Strategic Analysis of Netflix
An Introduction to Netflix:
Netflix rose fast to become the largest online streaming platform in the world. Its popularity surged faster during the pandemic when people stayed indoors following lockdowns in several leading markets, and Netflix was their main source of entertainment. The global online streaming platform added 10 million members during the second quarter of 2020. Overall, it has 193 million paid memberships across 190 countries. The largest markets of Netflix are the US and Canada, generating the biggest portion of its revenue. Its penetration of markets across Europe, Latin America, and in the Asia Pacific region has also grown stronger. Netflix has a strong competitive advantage supported by differentiated customer experience, a large collection of Netflix originals, its focus on innovation, and a competitive pricing strategy driving higher popularity across all consumer classes. The platform offers a vast set of originals, including movies and TV shows, top-rated among millennial users. Netflix viewers can access digital content from their smartphones, laptops, and other internet-enabled devices, including smart TVs. Its focus on creating original content and providing a superior viewing experience resulted in deeper market penetration. Overall, while Netflix continues to experience a fast surge in popularity and higher engagement rates than rivals, its focus on innovation continues to grow stronger. The company’s revenue also increased rapidly in recent years and has almost trebled in just five years. Rising from $6.8 billion in 2015, the annual net revenue of Netflix reached $20.2 billion in 2019. The company’s operating margin also expanded from 5% in 2015 to 13% in 2019. It indicates the firm’s growing profitability over the past five years.
External analysis of the online streaming industry:
The online streaming industry has advanced rapidly over the past several years, with online entertainment sources gaining precedence over TV and offline channels. According to Statista, by 2020, the Video Streaming segment’s revenue is estimated to reach $51.62 billion. Its revenue will follow an annual growth rate or CAGR of 10.7%, leading to a market volume of $85.7 billion by 2025. By 2020, user penetration must reach 11.9% and hit 17.2% by 2025. ARPU or Average Revenue per user is expected to reach above $58 by then. However, the US market will generate the most revenue of the entire global market, an estimated $24 billion by 2020. The number of users worldwide in SVoD is expected to hit 1.34 billion by 2020.
Main Competitors of Netflix:
Amazon Prime membership includes several benefits. Apart from free delivery on a large range of products sold on Amazon’s marketplace, it includes access to a large collection of videos and shows on the Prime Video Network. Prime is the largest competitor of Netflix. Apart from its services’ competitive pricing, Amazon has also added a large number of original videos to its collection that makes it stand out, including several shows in local languages targeted at its ever-growing audience in the emerging markets. Amazon Prime users in the US in December 2019 numbered 112 million. Its subscriber base in the US grew fast last year, rising from 95 million in December 2018.
Hulu is among the leading competitors of Netflix and experienced sharp growth in its subscriber base in the past year. Its memberships grew to 35.5 million from 27.9 million last year. Hulu has also adopted many different pricing plans to cater to the different needs of various user segments. The most basic plan costs $5.99 per month. However, there are pricier premium options also for Hulu viewers. Netflix is a global brand, but Hulu is available only in the US states, territories, and military bases.
YouTube has also emerged as a major competitor to Netflix. The social media network has a large collection of videos that engages users from all over the world and most of it is user-generated content. However, YouTube has also started offering movies for rent or purchase. With its vast collection of movies in various languages, YouTube competes with Netflix and other online streaming services providers. It also boasts an audience of above 2 billion.
Launched in November 2019, Disney+ has experienced rapid growth in its subscriber base. Its memberships grew to 50 million in just five months following its launch. With its launch, all the movies and TV shows previously available on other streaming services were made exclusive to Disney+. Disney has also included content from its Marvel, Star Wars, National Geographic, and Pixar franchises. In its first year, Disney+ plans to offer 7500+ TV shows and around 500 movies. However, that has still drawn a substantial subscriber base to the online streaming service.
Voot is an Indian subscription Video on Demand service launched in 2016 by Viacom18. Its business model is different from Netflix. Voot has relied mainly on advertisements as its core source of revenue. However, its subscriber base has grown to 100 million users in 2020. The pricing of Voot’s services is comparable to Amazon Prime’s. Its premium content can be accessed by paying around $1.5 extra. Voot also has cheaper annual plans for Indian users. It expects that subscriptions and advertising will together contribute equally to its revenue in the next three years. Right now, advertising forms a substantial part of its annual revenue. Voot’s services are limited to India and it is among the leading competitors of Netflix in the Indian market.
