Netflix — The Rise, The Stumble, and The Future
The Foundations of Netflix
In 1997, video rental stores dominated the entertainment-at-home market. Within this market, Read Hastings found pain points that were not resolved — the options available in the market were not customer friendly, they were extremely expensive and the customers were charged with fees if they failed to return the videos on time. Considering these pain points, Software Engineers Reed Hastings and Marc Randolph founded Netflix in 1998. Netflix essentially provided the customers with the option of renting out DVDs by mail and this was a game-changer in the video renting industry.
Netflix started off as a video delivery service where customers could go online and choose the video they wanted to watch. Netflix would then deliver these DVDs to the customers’ door. A year into the business, Netflix introduced a subscription model which basically meant that customers could now rent DVDs online for a fixed fee every month.
The Business Model Pivot
Netflix launched its subscription model in 1999 where it gained around 240,000 subscribers in the first year of the new business model. Post that, their subscriber base has exponentially increased with them now having over 220 million subscribers in 2022. This success can largely be attributed to their switch to a service-based, nonlinear business model — the one that they currently use.
One of the key factors that have made Netflix this successful is its ability to adapt and keep improving. They were able to look at their business model from an outsider’s viewpoint which gave up the ability to not only make the best of their current situation but also look at the possible scenarios 5 or 10 years down the line and plan around the future. They were able to capitalize on some of the key trends of the past decade –
- Content through Technology: Customers want to be able to access content anytime, anywhere. The best way to do that is through mobile phones.
- Convenience: Customers want their entertainment from the comfort of their homes where they can get a bank for their buck.
- Relevant Recommendations: Customers want technology to be able to recommend them new content when they themselves don’t know what they want to watch
Keeping in mind these key trends, Netflix made the bold decision to cannibalize its own business model to introduce key concepts like digitized services, a leaner approach, and a problem-solving mentality for the customers. Eventually, Netflix came up with their newer business model which is the one that they use right now.
Factors for success
Economies of Scale: One of the major factors for Netflix’s success has been its ability to leverage economies of scale. When Netflix started, its founder Hastings emphasized the importance of utilizing the first-mover advantage and gaining as many subscribers as possible before its competitors could even enter the market. The thought behind this was based on the model on which Netflix functions. Netflix essentially has a lot of money spent upfront (fixed costs) but once the content is produced, the cost of marketing and delivering the content to the customers (marginal costs) is relatively minimal. So, as the number of viewers/ subscribers for Netflix increases, the more revenue it will get and hence, more profits. Hence, even as the total cost (fixed costs + marginal costs) for Netflix goes up, the average cost begins to decline. This is how Netflix exhibits strong economies of scale and it is a vital part of its profitability.
As demonstrated by the graph above (Fig 4), every piece of content that Netflix produces has some fixed cost upfront and for every piece, as the number of viewers grows, the average cost of production declines.
Economies of Scope: Another important factor for Netflix’s future success is leveraging Economies of Scope. Netflix has recently entered the gaming industry by providing games on its platform. Since it already has subscribers that visit the platform on a regular basis, they don’t have to spend additional money on customer acquisition for their games. Also, because they have the infrastructure for the platform sorted out already, the games would essentially just be an additional layer on the platform. So introducing games would be a cost-effective venture because of the already successful content delivery setup.
Network Effects: Netflix benefits from positive network effects on multiple fronts. As Netflix increases its number of subscribers, the more chances of its content going viral. Further, when non-Netflix users see a high number of Netflix users, they are also encouraged to join the platform. Additionally, Netflix’s large customer base gives it tremendous leverage when they negotiate licensing or copyright deals with various content-creating parties.
Something for Everyone: Most of Netflix’s revenue comes from its streaming service and very little comes from the DVD rental service it continues to provide. Netflix wants to provide content to everyone and does not want the price to be a barrier to them being able to access the content. So instead of going with the ‘one price fits all model, Netflix decided to have tier level pricing for its streaming services. The different tiers provided are -
- Basic Plan —
- $9.99 per month
2. Content in Standard Definition
3. Users can only watch on one screen at a time
4. Access to every title on the platform
- Standard Plan —
- $15.99 per month
- Content in High Definition
- Users can watch on two screens simultaneously
- Access to every title on the platform
- Premium Plan —
- $19.99 per month
- Content in HD and 4K Ultra HD Resolution
- Users can watch on four screens simultaneously
- Access to every title on the platform
Bundling: Netflix provides its streaming services in a bundle. It has a large library of content that covers over 3000 unique categories of digital content most popular of which are -
- Action & Adventure (1365)
- Anime (7424)
- Children & Family (783)
- Classic (31574)
- Comedies (6548)
- Documentaries (6839)
- Dramas (5763)
- Horror (8711)
- Music (1701)
- Romantic (8883)
- Sci-fi & Fantasy (1492)
- Sports (4370)
- Thrillers (8933)
- TV Shows (83)
The number in the parentheses indicates the number of titles that fall under that genre/ category. It is important to note that these categories are not mutually exclusive i.e. one title can fall under multiple categories. The huge catalog of digital content is produced to attract as many people as possible and give the subscribers a sense that the platform has endless viewing material, which has at times resulted in a compromise on the content quality.
