011, the $6 billion physical DVD rental industry shrank at a 10% annual rate, and
was expected to continue to decline at a 13% annual rate from 2011 to 2016 as consumers rapidly
adopted streaming video services and downloaded media.7
Before the entrance of Netflix, the industry had been dominated by Blockbuster and other brick-
and-mortar chains of video rental stores. These stores carried a limited selection of videos with a heavy
emphasis on new releases. They typically charged $3 to $4 per rental and imposed late fees if the video
was not returned within a specified time period. Netflix’s monthly subscription, no late-fee, DVD-by-
mail model upended the industry and eventually drove Blockbuster and many independent video
rental stores into bankruptcy, according to analysts.8 New competitors renting physical DVDs from
automated kiosks also emerged in the decade. One was Coinstar’s Redbox, which was founded in 2002,
and offered $1 to $2 DVD rentals at 30,000 kiosks throughout the country by 2011. Many such kiosks
were conveniently located in supermarkets and convenience stores.
By the end of the decade, though, more Netflix customers were choosing to stream media directly
to their computers, set-top boxes, and other devices via the Internet than were renting DVDs, and the
company was heavily focused on acquiring streaming content.
Netflix, Inc.
Netflix was founded in 1997 after Hastings, a successful entrepreneur, found a rented copy of Apollo
13 in his closet and had to pay a $40 late fee on it. “I had misplaced the cassette. It was all my fault,”
Hastings explained. “I didn’t want to tell my wife about it. And I said to myself, ‘I’m going to
compromise the integrity of my marriage over a late fee?’ Later, on my way to the gym, I realized they
[the gym] had a much better business model. You could pay $30 or $40 a month and work out as little
or as much as you wanted.”9
By 2000, Hastings had settled on a business model and launched Netflix. The company charged
users a monthly subscription price for an unlimited number of rentals, with no late fees. Pricing was
tiered based on how many DVDs a user had at any given time (i.e., having one DVD at a time cost less
than having two DVDs at the same time). To use the Netflix service, users paid a monthly subscription
fee via credit card, created a profile, set up a queue of movies they wanted to watch, and were mailed
the DVDs via the U.S. Postal Service (USPS) when they reached the top of the queue. Netflix used the
data generated from its subscriber base (more than one million accounts by 2003, more than 20 million
by 2011) to create recommendations for every user. The recommendation engine reduced demand for
new releases, which were traditionally the most popular to rent and typically the most expensive DVDs
to buy, and drove demand for older or less heavily promoted movies. The company built a nationwide
network of processing centers that allowed for one-day DVD delivery to much of the U.S., and
monitored users’ queues to make shipping more efficient. Netflix went public in 2002.10 The company
enjoyed steady subscriber growth through the decade as it added DVD and streaming content, fueling
what Hastings described as a virtuous cycle of more subscribers creating more revenue, which allowed
for more content purchases.11
Headquartered in Los Gatos, California, Netflix employed more than 2,000 people worldwide in
2011, most of whom worked at its various U.S. DVD distribution facilities. Netflix boasted more than
20 million subscribers worldwide, the vast majority of whom were in the U.S. The company generated
$3.2 billion in revenue in 2011, up 48% from 2010. (See Exhibits 3a through 3c for 2002-2011 financials.)
Average monthly revenue per subscriber was $11.84, down 3% from 2010. In July 2011, Netflix began
requiring U.S. subscribers to subscribe separately to the streaming and DVD-by-mail segments of the
business. After the addition of streaming services in 2007 and the international expansions of 2010 and
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Netflix: Valuing a New Business Model 113-018
2011, Netflix began operating in three business segments: domestic streaming, international streaming,
and (domestic) DVDs by mail.
DVDs-by-Mail Business
Despite the decline in the market for DVD rentals, Netflix and its major competitors, Redbox and
Blockbuster (bought by DISH Network after its 2011 bankruptcy), still found customers who were
attracted to the physical media, and the companies continued to invest in DVD-content acquisition.12
Netflix began amassing its library of DVDs without any direct relationships to movie studios,
instead relying on DVD distribution companies to acquire new content with minimal discounts.
Beginning in 2000, Netflix transitioned to revenue-sharing agreements with movie studios. Studios
reduced the up-front price per unit to Netflix in exchange for a fee based on the number of times a title
was rented. Hastings explained, “We spent more money, not less, with the studios but got bigger
customer satisfaction. It was like paying 20% more and getting two times the number of copies.”13
Regardless of where the company got its DVDs, building a business around physical DVD rentals
was simpler than with streaming content. Hastings explained the important difference between
streaming content and DVDs: “U.S. laws enable anyone to buy a DVD and rent it [to others] as many
times as they want. We can go to Wal-Mart, buy DVDs, and place them in our rental library. We don’t
need a license from the content owner to do so. Online content doesn’t work like that. You have to
negotiate the distribution rights with the studios.”14 The law allowing the rental of physical DVDs
without requiring permission from the copyright holder was known as the “First Sale Doctrine”; it was
established by the U.S. Supreme Court in 1908.
Accounting for DVDs Netflix accounted for DVDs as a long term asset that was amortized
over a one-to three- year period on its balance sheet. The DVDs were amortized on a “sum-of-the-
months” accelerated basis over their estimated useful lives. The company estimated that the useful life
of a new release DVD was one year, while the useful life of a back-catalog DVD was three years. The
useful life of the DVD was determined by a combination of customer interest and the durability of the
actual physical disc.
Streaming Video Business