SWOT analysis of Netflix
Largest Online streaming site:
Netflix is the largest online streaming site providing its services across 190 countries. It enjoys the highest market penetration of all the online streaming services providers globally. Its market share is at 87% as of 2019, down from 90% in 2014. Despite it, the company has maintained its lead in the global market and continues to add new memberships in large numbers each quarter. In the second quarter of 2020, it added around 10 million new members. Overall, Netflix serves around 193 million users around the world. Netflix enjoys a strong competitive moat in the industry, and that is clear from its market share. Despite being notable players, its rivals like Amazon Prime and Disney Hotstar enjoy a much smaller market share than Netflix.
Even if Netflix is moderately profitable right now, its profitability is expected to rise faster in the future. From around 4% in 2016, the company’s operating margins grew to 13% in 2019 and can rise to 16% in 2020. According to The Motley Fool, when revenue is growing quickly and margins are expanding, profits rise quickly. Despite the rising competition in the online streaming industry, this trend should continue in the longer term. It means the operating margins of Netflix could be well above 20% in the near future. From $187 million in 2016, the company’s net income grew to $1.87 billion in 2019 or by ten times. The company’s profit margins have kept expanding mainly because content production or acquisition costs are fixed. Irrespective of how many people watch the shows, these costs tend to remain fixed. Therefore, adding extra subscribers brings enormous profits while there is nearly no additional cost incurred to provide services to more subscribers. In recent years, Netflix’s subscriber base has expanded rapidly, bringing the company lots of extra revenue. With it, there has been solid growth in its profitability. However, the company has selected to reinvest most of its revenues and profits back into creating more original content and building a competitive advantage that does not erode easily with time.
Netflix has become a global brand and offers its services to around 193 million subscribers worldwide. The number of memberships at Netflix has continued to rise fast in recent years. During the second quarter of 2020 only, the company added more than 10 million new subscribers as the pandemic drove people’s reliance on online sources of entertainment higher. Netflix offers its services to viewers in 190 countries. Its popularity overseas has grown driven by several factors including the quality of its content, differentiated and superior viewing experience, and an improved user interface. The pricing strategy used by Netflix has also helped the company grow its popularity and revenue base in various markets. Apart from that, the availability of content in various local languages has also drawn subscribers from different regions in the world.
One of the core sources of competitive advantage for Netflix is the high-quality original content it offers. The company’s key reason for creating its own content is that it will eventually help it lower its content costs in the longer term. It is a good idea since by creating original content, the company might save a lot on its licensing costs in the longer term. In the future, the company will need to invest very little in licensing content from others. However, Netflix will continue to fill the gap using others’ content. Still, the costs will be much lower, and the platform will have strengthened its profitability by combining higher subscriber income with lower operating expenses. Another benefit of creating its own original content is that that company has more control over the quality of the content it offers. With higher quality original content, the company also gained extra user loyalty, strengthening its competitive advantage in the online streaming industry. Original content draws subscribers in larger numbers and increases profitability. The company also invests in marketing the original content and promotes them online, through media and social media.
Focus on Innovation:
The company also makes good use of data and analytics to save big on user retention and beat competitive pressure. According to sources, the company saves big on user retention by using data to understand customers’ preferences better and serve them the content they prefer. It drives higher user engagement and stronger retention rates compared to rivals. Netflix uses the data collected from users and processes it using its advanced algorithms to provide the most suitable recommendations. Its recommendation system is believed to be more advanced than any of its rivals. According to Netflix:
“In addition to choosing which titles to include in the rows on your Netflix homepage, our system also ranks each title within the row, and then ranks the rows themselves, using algorithms and complex systems to provide a personalized experience. To put this another way, when you look at your Netflix homepage, our systems have ranked titles in a way that is designed to present the best possible ordering of titles that you may enjoy.”
Apart from that,
“We take feedback from every visit to the Netflix service and continually re-train our algorithms with those signals to improve the accuracy of their prediction of what you’re most likely to watch. Our data, algorithms, and computation systems continue to feed into each other to produce fresh recommendations to provide you with a product that brings you joy.”