Netflix’s Present Day Value Net
The value net comprises of four aspects –
- Customers: Who actually use the product or the service
- General Public (Individual Subscribers)
- Group subscribers (Family, Housemates)
- Media and Digital Content Enthusiasts
- Suppliers: Who provides Netflix with the resources to either produce or deliver content
- Internet Providers (Xfiniti, Verizon, etc)
- Media Production Houses (Universal, Warner Bros Media, Sony, etc)
- Production Supplies Manufacturers ( Manufacturers of Cameras, Lights, etc)
- Complementors : Who’s success also helps Netflix’s success in some way or the other
- Social Media Platforms (Facebook, Instagram, etc)
- Discussion Forums (Reddit, Twitter, etc)
- Other Streaming Platforms (Amazon Prime Video, Hulu, HBO Max, Fubo, Disney+, ESPN+, etc )
- YouTubers who do reaction videos
- Internet Providers
- Competitors : Who are competing with Netflix to gain market share in all the segments that Netflix is interested in
- Other Streaming Platforms (Amazon Prime Video, Hulu, HBO Max, Fubo, Disney+, ESPN+, etc )
- Movie Theaters (Regal, PVR, etc)
- Traditional Cable TV
- Other digital content delivery platforms (Youtube, Twitch, etc)
- Short-form content delivery (Instagram Reels, Youtube Shorts, Tik Tok)
- Gaming Companies (EA, Epic Games, Rockstar, etc)
- Music Streaming Platforms (Spotify, Apple Music, Amazon Prime Music, etc)
An important thing to make note of here is that one would instinctively believe that other streaming platforms would be direct competition to Netflix but they can also be Netflix’s complementors. What we forget to consider is that all these platforms together are bringing on the OTT revolution. So when all these platforms are successful, it would mean that online streaming as a whole is progressing which would in turn help Netflix succeed as well.
Another important thing to notice here is the inclusion of Gaming companies as a competitor. Netflix has begun to operate within an adjacent locus through the form of video game production. Netflix has launched mobile games through their app which customers can have access to with a general Netflix subscription. This expansion is still in its initial phase but it is evident that Netflix is making a serious attempt to expand the type of entertainment that can be found on the platform through gaming. The gaming platform will be able to benefit from the popularity of its original content as these games may often be an extension of the stories that have built loyal fanbases. Additionally, the games will already have a viewership ready since the users will already be on the platform for its streaming services.
Netflix’s Recent Tumble
With the emergence of numerous streaming platforms, Netflix which was the clear leader in the industry now faces some pretty stiff competition. The eventual winner in this competition amongst the steaming services is the customer. Customers do not compete against each other i.e. whether or not one customer subscribes to Netflix has no effect on another customer’s ability to become a Netflix subscriber. But that’s not the case when it comes to streaming services. If a customer subscribes to one of Netflix’s rivals, then it is perfectly possible that he or she would not subscribe to Netflix. This gives the customer tremendous power.
A glance at the present market structure could help understand this better. Netflix operates in the streaming and entertainment market and this particular market’s structure can be defined as an ‘oligopoly’. When a market is an oligopoly, that means that few companies control the entire share of the market as opposed to a number of smaller companies with distributed market share. One of the characteristics of an oligopoly market is that if one of the players in that market decides to drop its prices for the customers, there is a high chance of it starting a price war between the rivals. The other companies in the market will also most likely have to drop their prices if they want to stay competitive. So in Netflix’s case, if say Hulu or Amazon Prime Video decides to drop its prices, Netflix will also have to drop theirs otherwise they will risk losing more subscribers to their competitors.