The company acquired streaming content through licensing agreements with movie studios, TV
networks, and other distribution companies. Separate distribution deals were negotiated to make
content available on a range of Internet-connected devices such as PCs, smartphones, tablets, video
game systems (e.g., Microsoft’s Xbox, Nintendo’s Wii, and Sony’s PlayStation), set-top boxes that were
either provided by cable TV providers or bought by consumers (e.g., Apple TV or Roku), and Internet-
enabled TVs, DVD players, and Blu-ray players. Deals for streaming content could entail the rights to
a single film, a TV series, or a suite of past, current, and/or future output from a movie studio or TV
channel. Deals for streaming content, especially for feature films, were made more costly and
complicated by the fact that most content creators (film studios in the case of feature films) had already
sold the rights to distribute their content for many years to premium television channels, which saw
Netflix as a growing competitor. Netflix, therefore, had to negotiate with these premium channels for
their content distribution rights. The streaming content contracts that Netflix had recently negotiated
were fixed-length, fixed-price deals, rather than revenue-sharing agreements. In these arrangements,
the owners of content potentially made less money, but did not bear the risks involved with Netflix
losing subscribers.
Despite the complicated, expensive deals for streaming content, Hastings viewed streaming as the
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future of the industry, remarking in 2007, “We named the company Netflix [a name that combined the
Internet and “flicks”—a slang term for movies] for a reason; we didn’t name it DVDs-by-mail.”15 He
understood that offering streaming content to customers was a different business proposition than
DVDs-by-mail because of its increased content acquisition costs.16 In addition, some analysts feared
that Internet service providers (ISPs) would begin to target Netflix because the company’s streaming
video services would clog ISPs’ networks. In autumn 2011, for example, Netflix’s streaming services
accounted for almost 33% of peak hours Internet bandwidth used globally.17
Accounting for streaming content To account for streaming content, Netflix used the Financial
Accounting Standards Board’s (FASB) standard 63 (FAS 63). This standard specified that broadcasters
should account for a license agreement as the purchase of rights. Three criteria had to be fulfilled in
order for the rights to broadcast content to be considered an asset:18
1. the cost of each title had to be known or reasonably determinable,
2. the title (or the source file in the case of digital content) must have been received by the
broadcaster, and
3. the title had to be available for its first showing.
If content met all three criteria, FAS 63 stipulated that it should be recognized on the balance sheet
and the income statement. On the balance sheet the total value of the licensed titles would be recorded
as assets in the content library, and the total unpaid value of the licensed titles would be recorded as a
liability (called content account payable) if it was due in less than one year, or as other non-current
content liabilities if it was due in one year or later. On the income statement, companies had the choice
of amortization method used (e.g., straight-line or accelerated) but were encouraged to use a method
that reflected expected usage.
If content did not meet all three FAS 63 criteria, it would not be recorded as an asset on the balance
sheet unless a prepayment had been made. On the income statement, the pre-paid asset would be
amortized on a straight-line basis over the term of the agreement, and the amortization expense would
be recorded in the cost of subscription.
Subscribers
Netflix’s U.S. subscriber base of more than 20 million had steadily grown throughout the company’s
history. However, subscription cancellations were a major issue for the company. The subscriber mix
from one month to the next could be very different. One analyst estimated that annual subscriber churn
approached 45%.19 Unsubscribing from Netflix was easy. Customers paid for their subscriptions on a
monthly basis, unlike a magazine subscription which was typically prepaid for a year or more. When
a user unsubscribed from Netflix, his or her account details and queue of upcoming movies or TV
shows to watch were saved, making it easy to unsubscribe and resubscribe later. Netflix offered the
first month of service free to all new users, so users could potentially unsubscribe and resubscribe with
a different email address, street address, or credit card number and get multiple months of service free
of charge.
The company understood the importance of its large subscriber base. Netflix could leverage its
subscribers to compel movie studios and TV networks to agree to content deals, and could finance
those deals with the consistent monthly payments of its subscribers. The company noted, “If our efforts
to satisfy our existing subscribers are not successful, we may not be able to attract subscribers, and as
a result, our ability to maintain and/or grow our business will be adversely affected.”20
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Competitors
Netflix’s main competitors in DVD-rental operated in two different business models, rental kiosks
and rental stores, while its streaming competitors used several business models.
DVD competitors Redbox operated DVD rental kiosks throughout the U.S. The company
charged $1 per rental per day in most locations, although prices varied for Blu-ray movies or video
games. Users were required to use a credit or debit card to rent their movie, and the company
automatically charged late fees for rentals that were not returned on time.21 Blockbuster operated about
2,500 stores worldwide in 2011, about half of which were located outside the U.S. The company also
offered DVDs-by-mail, streaming video service, and DVD-rental kiosks.22
Ad-supported streaming video Companies including CBS, Hulu (a joint venture between
NBC Universal, News Corp., and Disney), YouTube (owned by Google), and other television networks
offered advertising-supported streaming video content. The amount and quality of content on these
ad-supported sites varied, from the hundreds of millions of hours of user-generated content on
YouTube to the range of current and past CBS shows on CBS.com, to the variety of TV shows and
movies available on Hulu. These websites were free to use and did not require subscriptions; however,
some ad-supported sites required users to create a profile and verify their age before they could watch
more-mature content. In addition, the range of content could change without notice, and access to back-
catalog programming could be limited.
Digital stores Netflix faced competition from online stores that allowed customers to buy and
instantly download digital copies of video files. These stores included Amazon.com, Apple’s iTunes
store, and others that priced digital content at similar rates to physical DVDs. To use these digital stores,
users generally were required to create an account and link it to a credit card. These digital stores
sometimes put a limit on the number of times content could be viewed or the time window in which
user could view the content.
Subscription services Netflix competed against two different types of subscription-based