Marketing is also a driver of solid competitive advantage and popularity for the online streaming brand, strengthening its presence in the global market. Netflix has created a strong brand image, and it has established itself as a distinct brand in the industry. The company has successfully generated strong brand recognition through its focus on marketing. It has positioned itself as a modern brand that aims to fulfill the entertainment needs of millennial users. Most of the content available on the platform is targeted at millennials. However, it has also included a nice range of content for kids. Strong brand recognition already drives strong brand recall and word of mouth, and through the use of technology and data and analytics, it can retain more users. Apart from that, Netflix spends on digital advertising and promotions to market its brand and individual movies and shows. In fiscal 2019, the company spent around $2.65 billion on marketing, of which around $1.88 billion were spent on advertising. With growing competition in the market, Netflix has also increased its marketing expenses. Its marketing expenditure grew by 13% in fiscal 2019 compared to the previous year.
Heavy operating expenses:
While Netflix has successfully grown its profitability, the company has to bear hefty operating expenses each year to operate profitably. Apart from the high cost of revenues, which mainly includes the amortization of streaming content assets and costs associated with the acquisition, licensing, and production of content, the company also incurs heavy marketing and R&D expenses. In 2019, the cost of revenues of Netflix was around $12.4 billion, or 62% of the net revenue of the company for the year. It had a net income of $1.9 billion, and its negative free cash flow for the year reached $3.3 billion or around $250 million higher than the previous year. The company has been burning cash heavily. While its cash flow is expected to improve this year, it may still take some time before Netflix can achieve neutral cash flow.
Mainly dependent on the US market:
Netflix mainly depends on the US and Canada markets for a large portion of its net revenue. They accounted for around 50% of its revenue in 2019. While the company’s revenue has increased in 2019 from nearly all regions, it will need to increase its penetration of the Asia Pacific and European regions to grow its revenue from these markets.
Substantial long term debt:
Netflix has accumulated heavy long term debt, which can be a cause of worry for the investors. The long-term debt of the company according to its annual report for 2019 grew by around 42% to $14.8 billion from $10.4 billion in 2018.
WallStreet Journal wrote about its debt in 2019, that an entertainment company’s cash obligations, and audience whims, make the profile of a content provider riskier. Moreover, Netflix’s debt levels understate its full obligations. Apart from its credit borrowings, the company has made contractual agreements for some of its content that it hasn’t yet paid. Like a company having signed leases, Netflix is still responsible for those payments.
The company can grow its sales and revenue by diversifying into newer and related areas. It could generate an extra $1.3 billion from the US market alone if it introduced a lower-priced and ad-supported tier in 2021. The company has a heavy debt load and if in the future its subscription growth rate falls, the company would need to diversify its business in order to service its debt. Netflix can also try more diversification strategies like a few it has already tried including game development based on some of its best performing originals.
Penetration of emerging markets:
Higher penetration of emerging markets like India and Brazil could also allow the company to grow its sales and revenue faster. The emerging markets apart from a large population of net-savvy millennials, also present an opportunity in the form of a large group of middle-class consumers whose lives are becoming increasingly digital in recent years. The company can introduce more competitive plans to expand its consumer base in the middle class in the emerging markets substantially.
More competitive Pricing:
The sales and subscriber base of the company can grow faster with lower prices or by using more competitive plans. Several of its competitors have offered more competitive plans and pricing to grow their sales. However, in emerging economies especially, the company can find faster growth in sales and revenue by introducing more competitive plans.
For example, all users do not access all kinds of content on the platform during a month. The company can introduce limited plans that allow users to watch only a limited number of programs every month. Such plans will grow the company’s subscriber base among the lower middle class in the emerging markets.
Rising competition poses a threat to the market share of Netflix. Apart from the direct competitors like Prime, Hulu, and Disney Hotstar, there are several more indirect competitors. Google-owned YouTube also poses a major threat with its large collection of movies that is available for sales or rent throughout the world. Other entertainment channels like gaming also pose a significant threat to Netflix’s market share. The size of the smartphone-using audience worldwide has kept growing larger but apart from Netflix, people use many more channels for entertainment. A large audience spends its time playing online games and on social media. The engagement level of each channel also decides its overall penetration of the global market. With increasing competitive pressure, Netflix has to pay higher attention to user engagement and to attract new users through quality and original content. Till now, the company has been reinvesting most of its revenue and profits in its content which has been adding to its operating expenses. HIgher competitive pressure also means higher pressure on profit margins.
