A Porter’s Five Forces Analysis of NetflixBy: Shannon Szabo-Pickering

Through it innovative distribution methods for delivering movies and television shows and intuition regarding changing consumer preferences for viewing these media forms, Netflix has grown into a dominant force in the entertainment industry. Started in 1997 as a via mail DVD rental service, Netflix capitalized on the emergence of DVDs as a replacement to video tapes. For a monthly subscription fee, consumers could rent DVDs, have delivered to their home, and return them anytime without late fees. In 2008, it became first-to market in offering digital on-demand services, offering anyone with internet access the opportunity to watch movies and television shows from the Netflix catalogue at their convenience and without commercial interruptions.

Digital streaming gave Netflix a competitive advantage over traditional entertainment distributors, allowing it to simultaneously implement a cost leadership and differentiation strategy. It proved to be an efficient distribution method, allowing Netflix to offer its services at a considerably lower price than cable and satellite, while simultaneously providing its audience with an improved and unique viewing experience compared to traditional television and movie viewing. Viewers could to watch TV and movies at their convenience, and Netflix additionally provided personalized viewing recommendations though the use of data mining techniques.

Netflix is widely seen as revolutionizing television and movie viewing, and is widely considered a major threat to traditional viewing platforms. In July 2014, Netflix surpassed 50 million global subscribers, with 36 million of them being in the United States (Netflix, 2015) and during peak hours, it accounts for more than thirty per cent of all Internet down-streaming traffic in North America (Auletta, 2013). Recently, Netflix has focused on aggressive international growth, and is now available in over 40 countries (Netflix,2015).

Despite being highly popular with customers, the Netflix business model does have some areas of concern. It is entirely dependent on outside suppliers for content, and faces high expectations for both price and quality, as well as a multitude of new entrants in the marketplace. Furthermore, it has come under scrutiny for price increases, its potentially unsustainable business model and over regulatory concerns such as the amount of Canadian content it offers. The following discussion assesses Netflix using Porter’s Five Forces Model to determine how market forces may affect Netflix now and in the future.

Threat of new entrants (Moderate)As a well-recognized growth sector in the movie and television industry, competition in online streaming is likely to intensify in the future. Many new online streaming entrants are likely to be current indirect competitors entering the on-demand streaming market to maintain market share and remain relevant and competitive in a changing media environment. Traditional providers of movie and television imitating Netflix business model have become, and are likely to remain, widespread entrants into the digital streaming services. In late 2014, Rogers and Bell Media respectively introduced Shomi and Crave TV to the Canadian marketplace; a recognition of market trends favouring digital on demand. Both of these services have built a reputation for sound television content, while Netflix is still widely seen as

the top provider of movie content. Both services also offer personalized recommendations, similar to the Netflix model. Additionally, Crave TV is available to customers for $4.00 per month, compared to $8.99 for Netflix and Shomi. However, Shomi and Crave TV are both only available to customers of certain television providers, while Netflix is available to anyone with internet access. Due to its vast amount of content, ease-of-access and predominant market share, Netflix still currently enjoys a competitive advantage over these newly introduced digital on-demand services.

Netflix is also facing the threat of new entrants in the United States. In October 2014, HBO and CBS both announced the launching of digital steaming services in 2015. These new entrants to digital streaming both have a competitive advantage in the amount of content they already own. However, as first to market Netflix has an established reputation, brand equity and market domination in the digital streaming realm. Additionally, a consensus among streaming competitors exists that, although offering similar services, the content offered by various streaming services creates a large enough point of difference where numerous providers can compete effectively in the marketplace. While Netflix may face many new entrants within its sector, it remains unclear whether these new entrants truly represent a threat.

Bargaining Power of Buyers (High) The current business model implemented by Netflix gives its customers a large amount of bargaining power. Consumers face minimal consequences for cancelling Netflix subscriptions. Customers may cancel at any time without termination fees, and have their profile information saved by Netflix for one year (How do I cancel Netflix? , 2015). The price sensitivity of Netflix consumers further increases their bargaining power. At $8.99 per month, Netflix is relatively inexpensive compared to traditional media outlets. The low price and high amount of content available through Netflix creates competitive advantage compared to traditional media outlets. However, it also creates high consumer expectations regarding both price and content, and may have inadvertently increased the bargaining power of consumers. Because of these expectations, consumers are extremely price sensitive and at risk of abandoning Netflix over relatively incremental price increases. In 2011, when Netflix divided its DVD by mail and streaming services, charging $7.99 per month for each service instead of $10 access to both distribution methods (Shankland, 2011), resulting in a loss of 800 000 subscribers within three months of the announcement. In 2014, it again raised its prices from $7.99 per month to $8.99 per month. It mitigated the risk of losing viewership by giving existing customers a two-year reprieve from price increases. Although this strategy appears successful in preventing the loss of customers, the amount of media coverage regarding the announcement illustrates the price sensitivity of Netflix customers, and its need to maintain a cost leadership strategy.

