Sufficient Competitive Strength to Fight Off Aggressive Rivals

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Netflix’s Strategy in 2018:
Does the Company Have
Sufficient Competitive Strength
to Fight Off Aggressive Rivals?
Arthur A. Thompson
The University of Alabama
Throughout 2017 and the first three months
of 2018, Netflix was on a roll. Movie and
TV show enthusiasts across the world were
flocking to become Netflix subscribers in unprecedented numbers, and shareholders were exceptionally pleased with Netflix’s skyrocketing stock
price. Over the past eight years, the company had
successfully transformed its business model from
one where subscribers paid a monthly fee to receive
an unlimited number of DVDs each month (delivered and returned by mail with one title out at a
time) to a model where subscribers paid a monthly
fee to watch an unlimited number of movies and
TV episodes streamed over the Internet. In 2018,
Netflix was the world’s leading Internet television
network with over 117 million streaming memberships in over 190 countries enjoying more than
140 million hours of TV shows and movies per day,
including original series, documentaries, and feature films. Netflix members could not only watch
as much streamed content as they wanted—anytime,
anywhere, on nearly any Internet-connected
screen—but they could also play, pause, and resume
watching, all without commercials. In the United
States, Netflix still had 3.4 million members in
2018 who, because of slow or limited Internet service, continued to receive DVDs solely by mail (but
the numbers of mail-only subscribers were steadily
declining).
CASE 14
Copyright ©2019 by Arthur A. Thompson. All rights reserved.
Netflix’s swift growth in the United States and its
promising potential for further expanding its international subscribers pushed the company’s stock price
to an all-time high of $331.44 on March 5, 2018, up
from an opening price of $124.96 on January 3, 2017.
Already solidly entrenched as the biggest and bestknown Internet subscription service for watching TV
shows and movies, the only two questions for Netflix
in 2018 seemed to be how big Netflix’s service might
one day become in the world market for on-demand
streaming of movies and TV episodes and whether
the company had the competitive and financial
strength to combat the efforts of larger, resource-rich
rivals looking to steal subscribers away from Netflix.
Financial statement data for Netflix for 2000
through 2017 are shown in Exhibits 1 and 2. Netflix
had never paid a dividend to its shareholders and the
company had declared it had no present intention of
paying any cash dividends in the foreseeable future.
Netflix’s Drive to Globalize
Its Operations
Exhibit 3 shows the remarkably short time frame
it took for Netflix to expand its operations from a
U.S.-only subscriber base to a global subscriber base.
As of 2018, Netflix had, for the time being, shelved
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EXHIBIT 1 Netflix’s Consolidated Statements of Operations, 2000–2017
(in millions, except per share data)
2000 2005 2010 2015 2016 2017
Revenues $ 35.9 $682.2 $2,162.6 $6,779.5 $8,830.7 $11,692.7
Cost of revenues (almost all
of which relates to amortization
of content assets)
35.1 465.8 1,357.4 4,591.5 6,029.9 7,659.7
Gross profit 0.8 216.4 805.3 2,188.0 2,800.8 4,033.0
Operating expenses
Technology and development 16.8 35.4 163.3 650.8 852.1 1,052.8
Marketing 25.7 144.6 293.8 824.1 991.1 1,278.0
General and administrative 7.0 35.5 64.5 407.3 577.8 863.6
Other 9.7 (2.0) — — — —
Total operating expenses 59.2 213.4 521.6 1,882.2 2,421.0 3,194.4
Operating income (58.4) 3.0 283.6 305.8 379.8 838.7
Interest and other income (expense) (0.2) 5.3 (15.9) (163.9) (119.3) (591.5)
Income before income taxes — 8.3 267.7 141.9 260.5 485.3
Provision for (benefit from)
income taxes
— (33.7) 106.8 19.2 73.8 (73.6)
Net income $(58.5) $ 42.0 $ 160.8 $ 122.6 $ 186.7 $ 558.9
Net income per share:
Basic $(2.98) $ 0.11 $ 0.44 $ 0.29 $ 0.44 $ 1.29
Diluted (2.98) 0.09 0.40 0.28 0.43 1.25
Weighted average common shares
outstanding (in millions)
Basic 19.6 374.5 365.5 425.9 428.8 431.9
Diluted 19.6 458.5 380.1 436.5 438.7 446.8
Note 1: Some totals may not add due to rounding.
Note 2: The company’s board of directors declared a seven-for-one split of its common stock in the form of a stock dividend that was paid
in July 2015. Outstanding share and per-share amounts disclosed for all periods prior to 2015 have been retroactively adjusted to reflect
the effects of the stock split.
Source: Company 10-K reports for 2003, 2006, 2010, and 2017.
efforts to overcome the government-erected barriers to entering the People’s Republic of China, the
world’s most massive market for entertainment. The
Chinese government had for several years refused to
issue Netflix a license to operate in China, preferring instead to control the content its citizens were
allowed to see—government censors required that an
entire series of a TV show had to be approved before
it could begin to be shown on an online platform.