A possible effect of this power could be seen recently as Netflix faced a net loss of around 200,000 subscribers around the world. Further, they expect to lose another 2 million subscribers over the next quarter. This had a cascading effect on Netflix’s share price. After they announced the news about the loss of subscribers in the first quarter, Netflix Inc. shares fell 35% to $226.19 per share, which meant that this was their worst day in the stock market since 2004. In terms of dollar losses, the streaming giant lost about $54.4 Billion dollars in market cap overnight.
When Hasting was interviewed about this, he said, “I know it’s disappointing for investors, and it is for sure,”. But internally, we’re really geared up, and this is like our moment to shine. This is when it all matters. And we’re super focused on achieving those objectives and getting back into our investors’ good graces.”
The reactions from the stock analysts like Jeff Wlodarczak didn’t help Netflix’s cause one bit. He went back on his rating on the stock to “sell” which was originally “buy”. He also cut his target for the next 12 months from around $575 to $235 per share which amounts to about a 60% decrease. Wlodarczak mentioned to his clients, “After what can only be called a shocking 1Q subscriber miss and weak subscriber and financial guidance we reduced our subscriber forecasts and pushed back our profitability forecasts substantially,”
Additionally, Netflix's actions might land them in more losses in terms of the number of subscribers. In the aftermath of the recent war between Russia and Ukraine, Netflix has decided to suspend all of its services in Russia as a sign of protest of all the happenings. “Given the circumstances on the ground, we have decided to suspend our service in Russia,” a spokesperson for Netflix told Variety.
Future Plans for Netflix
With close competition breathing down its neck, Netflix will have to recover fairly quickly if they want to hold onto its position as the industry leader. A good starting point would be to take a closer look at the problem of password sharing amongst Netflix users. In an interview, Reed Hastings mentioned that, “Remember, these are over a hundred million households that already are choosing to view Netflix. They love the service. We just got to get paid, you know, in some degree for them.” So, if somehow, Netflix is able to get money for those 100 Million households, that should automatically improve their position. I don’t believe that restricting the number of logins would be the way to go. They still want the users to use their services. So, instead, they could maybe start charging for logins with more than ‘X’ number of IPs connecting to it.
With the popularity of short-form content increasing, we could see Netflix jumping on the bandwagon as well. They have already entered this space with their version of short-form content — Netflix Laughs. They could consider investing further into this idea which could potentially help to do two things — effectively market the content that is on the platform and increase users’ engagement with their product which in turn increases the amount of time they spend on the platform.
Netflix is considering introducing advertisements on their platform. Reed Hastings revealed that they will be examining what those plans will look like “over the next year or two.” Netflix COO Greg Peters seemed to be on board with this plan as he said, “advertising is an exciting opportunity for us.”
Hastings further added that “Those who have followed Netflix know that I have been against the complexity of advertising, and a big fan of the simplicity of subscription,” Hastings said. “But as much as I am a fan of that, I am a bigger fan of consumer choice. And allowing consumers who would like to have a lower price, and are advertising-tolerant, get what they want, makes a lot of sense. It is pretty clear that it is working for Hulu, Disney is doing it, HBO did it. We don’t have any doubt that it works.”
So we could soon be seeing further versioning come into the picture where a tier cheaper than the standard tier will be introduced. Users who opt into this plan will experience some ads but will get to watch the content at a cheaper price.
Another possible route that Netflix can consider is using the concept of ‘Decoy Pricing’. In simple words, Decoy Pricing is a pricing method that influences customers' choices in terms of their purchases. The “decoy” could go either way. It consists of either a slightly lower product price but with a much lower quality of product or service, or go the other way, a much higher price with a marginally higher quality of product or service. In Netflix’s case, they already have data about which shows are most popular in which parts of the world (some are popular globally like Friends or The Office). So, using this data, they could consider pricing certain content for a higher price and have users pay a premium on these most-watched shows. This could encourage consumption of other content on the platform and also purchasing the cheaper plans that already exist.
Netflix could further explore the gaming route. They already have games on their platform. Gaming streaming has been one of the hottest trends in recent years. Platforms like Twitch and Youtube have already jumped on the trend and stamped their dominance in that sector. So while it may not be the easiest space to enter, it could definitely be worth considering.
In conclusion, yes, Netflix has had a stumble but this isn’t the first time that it has happened. On previous occasions, they were able to pivot or do something else to bounce back. With their track record and the resources they have at their disposal, I am confident that they will be able to stabilize things soon and hold on to their position as the leader of the online content streaming market.