services. The first was made up of sites such as Amazon Prime, Hulu Plus, and others that offered users
access to a library of streaming content assembled through deals with movie studios, TV networks, and
film distribution companies. Neither of these companies’ subscription-based plans was self-sustaining
in 2011, though. Hulu Plus was still supplemented with ads, and gave customers access to a wider
variety of programming than Hulu’s free offering. Much of Hulu Plus’s programming had at one time
been available for free on Hulu. Amazon Prime’s streaming video service was offered as a free add-on
to the Amazon Prime free-shipping service.
TV Everywhere Netflix considered subscription-based services known as TV Everywhere to be

its major competition.23
Companies such as HBO (owned by Time Warner), with its HBO Go service,
and Showtime (owned by CBS), with Showtime Anytime, offered individuals who subscribed to their
premium cable channels access to content on computers, smartphones, tablets, and other Internet-
enabled devices. These cable channels already had access to content through their prior deals with
movie studios and their own popular TV shows, such as HBO’s Sex and the City or Showtime’s Weeds.
These networks, however, did not allow customers to sign up for streaming-only options, instead
requiring them to pay for a cable-TV package that included the premium channel.
Analyst Reactions
Analysts offered mixed reactions to Netflix’s shift from a DVD-focused to a streaming-focused
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company. They understood the rapid transition from physical to digital in all forms of media, and knew
that Netflix had little choice but to embrace streaming. Some analysts raised issues with Netflix’s
business model that they believed could make it difficult for the company to succeed, while others
came to the company’s defense.
Accounting Before it began investing heavily in streaming content in 2010, Netflix bought its
DVDs on a month-to-month basis and amortized them over a one- to three-year period, resulting in
about 40% amortization of assets each quarter.24 Once it began investing in streaming content, its costs
to acquire assets became larger: three- to five-year contracts that posed high up-front costs. These assets
were amortized over the life of the streaming contract, rather than the useful life of an individual film
or TV title. By the second quarter of 2011, Netflix’s quarterly amortization of its content had dropped
to about 24%.25 Analysts questioned the validity of amortizing the same film over a longer time period
based on it being in streaming format rather than a physical DVD. One analyst noted, “This dynamic
has eroded the quality of Netflix’s earnings and has led to a large disparity between its cash flow and
accrual earnings.”26 Other analysts defended Netflix’s accounting practices, however. One analyst
thought that Netflix’s accounting, “could be viewed as conservative. . . . We expect healthy subscriber
growth over time and by amortizing the content on straight-line basis, Netflix is actually initially
amortizing the costs of a lower subscriber base and ultimately lower revenue base (assuming
subscribers continue to grow).”27
Off-balance-sheet obligations Analysts also worried about the amount of streaming content
commitments that Netflix did not list on its balance sheet because they did not fall under FAS 63. Some
were concerned that Netflix would not have enough future revenue to pay for its streaming content
commitments when they came due.28 (Exhibit 4 shows Netflix’s content library and liabilities, Exhibit
5 shows the company’s off-balance-sheet commitments, and Exhibit 6 shows the growth in Netflix’s
content acquisition costs.) As Netflix noted in its SEC filings, however, its off- balance-sheet obligations
could be much higher than those currently acknowledged: “The company has entered into certain
license agreements . . . . It is unknown whether the company will receive access to these titles or what
the ultimate price per title will be. Accordingly such amounts are not reflected . . . . However such
amounts are expected to be significant.”29 Analysts defended Netflix’s methods, however, claiming
they were similar to those used by other media companies.30
Financing growth Netflix’s accounts payable were growing at a rapid rate, as it used trade
credit to pay for the bulk of its large streaming content deals (see Exhibit 7 for growth in accounts
payable). As one analyst noted in June 2011, “Days payable outstanding has gone from 35 days a year
ago to 72 days as of last quarter, and is now at a level not seen since 2002.”31 Some analysts worried
that Netflix would struggle to pay its obligations, especially as it began expanding overseas. If Netflix’s
subscriber numbers started to decline or its content grew stale because it could not strike deals with
the content owners who saw it as a competitor, it could enter into a downward spiral. Others, though,
believed that Netflix’s heretofore steady subscriber growth would continue to provide the company
with enough liquidity.
Economies of scale A point of agreement among analysts was the potential for Netflix to
leverage economies of scale in its streaming business that were absent from its DVD business because
of the revenue-sharing agreements for acquiring DVD content. Because the company’s streaming
content was paid for in fixed-price contracts, its website and video streaming infrastructure had been
in place for years, and the incremental cost of adding additional customers was small, analysts hoped
that Netflix could achieve economies of scale. One analyst believed, however, that if the streaming
business were to succeed, streaming content owners could push for revenue-sharing deals in the future,
noting that some streaming deals were already based on revenue sharing.32
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Insider sales A final point that concerned some analysts was the high level of insider stock sales.
Noting that Hastings had been selling about 5,000 shares each week for the last several months, and
several other C-level executives had also been actively selling their stock, one analyst questioned what
they thought about their business.33
The Strategic Shift