Aside from the censorship issue, most observers
believed the Chinese government also wished to protect aspiring local providers of Internet-based entertainment content from foreign competitors. As a
consequence of its nonexistent prospects for getting
an operating license from the Chinese government
any time soon, in 2017 Netflix negotiated a licensing arrangement to exclusively provide some of its
original content to a fast-growing Chinese company
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EXHIBIT 3 Netflix’s Expansion into
New Geographic Areas
Year Entry into New Geographical Areas
September 2010 Canada
September 2011 42 countries in Central America,
South America, and the Caribbean
January 2012 United Kingdom, Ireland
October 2012 Denmark, Sweden, Norway, Finland
September 2013 Netherlands
September 2014 Austria, Belgium, France, Germany,
Luxembourg, Switzerland
March 2015 Australia, New Zealand
September 2015 Japan
October 2015 Spain, Portugal, Italy
January 2016 Rest of the world—some 130
countries (but excluding the
People’s Republic of China, North
Korea, Syria, and Crimea)
Source: Company 2017 10-K Report, p. 21.
EXHIBIT 2 Selected Balance Sheet and Cash Flow Data for Netflix,
2000–2017 (in millions)
2000 2005 2010 2015 2016 2017
Selected Balance Sheet Data
Cash and cash equivalents $14.9 $212.3 $194.5 $1,809.3 $1,467.6 $2,822.8
Short-term investments — — 155.9 501.4 266.2 —
Current assets n.a. 243.7 637.2 5,431.8 5,720.3 7,670.0
Total content assets n.a. 57.0 362.0 7,218.8 11,008.8 14,682.0
Total assets 52.5 364.7 982.1 10,202.9 13,586.6 19,012.7
Current liabilities n.a. 137.6 388.6 3,529.6 4,586.7 5,466.3
Long-term debt* — — 200.0 2,371.4 3,364.3 6,499.4
Stockholders’ equity (73.3) 226.3 290.2 2,223.4 10,906.8 15,430.8
Cash Flow Data
Net cash (used in) provided by
operating activities
$(22.7) $157.5 $276.4 $ (749.4) $(1,474.0) $(1,785.9)
Net cash provided by (used in)
investing activities
(25.0) (133.2) (116.1) (179.2) 49.8 34.3
Net cash provided by (used in)
financing activities
48.4 13.3 (100.0) 1,640.3 1,091.3 3,077.0
*All of Netflix’s long-term debt consisted of senior unsecured notes that were issued at various points in time and had various maturity
dates and various fixed rates of interest.
Sources: Company 10-K Reports for 2003, 2005, 2011, and 2017.
named iQiyi (pronounced Q wee), the leading provider of online entertainment services in China
with some 60 million subscribers (as of early 2018).
Use of a licensing strategy was attractive to Netflix
because it provided a means of gaining content distribution in China and building awareness of the
Netflix brand and Netflix content, but the licensing
arrangement was expected to generate only small
revenues.
The U.S. government had instituted restrictions
precluding all U.S.-based companies from having
operations in North Korea, Syria, and Crimea.
Netflix estimated that it usually took about two
years after the initial launch in a new country or
geographic region to attract sufficient subscribers
to generate a positive “contribution profit”—Netflix
defined “contribution profit (loss)” as revenues less
cost of revenues (which consisted of amortization
of content assets and expenses directly related to
the acquisition, licensing, and production/delivery
of such content) and marketing expenses associated with its domestic streaming and international
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United States) or delivering/returning DVDs by mail
(as at Netflix) and unleashed a fierce battle among
the providers of streamed content in countries across
the world to become the preferred streamed content provider (or, at worst, a frequently used content
provider).
Consumers could view streamed entertainment
from growing numbers and types of providers and
the options included:
• Using a TV remote to order movies and popular
TV shows instantly streamed directly to a TV (or
other connected device) on a pay-per-view basis
(generally referred to as “video-on-demand” or
VOD). Most all traditional cable and satellite providers of multichannel TV packages were promoting a library of several hundred movie titles (and
often prior episodes of top TV shows, as well as
other content) available on-demand to regular subscribers having a cable or satellite box; the rental
prices for pay-per-view and VOD movies from such
providers ranged from $1 to $6, but the rental price
for popular recently released movies was usually
$3.99 to $5.99. However, most every traditional
cable and satellite provider had recently begun
offering a growing variety of content-viewing
options that were streamed directly to a single
location (and viewable simultaneously on up to as
many as eight compatible WiFi enabled devices)
via a special downloadable streaming application
that eliminated the need for a cable/satellite box.
These streaming options allowed subscribers to
customize their own service package (number of
channels, Internet speed, telephone service, and
home security service). Recently, in the United
States, wireless phone providers like AT&T and
Verizon had also begun installing thousands of
miles of fiber-optic cable annually in their service areas that enabled them to simultaneously
provide residences and apartments with multiple
content-viewing options (including VOD), perhaps bundled with telephone service, ultra-highspeed Internet service, and/or home security at an
attractive monthly price (for a specified period,
usually one or two years).
• There were many subscription-based providers of
streamed video content across the world in 2018,
and more new entrants were expected in upcoming
years. In the United States, the clear market leader
was Netflix, followed by Amazon Prime, and Hulu;
streaming business segments (the company had
ceased all marketing activities related to its domestic
DVD business).
