Transcript Selection: The Long Tail in Action

Information Systems:
A Manager’s Guide to Harnessing Technology
By John Gallaugher
© 2012, published by Flat World Knowledge
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© 2012, published by Flat World Knowledge
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Chapter 4
Netflix in Two Acts: The Making of an E-commerce Giant
and the Uncertain Future of Atoms to Bits
© 2012, published by Flat World Knowledge
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Learning Objectives
•
Understand the basics of the two services operating under the Netflix
business model
•
Recognize the downside the firm may have experienced from an early IPO
•
Appreciate why other firms found Netflix’s market attractive, and why
many analysts incorrectly suspected Netflix was doomed
•
Understand the factors that led to customer exodus and stock market
collapse, and identify mistakes Netflix made in rebranding the firm and
splitting its offerings
© 2012, published by Flat World Knowledge
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Learning Objectives
•
Understand how many firms have confused brand and advertising, why
branding is particularly important for online firms, and the factors behind
Netflix’s exceptional brand strength
•
Understand the long tail concept, and how it relates to Netflix’s ability to
offer the customer a huge (the industry’s largest) selection of movies
•
Know what collaborative filtering is, how Netflix uses collaborative
filtering software to match movie titles with the customer’s taste, and in
what ways this software helps Netflix garner a sustainable competitive
advantage
© 2012, published by Flat World Knowledge
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Learning Objectives
•
List and discuss the several technologies Netflix uses in its operations to
reduce costs and deliver customer satisfaction and enhance brand value
•
Understand the role that scale economies play in Netflix’s strategies, and
how these scale economies pose an entry barrier to potential competitors
•
Understand the role that market entry timing has played in the firm’s
success
© 2012, published by Flat World Knowledge
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Learning Objectives
•
Understand the shift from atoms to bits, and how this is impacting a wide
range of industries
•
Recognize the various key issues holding back streaming video models
•
Know the methods that Netflix is using to attempt to counteract these
challenges
© 2012, published by Flat World Knowledge
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Introduction
•
When Netflix went public, financial disclosure rules forced the firm to
reveal how profitable it was
•
Rivals such as Blockbuster and Wal-Mart showed up
•
Competitors underestimated Netflix because:
– It was an Internet pure play without a storefront
– Its overall customer base was microscopic in comparison
© 2012, published by Flat World Knowledge
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Introduction
•
Netflix survived big competitors, a price war, and spending on the rise
•
Factors leading to customer exodus and stock market collapse:
– Netflix split it’s base service charge of $10 into two $8 plans for DVD-by-mail
and Internet streaming
• This caused a 60 percent price hike for customers who wanted to continue with both
services
– Netflix announced its plans to offer the two distinct services in two separate
websites
© 2012, published by Flat World Knowledge
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Introduction
•
•
Netflix lost over 800,000 customers, its stock tumbled from $304 a share
to below $75
Whether Netflix makes a successful transition from DVD-by-mail business
to Internet streaming remains to be seen
© 2012, published by Flat World Knowledge
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Why Study Netflix?
•
•
•
It gives us a chance to examine how technology helps firms craft and
reinforce a competitive advantage
It illustrates how a highly successful firm can still be challenged by
technical shifts
It gives us an opportunity to examine issues that include digital goods,
licensing, platform competition, and supplier power
© 2012, published by Flat World Knowledge
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How Netflix Works: A Model in Transition
•
Netflix settled on a DVD-by-mail service model
– It charges a flat-rate monthly subscription
– Customers don’t pay mailing expenses and late fees
•
Videos arrive in Mylar envelopes containing:
– Prepaid postage
– Return address
•
After watching the video, consumers:
– Slip the DVD back into the envelope
– Drop the disc in the mail
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How Netflix Works: A Model in Transition
•
Users make their video choices in their “request queue” at Netflix.com
•
Consumers use the Web site to:
– Rate videos
– Specify movie preferences
– Get video recommendations
– Check out DVD details
– Share their viewing habits and review
© 2012, published by Flat World Knowledge
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How Netflix Works: A Model in Transition
•
Netflix operates via a DVD subscription and video streaming model
– These started as a single subscription, but are now viewed as two separate
services
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Act I: Netflix Leverages Tech and Timing to Create
Killer Assets in DVD-by-Mail
•
•
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Building a great brand online starts with offering exceptional value
Advertising builds awareness, but brands are built through customer
experience
Subscribers expectations from Netflix:
•
•
•
•
•
Huge selection
Ability to find what they want
Timely arrival
Ease of use and convenience
Fair price
Technology drives all of these capabilities
Technology is at the center of the firm’s brand
building efforts
© 2012, published by Flat World Knowledge
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Selection: The Long Tail in Action
•
Netflix offers its customers a selection of over 125,000 DVD titles
•
Traditional retailers cannot offer this because of shelf space constraints
•