In November 2010, Netflix offered its first streaming-only subscription: $7.99/month for unlimited
viewing. At this point, the most popular subscription offered by Netflix was $9.99/month for an
unlimited number of DVD rentals (with one DVD out at a time) and unlimited streaming. However,
the company had already begun to view streaming as the core future business and, as one manager
noted, “DVDs by mail was treated as a $2 add-on to our unlimited streaming plan.”34
On July 12, 2011, with Netflix’s stock trading at $291/share, the company announced a major change
in subscription plans and pricing. Subscribers would no longer be able to combine DVD rentals and
streaming video in one account. Users could subscribe to a DVD-only plan for $7.99/month, a
streaming-only plan for $7.99/month or, if they wanted both features, they could sign up for both plans
independently for their combined cost, $15.98/month. This change amounted to a 60% price hike for
those customers who wanted to continue to get DVDs and streaming video, which was previously
offered for $9.99/month. Customers were unhappy with the increase in price and many threatened to
drop the service when the price change went into effect on September 1.35 Netflix’s stock started a swift
decline, dropping about 3% per week for the next several weeks.
Despite customer complaints, Netflix kept its price change in place and moved one step further with
an announcement on September 18 (as the company’s stock was trading at $143/share) of plans to
rebrand its DVD-by-mail service as Qwikster. In a blog post,36 Hastings described that the new service
would be housed on an independent website and require customers to create new accounts on
www.qwikster.com; the new service would not be integrated with Netflix’s billing, recommendation,
or queue systems. The company’s streaming service would remain under the Netflix brand. In
addition, Hastings announced that Qwikster would begin offering video game rentals, something
Netflix had never done. Customers reacted to this announcement with more anger; almost 30,000
people commented on Hastings’ blog post, many of whom announced their plans to cancel their
subscriptions.37
On October 10, with a stock price of $111 per share, just 22 days after announcing Qwikster,
Hastings responded to the criticism with a simple statement: “no change: one website, one account,
one password . . . . in other words, no Qwikster.”38 DVD rentals would stay at Netflix.
What Should Netflix Order Next?

Would Netflix’s recent subscriber losses in response to the price hike and Qwikster debacles
continue, or turn around? Even if the subscriber losses turned around, would the company be able to
generate enough revenue to pay for its current and future streaming commitments? In January 2012,
all of these concerns were reflected by Netflix’s stock, which was trading at its lowest level in 18
months; and investors and analysts now faced the challenge of valuing the new, streaming-focused
company (see Exhibit 8 for analysts’ price ranges).
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Exhibit 1 Netflix Stock Performance, January 2010–December 2011
300
250
200
150
100
50
0
May-…
Nov-…
May-…
Nov-…
Mar-…
Aug-…
Dec-…
Mar-…
Aug-…
Dec-…
Apr-10
Oct-10
Apr-11
Oct-11
Jan-10
Feb-10
Jun-10
Jul-10
Sep-10
Jan-11
Feb-11
Jun-11
Jul-11
Sep-11
Source: Casewriter, from Thomson Reuters Datastream, accessed December 2016.
Exhibit 2 Netflix Quarterly Subscriber Growth and Subscriber Acquisition Cost
30,000,000 35
25,000,000 30
25
20,000,000
20
15,000,000
15
10,000,000
10
5,000,000 5
- 0
Total subscribers Subscriber acquisition cost
Source: Casewriter, Netflix 10Q filings, 1Q 2008-4Q 2011,

http://ir.netflix.com/sec.cfm?DocType=Quarterly&Year=&FormatFilter=, accessed December 2016.
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113-018 -9-
Exhibit 3a Condensed Consolidated Statement of Operations, 2002-2011 (in $ thousands, except share and par value data)
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Revenues 152,806 272,243 506,228 682,213 996,660 1,205,340 1,364,661 1,670,269 2,162,625 3,204,577
Cost of revenues:
Subscription 77,044 147,736 273,401 393,788 532,621 664,407 761,133 909,461 1,154,109 1,789,596
Fulfillment and sales expenses 20,458 31,898 59,666 71,987 94,364 121,761 149,101 169,810 203,246 250,305
Total cost of revenues 97,502 179,634 333,067 465,775 626,985 786,168 910,234 1,079,271 1,357,355 2,039,901
Gross Profit 55,304 92,609 173,161 216,438 369,675 419,172 454,427 590,998 805,270 1,164,676
Operating Expenses:
Technology and development 14,625 17,884 22,906 35,388 48,379 70,979 89,873 114,542 163,329 259,033
Marketing 35,783 49,949 98,027 144,562 225,524 218,212 199,713 237,744 293,839 402,638
General and administrative 6,737 9,585 16,287 35,486 36,155 52,404 49,662 51,333 70,555 117,937
Stock-based compensation 8,832 10,719 16,587 0 0 0 0 0 0 0
Gain on legal settlement 0 0 0 0 0 -7,000 0 0 0 9,000
Gain on disposal of DVDs* 0 0 0 -1,987 -4,797 -7,196 -6,327 -4,560 -6,094 *
Total operating expenses 65,977 88,137 153,807 213,449 305,261 327,399 332,921 399,059 521,629 788,608
Operating Income -10,673 4,472 19,354 2,989 64,414 91,773 121,506 191,939 283,641 376,068
2024.
Other income (expense):
Interest expense on lease financing obligations 1,697 2,457 2,592 5,753 15,904 -1,188 -2,458 -6,475 -19,629 -20,025
Interest and other income (expense) -11,972 -417 -170 -407 0 20,340 12,452 6,728 3,684 3,479
Income before income taxes -20,948 6,512 21,776 8,335 80,318 110,925 131,500 192,192 267,696 359,522
Provision for income taxes 0 0 181 -33,692 31,236 44,317 48,474 76,332 106,843 133,396
Net income -20,948 6,512 21,595 42,027 49,082 66,608 83,026 115,860 160,853 226,126
* 2011 Gain on disposal of DVDs was not available on company 10K and was included as part of general and administrative expenses in 2011.
Net income per share:

Basic -$0.74 $0.14 $0.42 $0.79 $0.78 $0.99 $1.36 $2.05 $3.06 $4.28
Diluted -$0.74 $0.10 $0.33 $0.64 $0.71 $0.97 $1.32 $1.98 $2.96 $4.16
Weighted average common shares outstanding
Basic 28,204 47,786 51,988 53,528 62,577 67,076 60,961 56,560 52,529 52,847
Diluted 28,204 62,884 64,713 65,518 69,075 68,902 62,836 58,416 54,304 54,369
Stock-based compensation included in expense line items
Fulfillment expenses 1,055 1,349 1,702 1,225 925 427 466 380 1,145 1,500
Technology and development 3,007 3,979 6,561 4,446 3,608 3,695 3,890 4,453 10,189 28,922
Marketing 1,640 1,586 2,507 2,565 2,138 2,160 1,886 1,786 3.043 6,107
General and administrative 3,130 3,805 5,817 6,091 6,025 5,694 6,022 5,999 13,619 25,053
Source: Netflix, Inc. Form 10-K, 2002-2011, http://ir.netflix.com/sec.cfm?DocType=Quarterly&Year=&FormatFilter=, accessed April 2017.
113-018 -10-
Exhibit 3b Condensed Consolidated Balance Sheet Data 2002-2011 (in $ thousands, except share and par value data)
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Assets
Cash and cash equivalents 59,814 89,894 174,461 212,256 400,430 177,439 139,881 134,224 194,499 508,053
Short-term investments 43,796 45,297 0 0 0 207,703 157,390 186,018 155,888 289,758
Prepaid expenses 2,753 2,231 2,741 7,848 4,742 6,116 8,122 12,491 62,217 56,007
Prepaid revenue sharing expenses 303 905 4,695 5,252 9,456 6,983 18,417 17,133 0 0
Current content library, net 0 0 0 0 0 16,301 18,691 37,329 181,006 919,709
Deferred tax assets 0 0 0 13,666 3,155 2,254 5,617 0 0 0
Other current assets 409 619 5,449 4,669 10,635 15,627 13,329 23,818 43,621 57,330
Total current assets 107,075 138,946 187,346 243,691 428,418 432,423 361,447 411,013 637,231 1,830,857
Content library, net 9,972 22,238 42,158 57,032 104,908 112,070 98,547 108,810 180,973 1,046,934
Intangible assets, net 6,094 2,948 961 457 969 0 0 0 0 0
Property and equipment, net 5,620 9,772 18,728 40,213 55,503 113,175 124,948 131,653 128,570 136,353
Deposits 0 0 0 1,249 1,316 0 0 0 0 0
Deferred tax assets 1,690 1,272 1,600 21,239 15,600 16,865 22,409 15,958 17,467 28,300
Other assets 79 836 1,000 800 2,065 4,465 10,595 12,300 17,826 26,752
Total assets 130,530 176,012 251,793 364,681 608,779 678,998 617,946 679,734 982,067 3,069,196
Liabilities and Stockholders’ Equity
Current liabilities:
2024.
Accounts payable 20,350 32,654 49,775 63,491 93,864 99,951 100,344 91,475 222,824 1,012,566
Accrued expenses 9,102 11,625 13,131 25,563 29,905 36,466 31,394 33,387 36,489 61,374
Current portion lease financing obligations 1,231 416 68 0 0 823 1,152 1,410 2,083 2,319
Deferred revenue 9,743 18,324 31,936 48,533 69,678 71,665 83,127 100,097 127,183 148,796
Total current liabilities 40,426 63,019 94,910 137,587 193,447 208,905 216,017 226,369 388,579 1,225,055
Long-term debt 288 241 600 0 0 0 0 200,000 200,000 200,000
Long-term debt due to related party 0 0 0 0 0 0 0 0 0 200,000
Lease financing obligations, excluding current portion 460 44 0 842 1,121 35,652 37,988 36,572 34,123 31,800
Other liabilities 0 0 0 0 0 4,629 16,786 17,650 69,201 769,531
Total liabilities 41,174 63,304 95,510 138,429 194,568 249,186 270,791 480,591 691,903 2,426,386
Stockholders’ equity:
Common stock 45 51 53 55 69 65 62 53 53 55
Additional paid-in capital 260,044 270,836 292,843 315,868 454,731 402,710 338,577 0 51,622 219,119
Deferred stock-based compensation -11,702 -5,482 -4,693 0 0 0 0 0 0 0
Treasury stock at cost 0 0 0 0 0 0 -100,020 0 0 0
Accumulated other comprehensive income 774 596 -222 0 0 1,611 84 273 750 706
Retained earnings -159,805 -153,293 -131,698 -89,671 -40,589 25,426 108,452 198,817 237,739 422,930
Total stockholders’ equity 89,356 112,708 156,283 226,252 414,211 429,812 347,155 199,143 290,164 642,810
Total liabilities and stockholders’ equity 130,530 176,012 251,793 364,681 608,779 678,998 617,946 679,734 982,067 3,069,196
113-018 -11-
Exhibit 3c Condensed Consolidated Statements of Cash Flow, 2002-2011 (in $ thousands, except share and par value data)
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Cash Flows from operating activities:
Net income -20,948 6,512 21,595 42,027 49,082 66,608 83,026 115,860 160,853 226,126
Adjustments to reconcile net income to net cash provided by:
Acquisition of streaming content library 0 0 0 0 0 -34,821 -48,290 -64,217 -406,210 -2,320,732
Change in streaming content liabilities 0 0 0 0 0 0 0 -4,014 167.836 1,460,400
Amortization of content library* 20,558 46,271 82,333 96,883 141,160 203,415 209,757 219,490 300,596 795,872
Depreciation / amortization of property and equipment and intangibles 5,919 4,720 5,871 9,134 16,648 22,219 32,454 38,044 38,099 43,747
Stock-based compensation expense 8,832 10,719 16,587 14,327 12,696 11,976 12,264 12,618 27,996 61,582
Excess tax benefits from stock-based compensation 0 0 176 0 -13,217 -26,248 -5,220 -12,683 -62,214 -45,784
Other non-cash items 9,750 -1,501 -2,459 -3,577 -9,294 -15,158 -15,754 -8,944 -9,128 -4,050
Deferred taxes 0 0 0 -34,905 15,988 -893 -8,427 6,328 -962 -18,597
Changes in operating assets and liabilities:
Prepaid expenses and other current assets -44 -290 -9,130 -4,884 -7,064 -3,893 -4,181 -5,358 -18,027 -4,775
Prepaid content 0 0 0 0 0 0 0 -5,643 -35,476 6,211
Accounts payable 6,635 12,304 17,121 8,246 3,208 16,555 7,111 1,537 18,098 24,314
Accrued expenses 4,558 2,523 1,506 12,432 17,559 32,809 -1,824 13,169 67,209 68,902
Deferred revenue 4,806 8,581 13,612 16,597 21,145 1,987 11,462 16,970 27,086 21,613
Other assets and liabilities 48 -47 359 242 279 2,868 11,659 1,906 645 2,883
Net cash provided by operating activities 40,114 89,792 147,571 157,507 248,190 277,424 284,037 325,063 276,401 317,712
Cash flows from investing activities
Acquisition of content library -24,070 -55,620 -102,971 -111,446 -169,528 -208,647 -162,849 -193,044 -123,901 -85,154
Purchases of short-term investments -43,022 -1,679 -586 0 0 -405,340 -256,959 -228,000 -107,362 -223,750
2024.
Proceeds from sale of short-term investments 0 0 45,013 0 0 200,832 307,333 166,706 120,857 50,993
Proceeds from maturities of short-term investments 0 0 0 0 0 0 0 35,673 15,818 38,105
Purchases of property and equipment -2,751 -8,872 -14,962 -27,653 -27,333 -44,256 -43,790 -45,932 -33,837 -49,682
Acquisition of intangible asset 0 0 0 -481 -585 -550 -1,062 -200 -505 0
Proceeds from sale of DVDs 1,988 1,833 5,617 5,781 12,909 21,640 18,368 11,164 12,919 3,674
Investment in business 0 0 0 0 0 0 -6,000 7,483 0 0
Other assets 554 -339 -492 551 -1,332 297 -1 71 -70 0
Net cash provided by (used in) investing activities -67,301 -64,677 -68,381 -133,248 -185,869 -436,024 -144,960 -246,079 -116,081 -265,814
Cash flows from financing activities:
Principal payments of lease financing obligations -17,144 -1,334 -436 -79 -328 -390 -823 -1,158 -1,776 -2,083
Proceeds from issuance of common stock 88,020 6,299 6,035 13,393 112,964 9,609 18,872 35,274 49,776 19,614
Excess tax benefits from stock-based compensation 0 0 0 0 13,217 26,248 5,220 12,683 62,214 45,784
Borrowings on line of credit, net issuance costs and payments 0 0 0 0 0 0 0 -1,022 0 0
Net proceeds from public offering of common stock 0 0 0 0 0 0 0 0 0 199,947
Proceeds from issuance of debt, net of issuance costs 0 0 0 0 0 0 0 193,917 0 198,060
Repurchases of common stock -6 0 0 0 0 -99,858 -199,904 -324,335 -210,259 -199,666
Net cash (used in) provided by financing activities 70,870 4,965 5,599 13,314 125,853 -64,391 -176,635 -84,641 -100,045 261,656
Effect of exchange rate on cash 0 0 -222 222 0 0 0 0 0 0
Net increase (decrease) in cash and cash equivalents 43,683 30,080 84,567 37,795 188,174 -222,991 -37,558 -5,657 60,275 313,554
Cash and cash equivalents, beginning of period 16,131 59,814 89,894 174,461 212,256 400,430 177,439 139,881 134,224 194,499
Cash and cash equivalents, end of period 59,814 89,894 174,461 212,256 400,430 177,439 139,881 134,224 194,499 508,053
* Amortization of content library (Netflix provided amortization of DVDs and streaming content separately starting 2009)
Amortization of streaming content 48,192 158,100 699,128
Amortization of DVDs content 171,298 142,496 96,744
Exhibit 4 Netflix’s Content Library and Content Liabilities, 2010 and 2011 ($ thousands)
Content Library 2010 2011
Streaming DVD Total Streaming DVD Total
Total content library, gross 441,637 627,392 1,069,029 2,552,284 599,155 3,151,439
Accumulated amortization (143,227) (563,823) (707,050) (632,270) (552,526) (1,184,796)
Total content library, net 298,410 63,569 361,979 1,920,014 46,629 1,966,643
Current content library, net 181,006 0 181,006 919,709 0 919,709
Non-current content library, net 117,404 63,569 180,973 1,000,305 46,629 1,046,934
Content Liabilities 2010 2011