Regulatory threats :
Growing regulatory pressures also pose a threat to the sales and profitability of Netflix. The online providers of entertainment and social media networks are dealing with challenges related to user privacy and data security. Netflix has maintained a clean image in this area. Compared to Facebook, its image is a lot stronger in this area. However, legal challenges still exist and some of Netflix shows came under fire because of their content. For example, its ‘ The Bad Boy Billionaires ‘ show faced a legal threat in India because of its content. While Netflix has managed to navigate through all kinds of regulatory storms with success, the company will need to play cautiously at this front to avoid damaging its reputation.
Growing costs of content creation:
The costs of content creation have kept growing for Netflix. Apart from creating its own content, Netflix also licenses content from others. However, its business is not very diversified and also has few options for diversification. As a result, to maintain its lead in the online streaming industry, the company must continue to invest in original content to retain its edge. Apart from that, to grow user engagement and success in the various local markets, it must create more local content for the local audiences. All of this exerts pressure on the company’s balance sheet because it comes at the cost of rising debts. Overall, it has a negative impact on the company’s profits.
Pestel Analysis of Netflix
Companies operating in the global market face many kinds of challenges. Many of these challenges are political or legal in nature, but there are many economic, technological, and social challenges also before the firms trying to grow internationally. While the economic environment has remained favorable worldwide before the pandemic, helping companies across all industries grow at a faster pace, the pandemic has driven economic activity downwards in many leading markets. It has hurt performance across several industries. However, the technology and online streaming industries have flourished despite the downward drift in the global economy. The impact has not been the same across all economies but more or less key industry sectors across all regions have been badly hurt. A PESTEL analysis helps understand the impact of these factors on a business and how it challenges or supports the particular business under discussion. In this Pestel analysis, we will analyze the impact of these forces on Netflix and their level of impact.
Political factors have acquired a central role for businesses operating internationally. The intervention and control of governments with regard to international businesses has grown a lot in recent years. Governments around the world are exercising tighter control over how firms operate locally in their markets. The political systems, governance, and level of government control of businesses differ from market to market and region to region. For example, the internet is heavily censored in China, which heavily hinders the free operation of top international technology companies like Google and Facebook in the market. While Chinese law favors the local businesses mainly, international and particularly the businesses based in the US find it difficult to operate in China without facing censorship from the government.
Netflix operates worldwide in 190 countries but its core markets are the US and Canada which account for the largest part of its net revenue. Until now, Netflix has faced fewer political barriers compared to other large internet businesses like Google and Facebook. However, increased regulations related to user data and privacy affect Netflix just like the leading players in the internet industry.
Moreover, while the regulatory environment is currently evolving in most regions around the world, tax systems also vary from country to country. So, when operating overseas, companies like Netflix have to keep in mind the local political environment to avoid facing action from the government and the local government agencies.
Economic factors too play a direct role in the context of international business and their impact is quite deep on the profitability of international businesses. Large international businesses are affected heavily by economic fluctuations in the international economic environment. A stronger dollar worldwide has continued to hurt the profitability of American businesses for the past few years. Apart from that, the level of economic activity in the global environment also has a direct impact on businesses’ profitability by affecting the purchasing power of customers worldwide.
The pandemic hurt demand, sales, and profitability of businesses in many industries. The industries most severely affected by the pandemic’s economic impact included retail, manufacturing, and travel as well as several more. However, there were also some industries that remained nearly unscathed despite the decline in economic activity that the pandemic caused. The cloud industry and the tech as well as e-commerce industries remained nearly unscathed despite the pandemic since people’s reliance on digital services grew. More people were buying online since prolonged lockdowns forced them to remain indoors while restaurants, pubs, and cinema halls stayed closed. Netflix also experienced fierce growth in its memberships in the second quarter. The main reason was that while the pandemic had a really strong impact on the lower end of the market, it had a relatively lower or no impact on the higher end which was evident from the sales of premium smartphones. A larger number of people worldwide now access digital services including Netflix through their smartphones compared to some years ago.
