To:

Reed Hastings, CEO Netflix

From: Katerina Tikhonova, Consultant Strategic Management RE: Netflix Assessment Date: January 2, 2013 Dear Mr. Hastings: As per our contract, following is the assessment that you employed my firm to prepare with recommended actions to improve your companys future prospects. Following is a list of the sections: 1) 2) 3) 4) 5) 6) 7) Evaluation of Competitive Forces in the Movie Rental Industry Forces Driving Change in the Industry Industrys Key Success Factors Critique of Netflix Strategy and Business Model SWOT Analysis Assessment of Netflix Strategic and Financial Performance Recommendations

While my firm is prepared to respond to any inquiries that result from this report, please be advised that Strategic Management is not liable for any result that may come from the implementation of its recommendations and is based upon information that is readily available to the general public (all references included). Please let me know if I can be of any further assistance and thank you for your business. Respectfully yours,

Katerina Tikhonova

1)

The competitive forces in the movie rental industry are no different than they are for any other. Accepted as business lore since publication in the Harvard Business Review, Harvard University professor Michael Porter authored, How Competitive Forces Shape Strategy,1 which outlines that competition must be evaluated based five factors: a) What threat there is of new competitors; b) The bargaining power of suppliers; c) The bargaining power of buyers; d) The availability of substitute products; and e) Existing competition.

http://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy/ar/1

Netflix future profits depend on these resulting forces and how they are dealt with. The structure of the movie rental industry demands that the analysis be performed in light of the fact that: a. Technology emerges making it relatively easy for competition to enter the market; b. Customers can switch between the availability of like products; c. Technological requirements are high for the service provided; and d. Regulations require respecting intellectual property laws and licensing requirements.

2) The forces driving change in the industry are:

i)

The ease by which selections can be made (user friendliness)*;

ii) Convenience of service*; iii) The number of video titles that are available for viewing; iv) Technological improvements in viewing, accessibility, streaming speeds; v) Entrance of wireless providers based on improvements in technology; and not least significant, vi) Cost for the service. * The distinction between ease and convenience may not be apparent but can be better understood when considering that Netflix competition includes store and kiosk video rentals which require leaving home (which

is less convenient) versus the ability to navigate and select available Netflix titles from a computer or other accessing device (ease of use).

3) The movie rental industrys key success factors are the nominal cost for the services to the users; high growth in expanding markets, and a weakened economy which has consumers searching out or increasing their less expensive entertainment options.

4) Netflix strategy and its business model appear to be working well for the company, although its financial success in recent years is a lagging indicator and requires a critique of its strategy to ensure that its strategy, as a leading indicator, continues to lead to continued financial success. Netflix strategy is sound in that it seeks to grow the streaming subscription business within the United States and globally by continuously improving the customer experience, with a focus on expanding streaming content, enhancing user interfaces and extending the streaming service to even more Internet-connected devices.2 This improvement of customer service facilitates the increase in subscriptions by: making it possible to secure additional content (which, in turn, drives a higher subscription rate; leading to greater word-of-mouth promotion of Netflix service, (which again, leads to more subscribers, but at a lower marketing through advertising expense; and

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 providing capital through retained earnings which allows Netflix to make further improvements to their service offering (and again, should lead to greater subscriptions. 5) Netflix strengths lie primarily with its intangible assets in that they enjoy an outstanding brand name and corporate image; intellectual property agreements and algorithms that permit errorless streaming service to the consumer, and a quality workforce which is also union-free. In addition, Netflix also has the capability to provide rentals via direct mail and has the largest online library of titles available to rent at a relatively low cost to the consumer (this includes no late fees for mail rentals). Netflix weaknesses are principally technological in that an internet accessibility is required for streaming and also requires, except for direct mail rentals, a hardware capable device (such as a computer, Sony Play Station 3, X-Box 360, TiVo, or a Blu Ray internet capable player). Opportunities for Netflix lie in the global market as developing nations are introduced to the technology required to access streaming video. 3 Another possibility which will be discussed in the recommendations is securing licensing for the provision of on line gaming rentals. The threats to Netflix are few but worthy of serious consideration. Blockbuster continues its viability as an ongoing concern, particularly now that theyve added their own capability for on line rentals. This is also true of Movie Gallery and Apple. Redbox (automated retail) and Blockbuster also provide in store rentals, but are of less serious a concern because of the inconvenience associated with the requirement

