Strategy Part 1: Defining our Playing Field
When we talk about strategy, we are essentially identifying where and how we will compete. To do so, we must first identify the boundaries of our target market as well as the current forces within that market.
Using the mission and values of our organization as a guide, we can better understand the competitive environment in which we play, therefore allowing us to determine the scope of what our business should and should not include.
In the following article, we’ll outline the first step in the strategic development process: determining where to play.
Using Netflix as a real-world example, determining where to play will help us to identify our optimal target market segment as well as the likely competitors we will face.
Playing Field
We can begin to define the playing field by focusing on three key areas:
- The Characteristics of the Environment
- The Most Important Customers
- The Competition
1. The Characteristics of the Environment
Characteristics: Netflix has long-been a specialized, premium service, focused on the segment of customers willing to pay a premium for on-demand access to an extensive library of movies and TV shows.
However, as we have seen over the past 10-years, the advancement of technology (notably, the availability of internet access at increasingly lower costs), has led to a change in industry structure, resulting in a slew of new entrants, thus increasing power among buyers.
As a result, Netflix’s premium on-demand service is becoming increasingly commoditized as new streaming players enter the market with lower prices.
Most popular video streaming services in the U.S. as of September 2019, by monthly average users (in millions).
Since Netflix specializes in premium & original programming, we can segment Netflix customers away from free services such as YouTube, which cater to more general audiences and produce minimal original programming.
Moreover, of the premium & original content producers, we can isolate those who specialize in streaming, versus tradition cable TV:
As we can see from the chart above, the top three premium streaming services in terms of content spending are 1) Disney/Hulu, 2) Netflix, 3) Amazon Prime.
Selling cycle: concerning the selling cycle, each of the top three streaming services benefits from a relatively short selling cycle as customers can quickly and easily signup on their websites.
As such, switching costs for consumers are quite low, thus requiring Netflix to continually invest in new and exciting content as a means of attracting and retaining customers.
From the chart below, we can see how this continual spending on new content is ramping up among the top three industry players:
Growth Characteristics of the Market: from the chart below, we can see how the video streaming market has rapidly grown; surpassing traditional cable TV subscribers in 2017:
Although the premium video streaming industry has grown quickly in North America, on a global scale, it is still considered to be in the early stages of the adoption curve, with market penetration still minimal in many emerging markets, like South America, Asia and India.
2. The Most Important Customers
The most important customers for Netflix are those willing and wanting to pay a premium for original programming, along with an extensive collection of available content.
More specifically, these customers value product features, such as:
- on-demand movies and TV shows;
- unlimited streaming;
- no commercials or advertising;
- a customized selection of content tailored to their unique interests;
- reliable service with an attractive user interface/experience, and;
- the ability to watch content across all personal devices (i.e. TV, tablet, smartphone)
As such, Netflix can equally define who is not their target customer, including price-conscious customers who place little/no value on customized experiences or original programming. For example, someone who only watches live sports and/or news.
3. The Competition
Concerning the competition, as internet access becomes increasingly available and less expensive, new players continue to enter the streaming game.
Moreover, it is essential to look not only at other streaming services but also at the industry as a whole, including content producers and distributors.
For example, in 2019, long-time partner and complementor, Disney, announced it would pull all content from Netflix as it launched a competing streaming service (i.e. Disney+).
Perhaps Netflix failed to effectively manage its relationship with Disney, thus encouraging Disney to compete rather than collaborate. As a result, the split with Disney has undoubtedly reduced value for Netflix customers.
Concerning tactics and scope, perhaps Netflix could have better positioned themselves by signing a long-term exclusivity contract, therefore making Netflix the exclusive link (i.e. provider) between customers and Disney content.
Conclusion: Profitability of the [Netflix] Playing Field
It is important to understand that growth is no guarantee of profitability. For an example of this reality, we need not look further than the dismal public market reception of companies like Uber and Lyft.
As for Netflix, although leadership has managed to grow its revenue and net income (thanks to continued customer acquisitions), net operating cash flow has grown increasingly negative, as Netflix must continually increase spending on content production and licensing as a means of attracting and retaining customers:
Regarding the profitability of the streaming playing field, we can make the following conclusion based on a classic Porter’s Five Forces analysis:
- The threat of new entrants is increasing (i.e. Disney), therefore reducing profitability as prices decline and costs increase.
- Due to the surge of new entrants, the power of content suppliers is increasing, therefore reducing profitability as content costs increase.
- Power among buyers (i.e. customers) is increasing due to lower switching costs and the availability of alternative services, therefore reducing profitability as prices decline and costs increase.
- The threat of substitutes is increasing, therefore reducing profitability as prices decline and costs increase.
- As rivalry among existing streaming services increases (i.e. Hulu, Amazon, Disney), profitability is reduced as prices decline and costs increase.
Therefore, while profitability for Netflix has historically been higher than average (compared to traditional cable television rivals), the commoditization of internet access and video streaming has led to a surge of new entrants into the industry, thus increasing power among buyers and content suppliers, while lowering switching costs, and strengthening the rivalry among competitors in the battle for original content production.
Solution?
Porter describes price competition as the most damaging form of rivalry.
Moreover, with rivals like Amazon and Disney offering their streaming services at a much lower price, this places downward pricing pressure on Netflix as their service becomes increasingly commoditized.
Unfortunately, unlike Amazon and Disney, Netflix has a sole source of revenue (i.e. memberships); whereas Amazon Prime Video has its wealthy parent company, and Disney has its theme parks and licensing deals. To compete by lowering its price would be a death sentence for Netflix as it would erode its already-thin margins.
Therefore, to successfully compete against well-diversified companies like Amazon and Disney, is it reasonable to conclude that Netflix must diversify its revenue streams if it wishes to survive.
Specifically, perhaps Netflix should look to other industries for guidance, such as Spotify which offers a free ad-supported version of its service in addition to its paid premium plan, thus driving additional advertising revenue.
About the Author
Matthew is the founder of Allied Venture Partners, a new AngelList syndicate dedicated to the growth and diversity of Western Canada’s technology ecosystem. To learn more, please visit Allied.VC
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