During the pandemic, while the sales of the entry-level smartphones were severely hurt, premium brands experienced impressive sales. Unemployment rose across various industries as companies were forced to layoff due to the lockdowns and the fast decline in demand and sales that followed. So, the pandemic has affected industries, regions, and classes of people to varying degrees. Netflix is an entirely digital business and while physical businesses were hurt the most by the pandemic and lockdowns including the cinemas that remained closed worldwide, Netflix emerged as the most attractive option for people missing their dose of entertainment in the meantime. Overall, while the economic impact of the pandemic will remain for some time, the world economy was in very good shape before the pandemic. So, in many parts of the world, people and businesses found it easy to bear the pandemic’s negative impact.
Moreover, people have grown used to digital lifestyles and using digital channels to obtain products and services. All these factors have worked in the favor of Netflix and despite the economic decline since the pandemic, its business has continued to flourish. The impact of the pandemic is expected to last. It has affected consumer behavior worldwide and these trends mark a lasting shift towards digital technology.
Sociocultural factors are also a key consideration in the area of international business, and firms that operate globally have to consider the impact of these factors on sales and profitability. Especially in marketing and sales, the importance of sociocultural factors has grown a lot. It is because changing social trends can have a strong impact on the sales of particular products and services. While with changing trends, the demand for certain products can rise, others can experience falling demand. For example, the rise of digital technology has brought sweeping changes worldwide. Across most regions, penetration of smartphones and the internet has grown, and people now depend mainly on digital channels for availing of various products and services. These changes have been sweeping across societies for some time, so the focus on digital marketing and sales has grown. Apart from the US & Canada, Netflix has also found impressive success in other regions, including Europe, Asia Pacific, and the Middle East. The company also focused on serving localized content for different societies and cultures. It helped the company connect with local audiences worldwide through content that matches their tastes and preferences. Netflix’s success can be partially attributed to the company’s focus on simultaneously catering to the tastes of varying audiences.
Technology has become the main driving force behind the transformation going on worldwide. Worldwide a digital transformation is underway across various industries, which has only gained pace with the pandemic. The pandemic has made people and businesses turn towards digital channels to sell and buy products and services since the brick and mortar model proved ineffective during the pandemic. Apart from e-commerce, people turned to digital channels for entertainment as well. Netflix is an entertainment company, but its business model is based mainly on digital technology. It offers its services online, and the users can watch Netflix movies and shows on any internet-enabled screen. The company offers a differentiated user experience. Apart from an easy to use interface, it also offers recommendations for viewers based on their viewing history and the choice of genres. However, to drive user retention and engagement level high, the company has to focus on continuous innovation to have the best-in-class experience.
Netflix invests a huge sum each year in research and development. The higher focus on innovation gives it an extra competitive edge. Netflix attracts new subscribers in larger numbers compared to the other providers of online streaming content. Technology has proved to be a key driver of popularity and profitability for the company that delivers content online in all corners of the world. Its advanced algorithms help optimize the user experience for nearly all types of viewers. Its penetration of international markets has also grown driven by the seamless user experience the platform provides. In 2019, the company spent around $1.7 billion on research and development compared to $1.2 billion in 2018. The company’s growing technological expenses reflect its higher focus on innovation and user experience, and on the other hand, they also reflect the growing competition in the industry.
Environmental factors have also acquired a critical role for businesses around the world in nearly all industries. While governments have formed laws to control businesses’ negative impact on the environment, the public is also highly aware of environmental concerns and how businesses affect the environment. Apart from these things, environmental concerns have become important because companies with a low environmental impact can find popularity faster among the general public and grow their brand image stronger. People like to buy from sustainable businesses. The importance of sustainability has grown with the pandemic, and now onwards, businesses will need to remain even more careful about their impact on the environment.
Netflix is mainly a digital business with low to zero net environmental impact. However, large businesses, whether they have an environmental impact or not, still are responsible for protecting and investing in the environment. While businesses like Netflix can have a zero direct impact on the environment, they may still indirectly impact the environment. For example, the electricity that Netflix uses is not entirely derived from renewable sources. Netflix matches its electricity consumption (generated from non-renewable sources) with regional renewable energy certificates and carbon offsets. The company also invests in renewable energy projects in several of the US states. Apart from that, the company also ensures sustainable operations and has continued to improve in this area over time. The company has also adopted practices that minimize wastage in its offices worldwide. The company takes its environmental impact seriously and has adopted practices that help it become more sustainable.