THE FAST-CHANGING
MARKET FOR
ENTERTAINMENT VIDEO
In 2018, the world market for entertainment video
(movies, TV episodes, and live-streamed events)
was undergoing rapid and disruptive change being
driven by (1) increasingly pervasive consumer access
to high-speed Internet connections, (2) the variety
of devices and downloadable apps that consumers
could use to access both broadcast and streamed
entertainment programs, and (3) the mounting
intensity with which well-known, resource-rich companies were competing for viewers of entertainment
programs. Close to half of the world’s population
of 7.6 billion people in 2018 used the Internet and,
of these, somewhere around 700 million currently
had access to broadband high-speed Internet connections. The number of people with broadband
Internet access was forecast to move rapidly toward 1
billion—a number that Netflix viewed as its near-term
market opportunity.1
YouTube and Facebook already
had two billion monthly active users, a number that
Netflix viewed as its long-term market opportunity
for accessing and attracting more subscribers.
People could watch streamed entertainment on
smartphones, all types of computers (tablets, laptops, and desktops), in-home TVs with either built-in
Internet connections or connected to a digital video
disc (DVD) player with built-in Internet access, and
recent versions of video game consoles. During the
past five to eight years, most households with highspeed Internet service and/or Internet-connected
TVs or DVD players had shifted from renting or
buying physical DVDs with the desired content to
almost exclusively watching streamed movies and TV
episodes. This was because streaming had the advantage of allowing household members to order and
instantly watch the movies and TV programs they
wanted to see and was much more convenient than
patronizing a nearby rent-or-purchase location. This
shift had permanently undercut the once-thriving
businesses of selling movie and music DVDs and/
or renting DVDs at local brick-and-mortar locations
and standalone rental kiosks (like Redbox in the
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EXHIBIT 4 The Percentage of Internet
Users in Selected Countries
Who Watched Online Video
Content on Any Device as
of January 2018
Country
Percentage of Internet Users
Watching Online Video
Content on Any Device
Saudi Arabia 95%
China 92%
New Zealand 91%
Mexico 88%
Australia 88%
Spain 86%
India 85%
Brazil 85%
United States 85%
Canada 83%
France 81%
Germany 76%
South Korea 71%
Japan 69%
Source: Statista, www.statista.com (accessed April 10, 2018).
others included Vudu, Sling TV, HBO NOW, Starz,
MAX GO® (Cinemax), Showtime, Direct TV Now,
and Play Station Vue. An estimated 37 percent of
TV viewers in the United States used subscriptionbased streaming services in 2017 to watch digital
video content on their TVs. However, YouTube
ranked first as the market leader among video and
entertainment websites, with almost 10 times as
many site visits to view videos as Netflix; of course,
most all YouTube videos could be accessed for
free, and many were videos uploaded by people or
brands. The number of video viewers using mobile
devices, such as smartphones and tablets, was
exploding all across the world. In the United States
alone, the number using mobile devices to watch
videos was projected to reach 179 million by 2020,
and an additional 57 million were expected to
watch videos on computers and Internet-connected
TVs. Exhibit 4 shows the percentage of Internet
users, by country, who watched online video content on any device as of January 2018.
Competitors offering pay-per-view and VOD rentals were popular options for households and individuals who rented movies occasionally (once or maybe
twice per month), since the rental costs tended to be
less than the monthly subscription prices for unlimited streaming from the various streaming providers.
However, competitors offering unlimited Internet
streaming plans tended to be the most economical
and convenient choice for individuals and households who watched an average of three or more titles
per month and for individuals who wanted to be able
to watch movies or TV shows or special live event
streaming on mobile devices.
Netflix was by far the global leader in Internet
streaming. It faced numerous competitors of varying
competitive strength, geographic coverage, and content offerings; currently, none could match Netflix’s
global scope or the size of its content library. In North
America, Netflix’s three biggest Internet streaming
competitors were Amazon Prime, Hulu, and HBO
(with its HBO NOW and HBO GO service options):
• Amazon Prime Video—Amazon competed with
Netflix via its Amazon Prime membership service. Individuals and households could become
an Amazon Prime member for a fee of $119 per
year or $11.99 per month (after a one-month free
trial); there was a discounted price for students. In
April 2018, Amazon announced that it had over
100 million Amazon Prime members globally.
While Amazon had originally created its Amazon
Prime membership program as a means of providing unlimited two-day shipping to customers who
frequently ordered merchandise from Amazon
and liked to receive their orders quickly, in 2012
Amazon began including movie and music streaming as a standard benefit of Prime membership—
Amazon’s video streaming service was called
“Prime Video.” Amazon’s Prime Video content
library contained thousands of movies that could
be streamed to members, over 40 original series
and movies, and some two million songs.
In 2017 and 2018, Amazon made Prime Video
more attractive to Prime members by (1) adding
Prime Originals to its offerings, like The Marvelous
Mrs. Maisel and the Oscar-nominated movie
The Big Sick, (2) debuting NFL Thursday Night
Football on Prime Video (which attracted more
than 18 million total viewers over 11 games), and
(3) expanding its slate of programming across the
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• Hulu—Hulu had 20 million subscribers as of May
2018, up from 12 million in May 2017. The subscription fee for Hulu was $8 per month for regular
streaming and $12 per month for commercial-free
streaming, and new subscribers got a one-week
free trial. The regular streaming option included
advertisements as a means of helping keep the
monthly subscription price low. Hulu also offered
plans that included not only its video streaming
service, but also packages that included 50 or
more live TV and cable channels (that included
sports, news, and entertainment) and options
to add on HBO®, Showtime®, and Cinemax®.