Bargaining power of buyers is augmented through the large number of alternatives available, with piracy sites providing free streaming services being especially concerning for Netflix. Although these sites violate copyright laws, Netflix has indicated it believes these sites represent the most pervasive threat to the organization. In 2012, Netflix filed with the Federal Election Commission to form a political action committee (PAC) called FLIXPAC (Netflix, 2015), a U.S. political action committee, with an anti-privacy agenda (Savitz, 2012). Recently, Netflix CEO Reed Hastings expressed concern over the increasing popularity piracy site Popcorn Time, citing it as a top competitor (O'Rourke, 2015).

Netflix mitigates the bargaining power of buyers by offering customers original content only available through Netflix. . In March 2011, Netflix began acquiring original content for its popular subscription

streaming service, beginning with the hour-long political drama House of Cards, which debuted on the streaming service in February 2013 (Netflix, 2015). Since then it has added more original content, which has popular with customers, including Orange and new episodes of Arrested Development. For fans of these programs, loss of access to these programs creates a consequence for cancelling their subscription and increases the difficulty and likelihood of switching providers. Access to this original content thereby decreases the bargaining power of these customers. However, the availability of alternatives and the price sensitivity of customers ultimately give bargaining power to buyers.

Threat of substitute products or services (moderate) Although often perceived as industries in decline, numerous substitutes for digital streaming remain in the marketplace. Substitute products my include satellite and cable television, DVDs and DVD rentals, and movie theatres. In Canada, according to regulatory figures, total cable and satellite subscribers declined for the first time in the year ending Aug. 31, 2013 (Bradshaw, 2014). As the latest technological advance in television and movie viewing, growth of on-demand video streaming has become a popular means for accessing content and a pervasive treat to traditional ways of viewing television and movies. The simultaneous rise in popularity for digital streaming and decline in popularity of traditional media outlets lowers the threat of substitute products.

However, some viewers may be reluctant to adopt new technologies. Although traditional substitutes for digital streaming services are higher in price and less user-friendly, they are deeply engrained in the consumer psyche, and those uncomfortable with new technologies may elect to utilize traditional methods of movie and television viewing. This consideration is especially important with regard to the aging population in many of Netflix’s key markets, including Canada and the United States; a demographic which has spent most of their lives viewing television and movies through traditional means.

Additionally, many of these substitute products offer benefits not yet offered through Netflix. Cable and satellite both offer appointment viewing, where viewers will watch live events, only shown on certain television and satellite networks. Movie theatres provide viewers with the opportunity to view movies immediately upon release, and provide a more immersive viewing experience.

Although many substitute products for on-demand video streaming are in decline, they remain ubiquitous in the entertainment industry and remain a threat to Netflix. However, as on-demand streaming continues to grow in popularity, the threat of substitute products may be diminished. With the rapid rate of change in technology, Netflix will likely face the threat of new and innovative substitutes in the future.

Bargaining power of suppliers (high) As Netflix obtains the majority of its content through licensing agreements with content proprietors, its suppliers have considerable bargaining power. When licensing agreements expire, content suppliers may elect to terminate their relationship with Netflix, thereby diminishing the amount of content Netflix can offer its consumers. In 2013, for example, a Netflix agreement with Viacom lapsed, causing Netflix to lose the right to air any Viacom programs, including its library Nickelodeon children’s programing. The prevalence of digital streaming services further enhances the bargaining power of suppliers. Once the

Netflix agreement lapsed, Viacom contracted with Amazon, illustrating that suppliers have a variety of digital streaming competitors with whom to form licensing agreements.

Potential suppliers are also offering their own digital download streaming services, a trend likely to continue in the future. Hulu, for example, is a digital on-demand service owned by 21st Century Fox NBC Universal and The Walt Disney Company. It offers hundreds of TV shows from ABC, BET, CBS, Comedy Central, CW, FOX, NBC, and other networks through its streaming internet video service (Fontinelle, 2014). Although commercials are included in its programing, this business model could be perceived as mitigating the risk of consumer price sensitivity by creating an additional revenue stream and making Hulu less reliant on subscription volume to remain profitable.

Furthermore, Netflix does not own the rights to its original content. It owns the right to stream programs such as Breaking Bad first and exclusively for a limited time, but the licensing rights may be sold to a competitor once the contract has expired (Auletta, 2013).

With Netflix being highly reliant on suppliers to provide the content it requires to acquire and maintain viewership, the bargaining power of the suppliers Netflix contracts with is extremely high, and ultimately poses a threat to the long-term viability of its current business model.