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that the consumer visit their locations and the severely limited access to titles. The most serious of all threats is likely to be Hulu, Amazon, and HBO.4 6) Netflix use of marketing programs to promote service to potential new subscribers appears to be working well as will be depicted by the lagging financial indicators. These efforts include securing new subscribers through online marketing efforts, including paid search listings, banner ads, text links and permission-based e-mails, as well as an active affiliate program. Netflix also engages its consumer electronics partners to generate new subscribers for service (although it is unclear if this is a compensated action). In addition, Netflix participates in various offline marketing programs, including TV and radio advertising, direct mail and print campaigns, consumer package and mailing insertions. Maintaining an active public relations program to increase awareness of service and drive subscriber acquisitions likewise yielded positive financial results. Unfortunately, however, these objectives are not nearly as quantifiable as any organization might like.5 There can be no doubt that the financial objective of any company is to be profitable. In this regard, Netflix has more than met their goals in recent years.6 Between 2009 and 2010, net income rose $44.993M, from $115.86 to $160.853, or 38.9% (44.993/115.860); the gain was slightly higher between 2010 and 2011 at 40.6% net income climbed to $226.126M [(226.126-160.853)/160.853]. Earnings Per Share (EPS) is likewise an indication of solid financial performance, particularly if the http://files.shareholder.com/downloads/NFLX/2249769821x0x607614/6bc75664-8a604398-8e52-fe918b79bf67/Investor%20Letter%20Q3%202012%2010.23.12.pdf 5 http://files.shareholder.com/downloads/NFLX/2249769821x0x460274/17454c5b-308848c7-957a-b5a83a14cf1b/132054ACL.PDF 6 http://files.shareholder.com/downloads/NFLX/2249769821x0x561754/3715da18-17534c34-8ba7-18dd28e50673/NFLX_10K.pdf (p.49).
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number of shares outstanding of common stock has not increased significantly (which makes the diluted EPS calculation relevant). Netflix EPS climbed from $2.05 [Net Income of $115.860M 56.56M Common Shares Outstanding] to $3.06 [$160.853M52.529M], or 49% [(3.06-2.05)/2.05] from 2009 to 2010; and then rose to $4.28 [$226.126M52.847M], or 40% [(4.28-3.06)/3.06], in 2011. Finally, any financial analysis would be incomplete without reviewing Netflix ability to meet current debt obligations using the current, or quick ratio [Current Assets (CA) Current Liabilities (CL)]. Netflix demonstrates outstanding solvency in this regard with a quick ratio of 1.639 in 2010 [$637.231MCL of $388.579], and 1.49 in 2011 [$1,830.055 $1,225.055].7

7) There is no reason to expect that Netflix strategy will not continue to yield positive strategic and financial performance as they rely on their intangible assets (such as brand, customer service, and requisite technological applications and algorithms) and continue to add titles to their current inventory of tangible assets, while giving serious consideration to entering the video gaming market to compete on another platform with Blockbuster and Amazon. Beyond this, there are only two recommendations that I can make where I see an opportunity to raise revenue. Although not technically a weakness (or strength), it is a customer benefit to be able to log into the Netflix website from any location with only one user account name and password. This enables one individual to share accounts such that revenues are lost. Cablevision has resolved this problem by requiring a box for any television that its http://files.shareholder.com/downloads/NFLX/2249769821x0x561754/3715da18-17534c34-8ba7-18dd28e50673/NFLX_10K.pdf (p.48).
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connected to in order to view any program. In the alternative, Kindle books permits only one device at a time (they can be de-registered and then re-registered without limit), making excessive sharing (beyond a family unit) much more difficult.