The Hulu library of offerings included all current season episodes of popular TV shows, over
15,000 back season episodes of 380+ TV shows,
over 425 movies, most in high-definition, and a
growing selection of Hulu-produced original content. Hulu was a joint venture co-owned by Walt
Disney (30 percent), Fox (30 percent), Comcast
(30 percent), and Time Warner (10 percent)
• HBO NOW and HBO GO—HBO NOW was an
option to receive unlimited streaming of content
in HBO’s library that included movies, documentaries, sports programs, and original series (Silicon
Valley, Game of Thrones, True Detective, Big Little
Lies, Sharp Objects) for a cancel-anytime monthly
subscription price of $14.99 (as of 2018). HBO
NOW content was viewable on mobile phones,
tablets, computers and Internet-connected TVs.
HBO NOW, offered only in the United States and a
few territories had over two million subscribers as
of February 2017. HBO GO was a bonus offering
only for people who subscribed to HBO through
a cable or satellite provider; such subscribers
used a downloadable app to access the HBO GO
website, entered their user name and password of
their cable provider to authenticate their subscription and then clicked on the desired HBO content
that was viewable on mobile phones, laptops, and
computers. HBO had no interest in offering its
HBO GO option to people who were not cable
subscribers because its principal revenue source
was a percentage of the monthly fees that nearly
140 million cable subscribers across the world
paid their cable company for HBO as part of
their cable package—HBO was typically the most
expensive of the premium cable channels offered
by cable/satellite providers. However, as of 2018,
HBO was offering a direct streaming service akin
globe—launching new seasons of Bosch, Sneaky
Pete, and The Man in the High Castle from the
United States, The Grand Tour from the United
Kingdom, You Are Wanted from Germany, while
adding new Sentosha shows from Japan, along
with Breathe and the award-winning Inside Edge
from India. In April 2018, Amazon announced it
had agreed to pay the National Football League
$65 million a year to stream NFL Thursday Night
Football globally to its Amazon Prime members
in 2018 and 2019. Also in 2018, Prime Channels
offerings were expanded to include CBS All
Access in the United States and newly launched
channels in the United Kingdom and Germany.
In 2017, Prime Video Direct secured subscription
video rights for more than 3,000 feature films and
committed over $18 million in royalties to independent filmmakers and other rights holders.
Going forward, the Prime original series pipeline
included Tom Clancy’s Jack Ryan, starring John
Krasinski; King Lear, starring Anthony Hopkins
and Emma Thompson; The Romanoffs, starring
Aaron Eckhart and Diane Lane ; Carnival Row, starring Orlando Bloom and Cara Delevingne; Good
Omens, starring Jon Hamm; and Homecoming,
starring Julia Roberts in her first television series.
In addition, Prime Video had acquired the global
television rights for a multi-season production of
The Lord of the Rings, as well as Cortés, a miniseries based on the epic saga of Hernán Cortés from
executive producer Steven Spielberg and starring
Javier Bardem. Amazon’s 2018 budget for Prime
Video original content additions and enhancement was reportedly $5 billion.
Other 2018 benefits of becoming an Amazon
Prime member included discounted prices on
Kindle eBooks, free reading of designated digital
editions of books and magazines, special deals/
coupons on purchases of selected products that
Amazon sold, one-click ordering via a “dash button,” shopping with Alexa, cloud storage and sharing of personal photos and videos, and an opt-in
DVD rental service (for an extra fee). In addition,
Amazon competed with Netflix’s DVDs-by-mail
subscription service by allowing people to rent any
streamed or downloadable movie, TV program, or
other digital content for a limited time (for viewing on a personal computer, portable media player
or other compatible device) or to purchase such
content in the form of a downloadable file.
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to HBO NOW in several countries that had low
cable subscriber rates (namely Spain, Columbia,
and the four Nordic countries—Norway, Denmark,
Sweden, and Finland). HBO was a division of
Time Warner, which had agreed to merge with
AT&T, pending government approval.
In April 2018, Comcast, one of the largest cable
operators in the United States, announced it had
expanded its partnership with Netflix and would
begin including a Netflix subscription in new and
existing packages offered to its cable subscribers.
In July 2018, The Wall Street Journal reported that
Walmart was likely to enter the video streaming
market and establish a subscription service with
programming that targeted “Middle America” and
that would likely involve a subscription price below
what Netflix charged.2
Walmart was working with a
veteran television executive with experience in paytelevision on plans for the service.
NETFLIX’S BUSINESS MODEL
AND STRATEGY
Since launching the company’s online movie rental
service in 1999, Reed Hastings, founder and CEO
of Netflix, had been the chief architect of Netflix’s
subscription-based business model and strategy that
had transformed Netflix into the world’s largest online
entertainment subscription service. Hastings’s goals
for Netflix were simple—build the world’s best Internet
service for entertainment content, keep improving
Netflix’s content offerings and services faster than
rivals, attract growing numbers of subscribers every
year, and grow long-term earnings per share. Hastings
was a strong believer in moving early and fast to initiate strategic changes that would help Netflix outcompete rivals, strengthen its brand image and reputation,
and fortify its position as the industry leader.
