Looking over thirty years back, it is quite fascinating to reflect how our customs of viewing films at home have shifted during that period: We started in the early 80s with rental of videotapes at local library stores to be played on our good-old VCR; next, we explored the variety of films offered on multiple movie channels of cable and satellite TV networks; then moved in the 90s from videotape to DVD rental; later-on discovered the convenience of vide0-on-demand (VOD) services launched by our cable and satellite TV providers; and more recently we may have started to select and stream films online via the broadband Internet. Some changes to go through in just three decades! Even when excluding options that involve the acquisition of film copies (e.g., on DVD), much activity in this field is apparent. And all that has come evidently at the expense of cinema theatres whose numbers in city centers have diminished significantly, and urban social life has changed with it.

An important and interesting player in the field of film viewing at home is Netflix Inc. (www.netflix.com). The company started in 1997 in the US with an exceptional rental service of films — order online, receive and return a DVD by mail. Yet in 2007 Netflix moved into the domain of video streaming and it is now a growing part of its business. An early move by Netflix has gained it advantages that other Internet companies try to challenge.

Last December the Fortune Magazine selected Reed Hastings, founder and CEO of Netflix, as Businessperson of the Year 2010  (1). He arrived first ahead of fifty nominees rank-ordered by Fortune. The selection was based on reader’s choice, financial-based metrics (e.g., stock performance, revenue growth, and profit growth), and additional off-the-book factors related to marketing and managerial leadership and style. Hastings scored first on stock performance (during 2010 Netflix share price more than tripled on NASDAQ from $50 to ~$175 climbing at a steady rate) and ranked third in reader’s choice.

Four main reasons emerge from the story on Hastings and Netflix that seem to explain better how he became deserving of the award:

Hastings had a foresight already in the early 2000s that DVDs and the service concept of rental are going to lose favour with consumers and therefore decay before too long. Consumers would want access to films that is much more convenient, fast and direct. Led by this vision, he has been willing to take risks exploring, developing and testing different types of solutions for delivering film videos to consumers at their homes that rely on Internet broadband technology. Significantly, Hastings did not let himself get locked on a solution just because the company has spent that much resources on developing a prototype if he eventually realized it was not the right approach after all. For instance, Netflix developed a branded device of a hard drive type to which consumers would be able to gradually (i.e., rather slowly) download a whole film and watch later. But YouTube that went on air in 2005 quickly convinced him that the hard drive approach is obsolete and that the solution should be in the realm of live streaming, so he dropped the hard-drive concept and changed course. Netflix did not come first with streaming and was inspired by YouTube but it still had to find a way to efficiently stream full feature films. Later on Hastings was also dissatisfied with another branded device, realizing that his customers should not be burdened with proprietary hardware from Netflix. Instead, its current solution is in software applications, giving customers flexibility to stream films to a variety of devices (e.g., computers, TVs, tablets, smartphones). In an interview to Fortune Hastings said with regard to his decision to give up Netflix-branded device: “But if you are not genuinely pained by the risk involved in your strategic choices, it’s not much of a strategy” (p. 54).

Furthermore, Hastings did not refrain from introducing the new mode of content delivery simultaneously with the incumbent rental of DVDs by mail even though the new service could hurt or ‘cannibalize’ business from the existing one. Companies who plan to introduce a new product are often cautioned of cannibalizing a product they already offer to fulfill a similar purpose or function for the consumers. Accordingly, many companies that look to expand their product lines test carefully the sources of demand for the new introduction. Managers that become attached to a successful product they previously helped bring about are reluctant to do something that may help “killing it”. Watching out of cannibalization is in place when the company aims to increase variety of models to different consumers’ tastes or merely prove it is not freezing. However, cannibalization can be justified as in the case of Netflix when Hastings projected that the days of DVD rental where in any case numbered. Then progressing a transition proactively, letting the new solution grow at the expense of the old is the more appropriate course of action.

• The customer base of Netflix has started to expand impressively in 2005, growing from 5 million subscribers to nearly 10 millions by the end of 2008, and is estimated in the end of 2010 at 20 million subscribers.
• Unfortunately the chart of Fortune does not show how the ratio of subscribers between “renters” to “streamers” changes, but they do report that in the 3rd quarter of 2010 66% of customers used streaming for at least 15 minutes compared with 55% at the beginning of the year and only 37% in mid-2009.