Streaming DVD Total Streaming DVD Total
Content accounts payable 136,841 31,854 168,695 905,792 18,914 924,706
Non-current content liabilities 48,179 0 48,179 739,628 0 739,628
Total content liabilities 185,020 31,854 216,874 1,645,420 18,914 1,664,334
Source: Netflix, 2011 10K.
Exhibit 5 Netflix’s Off-Balance Sheet (non-FAS 63) Commitments by Contract Length as of December
31, 2011
Contractual Obligations Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Total
(thousands)
Streaming content obligations $797,649 $2,384,373 $650,480 $74,696 $3,907,198
Source: Compiled by casewriter from Netflix, Inc., “Netflix Streaming Content Accounting,” http://ir.netflix.com, accessed
December 2016.
Exhibit 6 Netflix’s Growing Costs of Content Acquisition, 1Q 2008-4Q 2011 (in $ millions)
Addition of Content
1,200
1,000
1,000
800
632
560
600
400
207 214
200 145
57 87 90
51 44 29 38 46 43 46
-
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Source: Compiled by casewriter from Netflix 10-Q reports, 1Q 2008 through 4Q 2011.
12
2024.
Exhibit 7 Netflix’s Growing Accounts Payable, 1Q 2008-4Q 2011 (in $ millions)
2,000
1,814
1,800
1,600
1,400
1,200 1,123
1,000
810
800
600
392
400 292
202
200 118 122 121 117 131 121 113 109 125 144
-
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Source: Compiled by casewriter from Netflix 10-Q reports, 1Q 2008 through 4Q 2011.
Exhibit 8 Analyst Price Targets
Analyst Price Target, Spring 2011 Price Target, Fall 2011