Netflix’s SubscriptionBased Business Model
Netflix employed a subscription-based business
model. Members could choose from a variety of
subscription plans whose prices and terms had varied over the years. Originally, all of the subscription
plans were based on obtaining and returning DVDs
by mail, with monthly prices dependent on the number of titles out at a time. But as more and more
households began to have high-speed Internet connections, Netflix began bundling unlimited streaming
with each of its DVD-by-mail subscription options,
with the long-term intent of encouraging subscribers to switch to watching instantly streamed content
rather than using DVD discs delivered and returned
by mail. The DVDs-by-mail part of the business had
order fulfillment costs and postage costs that were
bypassed when members opted for instant streaming.
In 2018, Netflix offered three types of streaming
membership plans. Its basic plan, currently priced at
$7.99 per month in the United States, included access
to standard definition quality streaming on a single
screen at a time. Its standard plan, currently priced at
$10.99 per month, was the most popular streaming
plan and included access to high-definition quality
streaming on two screens concurrently. The company’s premium plan, currently priced at $13.99 per
month, included access to high definition and ultrahigh definition quality content on four screens concurrently. As of December 31, 2017, international
pricing for the three plans ranged from approximately $4 to $20 per month per U.S. dollar equivalent. Top management expected that the prices of the
membership plans in each country would likely rise
over time.
Netflix had organized its operations into three
business segments: domestic streaming, international
streaming, and domestic DVD. The domestic streaming
segment derived revenues from monthly membership
fees for services consisting solely of streaming content
to members in the United States. The international
streaming segment derived revenues from monthly
membership fees for services consisting solely of streaming content to members outside the United States. The
domestic DVD segment derived revenues from monthly
membership fees for services consisting solely of DVDby-mail. Recent performance of Netflix’s three business
segments is shown in Exhibit 5.
The DVD-by-Mail Option Subscribers who opted to
receive movie and TV episode DVDs by mail went
to Netflix’s website, selected one or more movies
from its DVD library, and received the movie DVDs
by first-class mail generally within one business day.
Subscribers could keep a DVD for as long as they
wished, with no due dates, no late fees, no shipping
fees, and no pay-per-view fees. Subscribers returned
DVDs via the U.S. Postal Service in a prepaid return
envelope that came with each movie order.
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EXHIBIT 5 Netflix’s Performance by Business Segment, 2015–2017 (in millions,
except for average monthly revenues per paying member and
percentages)
Domestic Streaming Segment 2017 2016 2015
Memberships
Paid memberships at year-end 52.8 47.9 43.4
Trial memberships at year-end 2.0 1.5 1.3
Total 54.8 49.4 44.7
Net membership additions 5.5 4.7 5.6
Average monthly revenue per paying
membership
$ 10.18 $ 9.21 $ 8.50
Revenues $6,153.0 $5,077.3 $4,180.3
Cost of Revenues (Note 1) 3,319.2 2,855.8 2,487.2
Marketing costs 553.3 382.8 313.6
Contribution profit (Note 2) $2,280.5 $1,838.7 $1,375.5
Contribution margin 37% 36% 33%
International Streaming Segment
Memberships
Paid memberships at year-end 57.8 41.2 27.4
Trial memberships at year-end 5.0 3.2 2.6
Total 62.8 44.4 30.0
Net membership additions 18.5 14.3 11.7
Average monthly revenue per paying
membership
$ 8.66 $7.81 $ 7.48
Revenues $5,089.2 $3,211.1 $1,953.4
Cost of Revenues (Note 1) 4,137.9 2,911.4 1,780.4
Marketing costs 724.7 608.2 506.4
Contribution profit (Note 2) $ 226.6 $ (308.5) $ (333.6)
Contribution margin 4% (10)% (17)%
Domestic DVD Segment
Memberships
Paid memberships at year-end 3.3 4.0 4.8
Trial memberships at year-end .1 .1 .1
Total 3.4 4.1 4.9
Net membership losses .7 .8 .9
Average monthly revenue per
paying membership
$ 10.17 $ 10.22 $ 10.30
Revenues $ 450.5 $ 542.3 $ 645.7
Cost of Revenues (Note 1) 202.5 262.7 323.9
Marketing costs — — —
Contribution profit (Note 2) $ 248.0 $ 279.5 $ 321.8
Contribution margin 55% 52% 50%
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Global Totals
Global streaming memberships
at year end
117.6 93.8 74.8
Global streaming average monthly
revenue per paying membership
$ 9.43 $ 8.61 $ 8.15
Revenues $11,692.7 $8,830.7 $6,779.5
Operating income 838.7 379.8 305.8
Operating margin 7% 4% 5%
Net income $ 558.9 $ 186.7 $ 122.6
Note 1: Cost of revenues for the domestic and international streaming segments consist mainly of the amortization of streaming content
assets, with the remainder relating to the expenses associated with the acquisition, licensing, and production of such content. Cost of
revenues in the domestic DVD segment consist primarily of delivery expenses such as packaging and postage costs, content expenses,
and other expenses associated with the company’s DVD processing and customer service centers.
Note 2: The company defined contribution margin as revenues less cost of revenues and marketing expenses incurred by segment.
Source: Company 2017 10-K Report, pp. 19–22 and pp. 59–61.