 Netflix was looking for ways to improve on its film recommendation system to its customers. Being able to customize film offers that better fit customers’ preferences based on existing customer knowledge has become a core competence requisite, making search for relevant films by customers easier and more pleasurable. Rather than investing all the effort in-house or outsourcing it to some expert BI company, Hastings took a brave initiative and announced in 2009 a competition, the Netflix Prize of 1 million dollars. Talented engineers, computer scientists, statisticians etc., organized in teams, joined the challenge to develop a new enhanced model of personalized film recommendations. The full story of the competition is beyond the scope of this post; in view of the positive way it worked out it may be concluded that Hastings allowed talented professionals from around the world participate in an important enterprise of Netflix, with opportunities to enhance their careers and win a hefty prize, and in return received a powerful sophisticated model that would improve the service performance of Netflix. There is also reason to expect the competition story added value to the brand (e.g., a story in Fortune).

• Two points are interesting noting about the model of the winning team (BellKor). The model conceptualized a map of film titles grouped in “regions” where titles in a region may share in common a genre, actors, or specific aspects of content and style.
• First, the spatial spread of film titles is based on data of customer characteristics, films they viewed and ratings assigned, if any. As such, the inclusion of titles in the same region may not be immediately interpretable based on some objective classification of genres but reflects similarities between films as perceived by the customers.
• Second, distances between any two titles can matter. Thus, while a film title is likely to match better with another title in the same region than from other regions, if the first film is close to a border it may make a better match with a second film just across the border in a neighbouring region than with a third film that is located in the same region but farther on the other end. 

A fourth factor that may have helped Hastings to succeed with Netflix can be associated with his own character and style of management. Apparently, in a pervious company he founded and managed he has been recognized as a very aggressive boss, impatient and somewhat erratic. It earned him the nickname ‘animal’, courtesy of one his senior managers, McCord, who admits that at first he was reluctant to rejoin Hastings at Netflix. Hastings said to Fortune that one of the problems was he never spent time to build a distinct culture to his previous software company. At Netflix he is reportedly more attentive to other people, willing to listen to their ideas in brainstorming even if he does not agree , and cares more about the development of high-esteemed professional culture that relies on trust in the integrity and commitment of employees (it is a “no perks” company according to McCord, all their fun is from building products).

This is definitely not all of the story of success of Netflix. Probably more contributing factors may be suggested, and there also are challenges that Netflix will have to confront in the near future to maintain its strengths in the market. Notably, streaming applies not only to feature films but also to a wide variety of TV programme series.

In the past three years Netflix was smart and quick to secure agreements for rights to stream content, particularly new films, with leading production studios such as Paramount, Lion Gate and MGM (in consortium via their joint venture Epix). Competition on rights with studios as well as TV networks (e.g., ABC, CBS, HBO) promises to be a hot topic for the foreseeable future in this field. Just in December Netflix signed with ABC. Amazon is already showing interest in offering streaming to its subscribers and is seeking attractive agreements. Netflix is also likely to face resistance from cable and satellite TV networks who feel threatened by their activity. Limitations in availability of films and programmes for streaming will curtail its advantage to customers vis-a-vis rentals and could also reduce the effectiveness of recommendations of content for access by streaming.   

 There is likely to be a continued quest for capacity to stream ever-increasing amounts of video data via the broadband Internet. It is estimated that Netflix already captures 20% of all broadband downstream traffic during peak hours in the US. If indeed consumers look at streaming as the preferred way to access and watch films and TV programmes in coming years, the contest will be more intense. Internet Service Providers already seem to make their own considerations, possibly charging their own customers by volume downstream (as already done with respect to mobile devices). So while Netflix may charge $7.99 monthly on a stream-as-you-can basis, subscribers may be required to pay an additional fee to their ISPs  (2).

On a final bright note, streaming can open new opportunities for Netflix to extend its business outside the US and Canada (started just in 2010). Less constrained by the logistics of rental by mail, it may obtain access to broadband channels to stream film and TV content to customers in more countries, perhaps first in Europe and then in other regions.

Ron Ventura, Ph.D. (Marketing)   

 (1) Reed Hasting: Leader of the Pack, Michael V. Copeland, 2010, Fortune, Europe Edition, Vol. 162, No. 9, December 6, pp. 49-56

(2)  Netflix on a roll as streaming catches on, FT.com, 28 January 2011