Canaccord Genuity $300 – BUY $60 - SELL
Piper Jaffray $280 – BUY $100 - BUY
Credit Suisse $280 - BUY $100 - BUY
Janney Capital Markets $170 - SELL $51 - SELL
Oppenheimer $360 - BUY $100 - BUY
Source: Compiled by casewriter from Terry Heath, “Netflix, Inc.,” Canaccord Genuity, May 24, 2011; Jeff Rath, “Netflix, Inc.,”
Canaccord Genuity, November 22, 2011; Michael J. Olson, “Netflix, Inc.,” Piper Jaffray, May 11, 2011; Michael J. Olson,
“Netflix, Inc.,” Piper Jaffray, November 22, 2011; Tony Wible, “Netflix, Inc.,” Janney Capital Markets, June 14, 2011;
Tony Wible, “Netflix, Inc.,” Janney Capital Markets, October 25, 2011; John Blackledge, “Netflix, Inc.,” Credit Suisse,
July 22, 2011; John Blackledge, “Netflix, Inc.,” Credit Suisse, November 22, 2011; Jason Helfstein, “Netflix, Inc.,”
Oppenheimer, July 18, 2011; and Jason Helfstein, “Netflix, Inc.,” Oppenheimer, October 27, 2011, via Thompson, all
accessed January 2013.
13
2024.
Endnotes
1 Netflix, Inc., “Company Timeline,” https://signup.netflix.com/MediaCenter/Timeline, accessed May 2012.

2 Willy Shih, Stephen Kaufman, and David Spinola, “Netflix,” HBS No. 9-607-138 (Boston: Harvard Business
School Publishing, 2007).

3
John Blackledge, Spencer Wang, and Ashton Ngwena, “Netflix Inc.: Three Controversies (Part II): Streaming
Accounting,” Credit Suisse Equity Research, September 8, 2011, via Thomson, accessed May 2012.
4
Tony Wible, “Liquidity Pressures Fuel Bigger Structural Questions and Overhang Risk,” Janney Capital
Markets, June 14, 2011, via Thompson, accessed December 2012.
5 Jon Friedman, “Netflix, RIM: 2 Stocks Dying from Image Woes,” Wall Street Journal MarketWatch, September
21, 2011, http://articles.marketwatch.com/2011-09-21/commentary/30766342_1_netflix-ceo-reed-hastings-

image-woes-takeover-rumors, accessed May 2012.
6Whitney Tilson, “Whitney Tilson: Why We’re Short on Netflix,” seekingalpha.com, December 16, 2010,
http://seekingalpha.com/article/242320-whitney-tilson-why-we-re-short-netflix, accessed May 2012.
7
Agata Kaczanowska, “IBISWorld Industry Report 53223: DVD, Game & Video Rental in the U.S.,” December
2011, via ibisworld.com, accessed May 2012.
8 Peter Cohan, “Why Blockbuster Went Bust While Netflix Flourished,” Daily Finance, September 23, 2010,
http://www.dailyfinance.com/2010/09/23/why-blockbuster-went-bust-while-netflix-flourished/, accessed
May 2012.
9 Reed Hastings as told to Amy Zipkin, “Out of Africa, Onto the Web,” New York Times, December 17, 2006,
www.nytimes.com/2006/12/17/jobs/17boss.html, accessed May 2012.