Rivalry amongst existing competitors (moderate)With the increasing number of new entrants to the digital-on demand market segment, a casual industry observer may expect the rivalry amongst competitors in this market segment to be high. Numerous digital streaming services, including Hulu, Google Play, YouTube and Amazon Instant, as well as Shomi and Crave TV in Canada have emerged, and the prevalence of digital streaming providers may be seen as increasing rivalry within the industry. However, perhaps counterintuitively, a collaborative competitive environment appears to be emerging among digital on-demand competitors. In 2014, Amazon introduced the Amazon Fire TV Stick, a USB port that provides customers with access to its Instant Video streaming service, as well as other digital streaming services including Netflix. Although the user interface strongly favors Amazon Instant content over other services, and the search feature doesn't comb through Netflix or most other non-Amazon apps (Amazon Fire TV Stick review: A streaming hot bargain, 2014). Google Chromecast is a similar product that offers the same aggregation of streaming services. The inclusion of third-party applications for these products indicates a recognition of the value added by offering easy access to competing products, as well as the ability of consumers to select multiple on-demand services.

Rival organizations have indicated that they believe the digital on-demand market is evolving in in a direction where consumers will subscribe to multiple digital on-demand services. In a 2014 Globe and Mail interview, Rogers Media president Keith Pelley expressed that their market research as indicated that “consumers can support two, three, even four [subscription video-on-demand] services”, allowing for multiple organizations to achieve market share despite the increasing number of direct competitors in the digital streaming arena. Credence to this argument is provided in the points of difference among competing organizations who offer a variety of content, which may act as an incentive for consumers to subscribe to multiple services. Due to the low cost of these services, consumers could purchase multiple subscriptions, and still pay a lesser amount then the cost of a traditional cable or satellite package.

Additionally, Netflix is perceived as a means of increasing revenue streams while simultaneously increasing viewership for traditional content providers. Licensing agreements with Netflix create

additional revenue for these organizations, and permitting Netflix to air prior seasons of popular television shows increases viewership of new episodes, which remain unavailable through Netflix and are available only through the original content provider. The AMC series Breaking Bad saw ratings double upon the availability of prior seasons through Netflix. AMC CEO Josh Sapan credited this rise in viewership to the program’s availability on Netflix, through which consumers “became engaged” (Auletta, 2013). Although Netflix faces many direct competitors, these competitors only pose a moderate threat based on the current competitive environment. However, rivalry may intensify as more competitors enter the market or consumers elect not to subscribe to multiple streaming services.

Netflix has established itself as an industry leader in digital streaming services. However, certain aspects of its current business model, including reliance on suppliers and a cost structure which makes Netflix highly dependent on volume to remain profitable and consumers sensitive to price increase, have created a situation where Netflix is highly vulnerable to competitive forces. In in a constantly changing technological environment, current market dominance does not guarantee continued or future dominance, and organizations need to remain flexible enough to adapt to changing consumer taste and to integrate new technological advances into their business models. The following is a list of recommendations for Netflix to remain competitive and profitable in the future:

In order to continue to provide original content, as well as to maintain a profitable business model, future price increases are an inevitability. In order to maintain a large customer base, Netflix will need to find ways to mitigate the effects of these price increases, by providing added value customers, being transparent regarding increases and by providing ample notice of price increases to allow customers time to adjust their expectations.

Create a product similar to Amazon Instant Google Chromecast. Future market dominance may go to the provider who most effectively aggregates various digital download services. These products provide a means of doing so, while still favouring producer content. Netflix may want to consider developing a way to include third party services online, instead of through a USB port.

Continue to concentrate on global expansion. Sales volume is important to the economic viability of the Netflix business model. Additionally, being first to market new regions provides Netflix with a competitive advantage.

Find a means of creating an additional revenue stream, through either advertising or another source, to provide high-quality content and for decreased reliance on sales volume to remain profitable.

Maintain good relationships with suppliers. Netflix may want to consider providing added value incentives to its suppliers, such as increased brand awareness by including supplier logos in its television and movie listings.

Build and maintain positive relationships with competitors. Seek strategic alliances, and remain open to collaboration.

In a constantly changing technological environment, innovation is key. Netflix needs to remain in touch with changing consumer preferences and offer innovative products to meet their needs in order to maintain market dominance.

Netflix has obtained market dominance through its innovation in delivering television and movie content, intuitive abilities to predict changing consumer tastes in content viewing; however, whether it has built a sustainable business model through these competitive advantages remains to be seen.

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Shankland, S. (2011, September 19). Netflix CEO's apology brings new backlash. Retrieved from Cnet: http://www.cnet.com/news/netflix-ceos-apology-brings-new-backlash/