The Domestic and International Streaming Options
Netflix launched its Internet streaming service
in January 2007, with instant-watching capability for 2,000 titles on personal computers. Very
quickly, Netflix invested aggressively to enable its
software to instantly stream content to a growing
number of “Netflix-ready” devices, including video
game consoles (made by Sony, Microsoft, and
Nintendo), Internet-connected DVD and Blu-ray
players, Internet-connected TVs, TiVo DVRs, and
special Netflix players made by Roku and several
other electronics manufacturers. At the same time,
it began licensing increasing amounts of digital content that could be instantly streamed to subscribers. Initially, Netflix took a “metered” approach to
streaming, in essence offering an hour per month
of instant watching on a PC for every dollar of a
subscriber’s monthly subscription plan. In 2010,
Netflix switched to an unlimited streaming option
on all of its monthly subscription plans. According
to one source, Netflix had an estimated 6,800 movie
titles and 530 TV shows available for streaming as
of 2010.3
In recent years, however, Netflix had gradually
shrunk the number of movie titles in its streaming
library to approximately 4,000 as of early 2018 and
dramatically increased the number of TV shows to
an estimated 1,570 in 2018. Netflix had increased the
number of new original content offerings in each of
the past five years. There were two reasons for the
shift in the makeup of Netflix’s streaming content.
One reason was internal data showing that subscribers spent only about one-third of their time on
Netflix watching movies; the second reason was a
conviction on the part of Netflix’s content executives
that if viewers were passionate about a movie, they
would have already seen it in theaters by the time it
ended up on Netflix. To make the company’s movie
library more valuable for its subscribers, Netflix had
begun releasing a progressively larger number of original movies (80 movies were scheduled for release
in 2018) and creating more multi-episode original
TV series like past hits House of Cards, The Crown,
Orange Is the New Black, and Stranger Things. Going
forward, Netflix was expected to continue to place
greater emphasis on its own original content—both
movies and original TV series—chiefly as a way to
more strongly differentiate itself from competitors;
top management had announced its intention to
spend $7 to $8 billion on original content in 2018, up
from $6 billion in 2017.
Netflix’s Strategy
Netflix’s strategy in 2018 was focused squarely on:
• Growing the number of domestic and international streaming subscribers.
• Enhancing the appeal of its library of streaming
content, with an increasing emphasis on exclusive
original movies and TV series produced in-house.
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• Spending aggressively on marketing and advertising in all of the countries and geographic regions
the company had recently entered to broaden
awareness of the Netflix brand and service and
thereby support the company’s strategic objective
to rapidly grow its base of streaming subscribers.
• Expanding the number of titles that members
could download for offline viewing.
• Continuously enhancing its user interface.
Subscriber Growth Netflix executives were keenly
aware that rapid subscriber growth was the key to
boosting the company’s profitability and justifying
the company’s lofty stock price of $330 (as of late
April 2018), which was an astonishing 264 times the
company’s 2017 earnings per share and 71 times the
consensus EPS of $4.65 that Wall Street analysts
and Netflix investors were anticipating the company
would earn in 2019. Netflix executives expected that
close to 75 percent of the gains in subscriber growth
in 2018 and over 80 percent of the gains in 2019 and
beyond would come in the international arena.
New Content Acquisition Over the years, Netflix
had spent considerable time and energy establishing
strong ties with various entertainment video providers to both expand its content library and gain access
to new releases as soon as possible after they were
released for first-run showing in movie theaters. Prior
to the recent push by Amazon Prime and Hulu to
attract streaming subscribers, Netflix had successfully negotiated exclusive rights to show titles produced by a few studios.
In August 2011, Netflix introduced a new “Just
for Kids” section on its website that contained a large
selection of kid-friendly movies and TV shows. By
March 2012, over one billion hours of Just for Kids
programming had been streamed to Netflix members.
New content was acquired from movie studios
and distributors through direct purchases, revenuesharing agreements, and licensing agreements to
stream content. Netflix acquired many of its newrelease movie DVDs from studios for a low upfront
fee in exchange for a commitment for a defined
period of time either to share a percentage of subscription revenues or to pay a fee based on content
utilization. After the revenue-sharing period expired
for a title, Netflix generally had the option of returning the title to the studio, purchasing the title, or
destroying its copies of the title. On occasion, Netflix
also purchased DVDs for a fixed fee per disc from
various studios, distributors, and other suppliers.
In the case of movie titles and TV episodes
that were streamed to subscribers via the Internet
for instant viewing, Netflix generally paid a fee to
license the content for a defined period of time, with
the total fees spread out over the term of the license
agreement (so as to match up content payments with
the stream of subscription revenues coming in for
that content). Following the expiration of the license
term, Netflix either removed the content from its
library of streamed offerings or negotiated an extension or renewal of the license agreement when management believed there was still enough subscriber
interest in the content to justify the renewal fees.
Over the past five years, Netflix’s rapidly growing subscriber base (as well as the streaming subscriber growth at Amazon Prime Video, Hulu, and
other providers) gave movie studios and the network
broadcasters of popular TV shows considerably more
bargaining power to command higher prices for their
content. Netflix management was acutely aware of its
diminishing bargaining power in acquiring content
that would be especially appealing to subscribers, and
the substantial negative impact that paying higher
prices for streaming content had on the company’s
current and future profit margins. Nonetheless,
Netflix executives believed there was still room for
the company to earn attractive profits on streaming if
it could grow its subscriber base fast enough to more
than cover the rising costs of content acquisition.