10 Netflix Inc. “Company Timeline,” https://signup.netflix.com/MediaCenter/Timeline, accessed May 2012.
11 Netflix, Inc., “Letter to Shareholders, October 24, 2011,” http://files.shareholder.com/downloads/NFLX/
1845894174x0x511277/85b155bc-69e8-4cb8-a2a3-22465e076d77/Investor%20Letter%20Q3%202011.pdf, accessed
May 2012.
12
Agata Kaczanowska, “IBISWorld Industry Report 53223: DVD, Game & Video Rental in the U.S.,”
December, 2011 via ibisworld.com, accessed May 2012.
13
Willy Shih, Stephen Kaufman, and David Spinola, “Netflix,” HBS No. 9-607-138 (Boston: Harvard Business
14 Willy Shih, Stephen Kaufman, and David Spinola, “Netflix,” HBS No. 9-607-138 (Boston: Harvard Business

15
Matthew Boyle, “Questions for . . . . Reed Hastings,” Fortune Magazine, May 23, 2007,
http://money.cnn.com/magazines/fortune/fortune_archive/2007/05/28/100034248/index.htm, accessed May
2012.
16
Reed Hastings, “An Explanation and Some Reflections,” September 18, 2011,
http://blog.netflix.com/2011/09/explanation-and-some-reflections.html, accessed May 2012.
17 Sandvine, “Global Internet Phenomena Report,” Fall 2011,
http://www.sandvine.com/downloads/documents/10-26-2011_phenomena/Sandvine%20Global%
20Internet%20Phenomena%20Report%20-%20Fall%202011.pdf, accessed May 2012.
18 Netflix, Inc., “Netflix Streaming Content Accounting,” http://ir.netflix.com, accessed May 2012.
19 Wible, “Liquidity Pressures Fuel Bigger Structural Questions and Overhang Risk.”
14
2024.
20 Netflix, Inc., 2010 Annual Report, http://ir.netflix.com/sec.cfm?DocType=Quarterly&Year=&Format

Filter=, accessed May 2012.
21 Redbox, “Facts About Redbox,” http://www.redbox.com/facts, accessed May 2012.
22Blockbuster LLC, “Company Overview,” http://blockbuster.mwnewsroom.com/Company-Overview,
accessed May 2012.
23 Netflix, Inc., “Letter to Shareholders, October 24, 2011,” http://files.shareholder.com/downloads
/NFLX/1845894174x0x511277/85b155bc-69e8-4cb8-a2a3-22465e076d77/Investor%20Letter%20Q3%202011.pdf,
accessed May 2012.
24 Tony Wible, “Liquidity Pressures Fuel Bigger Structural Questions and Overhang Risk.”
27 John Blackledge, Spencer Wang, and Ashton Ngwena, “Netflix Inc.: Three Controversies (Part II): Streaming
Accounting,” Credit Suisse Equity Research September 8, 2011, accessed via Thomson, May 2012.
29 Netflix, Inc., 2011 Annual Report, http://ir.netflix.com/sec.cfm?DocType=Quarterly&Year=&Format
Filter=, accessed May 2012.
33 Tony Wible, “Things That Make You go Hmmm…,” Janney Capital Markets, September 15, 2011, accessed via
Thomson, accessed December 2012.

34Netflix blog, “Netflix Introduces New Plans and Announces Price Changes,” July 12, 2011,
http://blog.netflix.com/2011/07/Netflix-introduces-new-plans-and.html, accessed May 2012.
35 Comments to Netflix blog, “Netflix Introduces New Plans and Announces Price Changes,” July 12, 2011,
http://blog.netflix.com/2011/07/Netflix-introduces-new-plans-and.html, accessed May 2012.

36 Reed Hastings, “An Explanation and Some Reflections,” September 18, 2011,
37 Reed Hastings, “An Explanation and Some Reflections,” September 18, 2011,
38 Reed Hastings, “DVDs will be staying at Netflix.com,” October 10, 2011,
http://blog.netflix.com/2011/10/dvds-will-be-staying-at-netflixcom.html, accessed May 2012.
15
2024.

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9-113-018

REV: JULY 14, 2017

Netflix: Valuing a New Business Model

Streaming Video Business

1. the cost of each title had to be known or reasonably determinable,

3. the title had to be available for its first showing.

Subscription services Netflix competed against two different types of subscription-based

TV Everywhere Netflix considered subscription-based services known as TV Everywhere to be

The Strategic Shift

What Should Netflix Order Next?

Exhibit 1 Netflix Stock Performance, January 2010–December 2011

Exhibit 2 Netflix Quarterly Subscriber Growth and Subscriber Acquisition Cost

Total subscribers Subscriber acquisition cost

Source: Casewriter, Netflix 10Q filings, 1Q 2008-4Q 2011,

Net income per share:

Content Liabilities 2010 2011

Source: Netflix, 2011 10K.

Exhibit 7 Netflix’s Growing Accounts Payable, 1Q 2008-4Q 2011 (in $ millions)

Exhibit 8 Analyst Price Targets

Analyst Price Target, Spring 2011 Price Target, Fall 2011

1 Netflix, Inc., “Company Timeline,” https://signup.netflix.com/MediaCenter/Timeline, accessed May 2012.

School Publishing, 2007).

21, 2011, http://articles.marketwatch.com/2011-09-21/commentary/30766342_1_netflix-ceo-reed-hastings-

www.nytimes.com/2006/12/17/jobs/17boss.html, accessed May 2012.

School Publishing, 2007).

20 Netflix, Inc., 2010 Annual Report, http://ir.netflix.com/sec.cfm?DocType=Quarterly&Year=&Format

Thomson, accessed December 2012.

http://blog.netflix.com/2011/07/Netflix-introduces-new-plans-and.html, accessed May 2012.

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