Traditional retailers can determine their breakeven point by considering:
– Number of customers that can reach a location
– Store size
– Store inventory
– Payback from inventory
– Cost to own and operate the store
© 2012, published by Flat World Knowledge
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Selection: The Long Tail in Action
•
Internet firms can have just a few highly automated warehouses
•
Long tail: A phenomenon whereby firms can make money by offering a
near-limitless selection
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Figure 4.3 - The Long Tail
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Selection: The Long Tail in Action
•
The long tail works because:
– Cost of production and distribution drop
– It gives the firm a selection advantage that traditional stores cannot match
– Geographic constraints go away and untapped markets open up
© 2012, published by Flat World Knowledge
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Selection: The Long Tail in Action
•
Netflix has used the long tail to create close ties with film studios
– Studios earn a percentage of the subscription revenue
– Netflix gets DVDs at a very low cost
– Studios do not spend on additional marketing
© 2012, published by Flat World Knowledge
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Cinematch: Technology Creates a Data Asset
that Delivers Profits
•
Netflix uses a proprietary recommendation system called Cinematch
•
Each time a DVD is returned, Cinematch asks the customer to rate it
•
Collaborative filtering: A classification of software that monitors trends
among customers and uses this data to personalize an individual
customer’s experience
– It can be mimicked by competitors
© 2012, published by Flat World Knowledge
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Cinematch: Technology Creates a Data Asset
that Delivers Profits
•
The data provided by Cinematch is a switching cost
•
To see how strong switching costs are is to examine Netflix’s churn rate
– Churn rate: The rate at which customers leave a product or service
– Churn rates for Netflix’s most active regions were below 4 percent
•
Netflix’s marketing costs benefit from satisfied customers, as referrals are
a better choice than advertisements
•
Netflix launched a crowdsourcing effort known as The Netflix Prize
© 2012, published by Flat World Knowledge
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A Look at Operations
•
Technology lies at the heart of Netflix’s warehouse operations
– Netflix has a network of fifty-eight ultra high-tech distribution centers
– Distribution centers are all located close to U.S.P.S. facilities
– Trucks collect DVD shipments from these U.S.P.S. hubs and return the DVDs to
the nearest Netflix center
– Scanners pick out incoming titles
– Netflix presorts outgoing mail before dropping it off at U.S.P.S. facilities
– All DVDs are hand-inspected for cracks and smudges
– Warehouse processes are linked to Cinematch
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A Look at Operations
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Staff members are expected to focus on improving the firm’s processes
•
Quality management features are built into systems
•
Netflix can monitor and record the circumstances surrounding any failures
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Killer Asset Recap: Understanding Scale
•
Netflix’s size gives it a huge scale advantage
•
Scale economies allow firms to:
– Lower prices
– Spend more on customer acquisition, new features, or other efforts
•
Smaller rivals have an uphill fight
•
Established firms end up straddling markets
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Killer Asset Recap: Understanding Scale
•
By moving first, Netflix gained scale advantages
– Largest network of distribution centers
– Largest customer base
– The firm’s industry-leading strength in brand and data assets
© 2012, published by Flat World Knowledge
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Act II: Netflix and the Shift from Mailing
Atoms to Streaming Bits
•
Many media products are created as bits (digital files)
•
When we buy a CD, DVD, book or newspaper, we’re buying physical atoms
that are a container for the bits
•
The shift from DVD-by-mail to the streaming business poses new
challenges for the firm
– When the DVD dies, Netflix’s high-tech shipping and handling infrastructure
will be rendered worthless
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Access to Content
•
When Netflix launched its streaming video option, only 17% of the DVD
catalog was available
•
Legal issues involved in securing the digital distribution rights
•
Windowing restricts the number of titles available
•
Wal-Mart uses its bargaining power to encourage studios to:
– Hold content from competing windows
– Limit offering titles at competitive pricing during the new release period
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But How Does It Get to the TV?
•
Netflix initially developed a prototype set-top box
•
It then developed a software platform that allowed firms to build Netflix
access into their devices
•
Advantages of the atoms to bits model
– Netflix will eliminate a huge chunk of its shipping and handling costs
– Bandwidth costs are minimal
© 2012, published by Flat World Knowledge
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But How Does It Get to the TV?
•
Disadvantages of the atoms to bits model
– Wrangling licensing costs is a challenge
– The switch to Blu-ray DVDs means that Netflix will be forced to carry two sets
of video inventory
• Standard
• High-definition
•
Bandwidth caps: Places a ceiling on a customer’s total monthly
consumption
© 2012, published by Flat World Knowledge
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No Turning Back
•
Streaming on-demand content with targeted ads could be a goldmine
combination
– It may radically undercut the one-commercial-for-all model of current
broadcast television
•
The streaming business also offers Netflix opportunities to explore new
revenue models
– It allows for rapid expansion into international markets
© 2012, published by Flat World Knowledge
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