As indicated earlier, Netflix had recently begun
devoting the majority of its new content acquisition budget to producing its own original movies and TV series
in-house. Several of these shows were being launched in
local languages with local producers to appeal directly,
if not exclusively, to subscribers in a particular country
or region. A new 2017 Brazilian science-fiction show
had scored well with audiences around the world, even
though it had been produced in Portuguese for Brazil—
Netflix’s first instance of a local-language program
working well in locations where other languages dominated. In the second half of 2018, Netflix introduced a
new original series produced in Denmark, called The
Rain, that Netflix executives believed would have broad
global appeal, along with the second season of the
Brazilian program (called 3%). Other new original content scheduled for 2018 included the second season of
13 Reasons Why (one of Netflix’s most watched television shows around the world in 2017), returning
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Case 14 Netflix’s Strategy in 2018 C-159
to bundle a subscription to Netflix in with their preferred channel packages. Netflix believed collaboration with a host of cable and mobile phone operators
across all geographic markets would likely become
common practice very quickly. Management was
particularly interested in partnering with mobile
operators to create quick and easy-to-use procedures
for mobile phone users across the world to access
Netflix streamed or downloadable programming.
Netflix believed it was particularly important to make
mobile streaming from Netflix instantly accessible to
those people who basically only wanted to have their
relationship with Netflix on a mobile device.
In 2018, Netflix expected its growth in marketing expenditures to outpace revenue growth, partly
because it had started investing in more extensive
marketing campaigns for new original titles to
create more density of viewing and conversation
around each title. Netflix CEO Reed Hastings
explained the logic behind trying to make certain
new titles a bigger hit in a particular nation or
among a particular demographic segment:
We believe this density of viewing helps on both retention and acquisition, because it makes our original
titles even less substitutable. Because we operate in so
many countries, we are able to try different [marketing]
approaches in different markets and continue to learn
[how best to market Netflix’s original content and differentiate Netflix from rival streaming providers].4
Netflix’s Title Selection Software and Efforts to
Enhance Its Interface with Users Netflix had developed proprietary software technology that allowed
members to easily scan a movie’s length, appropriateness for various types of audiences (G, PG, or R),
primary cast members, genre, and an average of the
ratings submitted by other subscribers (based on 1 to
5 stars). With one click, members could watch a short
preview of a movie or TV show if they wished. Most
importantly, perhaps, were algorithms that created
a personalized 1- to 5-star recommendation for each
title that was a composite of a subscribers’ own ratings
of movies/TV shows previously viewed, movies/TV
shows that the member had placed on a “watchlist” for
future viewing and/or mail delivery, and the overall or
average rating of all subscribers (several billion ratings
had been provided by subscribers over the years).
Subscribers often began their search for titles
by viewing a list of several hundred personalized
movie/TV show recommendations that Netflix’s
seasons of hits like Luke Cage, GLOW, Dear White
People, Unbreakable Kimmy Schmidt, Santa Clarita
Diet, Series of Unfortunate Events, and a comedy feature
film with Adam Sandler and Chris Rock, called The
Week Of.
Marketing and Advertising Netflix used multiple
marketing approaches to attract subscribers, but
especially online advertising (paid search listings,
banner ads on social media sites, and permissionbased e-mails), and ads on regional and national
television. To spur subscriber growth, Netflix had
boosted marketing expenditures of all kinds from
$25.7 million in 2000 (16.8 percent of revenues) to
$142.0 million in 2005 (20.8 percent of revenues)
to $298.8 million in 2010 (13.8 percent of revenues) to
$991.1 million in 2016 (11.2 percent of revenues), and to
$1.278.0 billion in 2017 (10.9 percent of revenues).
These expenditures related to:
• Online and television advertising in the United
States and newly entered countries. Advertising
campaigns of one type or another were underway
more or less continuously, with the lure of onemonth free trials and announcements of new and
forthcoming original titles usually being the prominent ad features. Netflix’s expenditures for digital
and television advertising were $1,091.1 million in
2017, $842.4 million in 2016, and $714.3 million in
2015, several multiples higher than the $205.9 million
spent in 2009.
• Costs pertaining to free trial subscriptions.
• Payments to the company’s partners. These partners consisted mainly of (1) consumer products
manufacturers who produced and distributed
devices (particularly remote controls) that facilitated connecting TVs and other media equipment
to Netflix, and (2) certain cable providers and
other multichannel video programming distributors, mobile operators, and Internet service providers who had begun collaborating with Netflix
to make it easy for their customers to connect to
Netflix. For example, most all brands of Internetconnected TVs now came with a preinstalled
Netflix app that was easily accessed via the TV
remote; some TV remotes even had Netflix buttons that provided Netflix subscribers with a oneclick connection to their watchlist.
In 2018, multi-channel TV providers like
Comcast and Sky were offering customers the option
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C-160 PART 2 Cases in Crafting and Executing Strategy
for immediate viewing. Netflix management saw its
title recommendation software as a quick and personalized means of helping subscribers identify and
then watch titles they were likely to enjoy.
In 2018, Netflix’ strategic initiatives in the user
interface arena were focused on enhancing the accessibility of Netflix content for subscribers by (1) offering
more programs in local languages and (2) improving
the streaming and download speeds for subscribers
with suboptimal Internet connections—by making program encoding much more efficient so content selections would load more quickly and provide mobile
users with a “really incredible video experience.”5
More efficient encoding also enabled subscribers with
spotty Internet connections to quickly download some
programs for later viewing when offline.
