The Birth and Infancy of Netflix
Netflix became an idea when founder Reed Hastings wasfurious over owing $40 in late fees to his local Blockbuster. Hastings hadforgotten to return a copy of the 1995 film, Apollo 13, of which he could have purchased3 copies for the same amount he paid in late fees.
Despite being motivated to remedy late fee frustration,Netflix started out charging late fees on their mail-order DVDs (yes, rememberwhen they’d mail you your movies?). This was because late fees served animportant operational purpose: late fees ensured that movies would be returnedto Netflix distribution centres on time, thus the company was able to manage aninventory of DVD selections with more certainty than if the late fees did notexist. Instead of solving the problem that inspired the birth of Netflix, theonly consumer problem that Netflix may have solved was accessibility because itallowed customers to browse movie titles from their own homes, and then receivethem and return them via mail, which arguably had more local drop-boxes thanBlockbuster had accessible locations. In fact, in 2001, Blockbuster claimedthat 60% of the American population lived within three miles from a Blockbuster(Gupta, 2005).Netflix’s mail-order movies made home entertainment more accessible to theremaining 40% of Americans, but they still had not solved their late-feeproblem.
Netflix’s Core Competencies
Right from the company’s inception, Netflix’s probability ofsuccess was enhanced by their consumer responsiveness as well as their abilityto adapt to their changing business environment. I would argue that those twoqualities – responsiveness to demand and adaptability – are some of the mostimportant markers of a sustainable business model.
Late Fees
Netflix listened to customers and addressed late feeresentment by researching alternative pricing models that existed outside oftheir industry. Their research settled them on a subscription pricing modelwhich was popular with the growing internet and cellphone providers at thetime. Looking to extra-industry models and successfully implementing themwithin their own industry is an indicator of their second core competency: adaptability.
By 2000, Netflix was adapting and solving newproblems that arose from their subscription model. Their subscription modeleliminated late fees but created the problem of inventory uncertainty; no latefees meant that customers could keep DVDs without consequences, and unreturnedDVDs meant Netflix would not have DVDs to rent.
Netflix solved this by making people want to returntheir movies on time. This was thanks to an incentive system that was builtinto their new subscription pricing model. No more late fees, but customers hadto return a movie if they wanted to rent another one. The limit on simultaneousrentals helped Netflix to predict inventory needs in a more efficient way than latefees could. This new pricing model also gave customers more control over their rentals;instead of punishing customers for returning a movie late, Netflix wasrewarding customers for returning movies. On a side note, this is psychology atwork within business, specifically, B.F. Skinner’soperantconditioning theory that describes positive and negative reinforcement.
Shipping and Delivery Times
Netflix was very attentive to the inconsistent customerexperience that resulted from DVD shipping times across the continental US. Inconsistencieswere dependant on where customers lived in relation to its central distributioncentre in California. By June 2002, Netflix resolved this by opening 10 newdistribution centres which brought shipping times to the east cost and Midwestfrom 5 days down to the conventional 1-2 days happily experienced by west coastcustomers (Gupta, 2005).
The new distribution centres were not only very capitalintensive, but they also increased their fixed and variable operating costs significantly,depending on volume of customers. However, the lost opportunity cost of notopening those distribution costs would have been greater. If Netflix had notopened new distribution centres, they will have left a niche ready foroccupation by an east coast or Midwest competitor, a risk that Netflix did notwant to take. Opening these centres was worth the investment since itmaintained Netflix’s large market share, and with time, the distributioncentres in their original form were no longer needed after the company moved toan online streaming platform. This presents another learning point where becauseNetflix was adaptable to its changing business environment and newtechnologies, the short-term costs of opening distribution centres paid off inlong-term gains by growing market share before transitioning to onlinestreaming.
Business Model Sustainability
All business models are only sustainable provided that theconditions that made that business model successful remain unchanged. That iswhy Netflix’s industry competition, Blockbuster, felt safe saying that “onlinerental services are serving a niche market…. We have not seen a business modelthat’s financially viable long-term” (Gupta, 2005).However, the business environment is always changing, so what makes Netflix’sbusiness models sustainable is the ability to pivot and adapt. As the Greekphilosopher Heracl*tus said, “The only constant in life is change”, so Netflixchanged with the times.
We see Netflix continue to adapt even today by usingsubscription pricing to access a fully online streaming service. Introduced in2007, Netflix streaming solved many of the problems that Netflix previouslyexperienced: accessibility, shipping times, and inventory control to name a few.Now that streaming has become a new industry standard, Netflix now needs tocompete by offering competitive content. So, once again Netflix adapted byproducing their own entertainment content using their subsidiary movieproduction company, Netflix Studios LLC. Both streaming and producing contenthas allowed Netflix to grow as a company.
Even now, the challenges that Netflix faces are brought about by the way they have responded to previous business problems, and their new opportunities result from how they resolved previous business problems. This is the cycle of innovation that pushes businesses and industries forward.
References:
Gupta, S. (2005). Netflix, Inc. (A). Michigan Ross School of Business.