The Financial Strain of Netflix’s
Growing Expenditures for
Original Content and Other
Content Acquisitions
The company’s heightened strategic emphasis on
original content produced in-house had resulted
in multi-billion-dollar annual increases in Netflix’s
financial obligations to pay for streaming content
and sharply higher negative cash flows from operations (see Exhibit 6). Netflix was covering these obligations with new issues of common stock and new
issues of senior notes (Exhibit 6); details of Netflix’s
outstanding senior notes are shown in Exhibit 7.
software automatically generated for each member.
Each member’s list of recommended movies was the
product of Netflix-created algorithms that organized
the company’s entire content library into clusters of
similar movies/TV shows and then sorted the titles
in each cluster from most liked to least liked based
on subscriber ratings. Those subscribers who favorably or unfavorably rated similar movies/TV shows
in similar clusters were categorized as like-minded
viewers. When a subscriber was online and browsing
through the selections, the software was programmed
to check the clusters the subscriber had previously
viewed, determine which selections in each cluster
the customer had yet to view or place on watchlist,
and then display those titles in each cluster in an
order that started with the title that Netflix’s algorithms predicted the subscriber was most likely to
enjoy down to the title the subscriber was predicted
to least enjoy. In other words, the subscriber’s ratings
of titles viewed, the titles on the subscriber’s watchlist, and the title ratings of all Netflix subscribers
determined the order in which the available titles in
each cluster or genre were displayed to a subscriber—
with one click, subscribers could see a brief profile
of each title and Netflix’s predicted rating (from 1 to
5 stars) for the subscriber. When subscribers came
upon a title they wanted to view, that title could be
watch-listed for future viewing with a single click.
A member’s complete watchlist of titles was immediately viewable with one click whenever the member
went to Netflix’s website. With one additional click,
any title on a member’s watchlist could be activated
EXHIBIT 6 The Growing Financial Strain of Netflix’s Strategic Emphasis on
Producing Original Content In-House, 2013–2017
2017 2016 2015 2014 2013
Streaming content obligations at year-end $17,694.6 $14,479.5 $10,902.2 $9,451.1 $7,252.2
Additions to streaming content assets 9,805.8 8,653.3 5,771.6 3,773.0 3,030.7
Additions to DVD content assets 53.7 77.2 78.0 74.8 65.9
Amortization of streaming content assets 6,197.8 4,788.5 3,405.4 2,656.3 2,122.0
Amortization of DVD content assets 60.7 79.0 79.4 71.9 71.3
Net cash used in operating activities (1,785.9) (1,474.0) (749.4) 16.4 97.8
Proceeds from issuance of debt 3,020.5 1,000.0 1,500.0 400.0 500.0
Proceeds from issuance of common stock 88.4 37.0 78.0 60.5 124.6
Outstanding senior notes 6,499.4 3,364.3 2,371.4 885.8 500.0
Source: Company 10-K Reports 2017, 2016, 2015, 2014, and 2013.
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Case 14 Netflix’s Strategy in 2018 C-161
We will continue to raise debt as needed to fund our
increase in original content. Our debt levels are quite
modest as a percentage of our enterprise value, and we
believe [issuing] debt is [a] lower cost of capital compared to equity.6
Netflix management forecasted that the company would a have a negative cash flow of $3 to $4
billion in 2018 and would also be cash flow negative
for several more years beyond as expenditures for
original content continued to grow. In April 2018,
CEO Reed Hastings said:
EXHIBIT 7 Netflix’s Outstanding Long-Term Debt as of May 2018
Debt Issues Principal Amount at Par Issue Date Maturity Date Interest Due Dates
5.875% Senior Notes $1.9 billion April 2018 November 2028 April 15 and November 15
4.875% Senior Notes $1.6 billion October 2017 April 2028 April 15 and October 15
3.625% Senior Notes $1.561 billion May 2017 May 2027 May 15 and November 15
4.375% Senior Notes $1.0 billion October 2016 November 2026 May 15 and November 15
5.50% Senior Notes $700 million February 2015 February 2022 April 15 and October 15
5.875% Senior Notes $800 million February 2015 February 2025 April 15 and October 15
5.750% Senior Notes $400 million February 2014 March 2024 March 1 and September 1
5.375% Senior Notes $500 million February 2013 February 2021 February 1 and August 1
Sources: Company press release April 23, 2018 and Company 2017 10-K Report, p. 51.
ENDNOTES
July 28, 2018, posted at www.wsj.com,
accessed July 31, 2018.
3 Travis Clark, “New Data Shows Netflix’s
Number of Movies Has Gone Down by
Thousands of Titles since 2010 — But Its TV
Catalog Size Has Soared,” Business Insider,
February 20, 2018, www.businessinsider.com
(accessed April 16, 2018).
1 Transcript of remarks by David Wells, Netflix’s
Chief Financial Officer, at Morgan Stanley,
Technology, Media & Telecom Conference,
February 27, 2018, www.netflix.com
(accessed April 5, 2018).
2 Joe Flint, Erich Schwartzel, and Sara
Nassauer, “Walmart Explores Its Own
Streaming Service,” Wall Street Journal,
4 As quoted in the transcript of the company’s
conference call announcing the company’s
financial results in the first quarter of 2018,
April 16, 2018, www.seekingalpha.com
(accessed April 30, 2018).
5 Ibid.
6 Company press release, April 16, 2018.
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