The critical role of legal factors for international businesses is clear from the hefty fines that the large technology companies like Apple, Google, and Facebook have paid over the years to governments in Europe and the US. Netflix has managed to maintain a clear image and has faced fewer legal battles compared to the larger players in the digital industry like Facebook or Google. However, that does not mean that Netflix is exempt from laws or can avoid fines even after violating applicable laws. The legal framework related to technology businesses and data collection related practices is still evolving in most corners of the world. There are several laws related to Data Privacy that leading players like Google, Facebook, or Netflix need to comply with. There is no single comprehensive law governing data privacy in the United States.
There are several laws addressing data privacy, and some of them are sector-specific, addressing data collection practices in various sectors of the industry. In contrast, the others are channel-specific laws governing data collection via various channels. One Federal law with broad jurisdiction in this area is the FTC Act. Still, several more laws address data collection practices in specific areas like the Children’s Online Privacy Protection Act, The Gramm-Leach-Bliley Act, and the Fair Credit Reporting Act. Apart from the Federal laws, there are hundreds of data protection and privacy laws among the US states and territories. Another important privacy legislation is the California Consumers Privacy Protection Act (CCPA), signed into law in 2018. The GDPR or the General Data Privacy Regulation is an important international Data protection law governing the collection, transmission, and use of data collected from any of the European Union’s 28 member states. You can read about the data collection practices of Netflix here.
However, it is not just the data protection-related laws that affect Netflix. Still, there are other applicable laws, including labor and environment laws, that the company needs to comply with. Overall, compliance is essential for businesses like Netflix, since noncompliance can often result in hefty fines. The fine can be a large part of its annual revenue.
Five Forces Analysis of Netflix
Bargaining power of buyers:
The overall bargaining power of Netflix’s buyers is low. The bargaining power of buyers becomes high in cases where there are multiple substitutes available in the market. The number of substitutes is not very high in the case of Netflix. There are few sellers in the market offering a similar experience and as large a collection of movies and TV shows in diverse genres and original content. Another important factor that has kept buyers’ bargaining power under control is the highly differentiated experience Netflix offers. Other providers also offer streaming services, but Netflix offers something superior and also highly differentiated. It caters to the tastes and choices of diverse customer segments from all the regions in the world. Overall, Netflix customers get to choose from a vast collection of content that includes its own original content and content from other makers and shows and movies in diverse genres. Moreover, the company has created a differentiated viewing experience that is optimized for all screens. Buyers’ bargaining power becomes high when there are several substitutes to choose from or when several sellers are offering similar products in the market. While Netflix has several competitors like Amazon Prime, Disney Hotstar, YouTube, and Hulu, Netflix’s product mix is considerably superior compared to the others. It offers Netflix a strong competitive advantage in the global market. Compared to its rivals, Netflix wins by a strong margin in the online streaming industry. The bargaining power of the buyers is also low because of their smaller size. Like a few players in the telecom industry that offer free Netflix memberships with their plans, some of the larger buyers hold some bargaining power because of the larger size of their purchases.
Bargaining power of suppliers:
The bargaining power of Netflix suppliers is moderate. Some of the largest suppliers hold most of the bargaining power. Most of these suppliers are movie brands and technology providers like AWS. These are the largest suppliers providing their services to Netflix, and their importance grows for Netflix because of the quality of their content or technological services. Apart from creating its own content, Netflix also buys content from other suppliers. Some of the leading suppliers include Dreamworks owned by Comcast, Lionsgate, and Gaumont Film Company. According to Netflix,
“Since 2013, DreamWorks Animation Television and Netflix have released 12 original series including DreamWorks Trollhunters, Dragons: Race to the Edge, DreamWorks Voltron Legendary Defender, All Hail King Julien, DreamWorks Spirit: Riding Free, Dinotrux and more, winning 17 Daytime Creative Arts Emmys and six Annie Awards.”
Its leading suppliers of content and services hold some strong bargaining power. AWS is the main supplier in terms of technology since Netflix employs its cloud computing services to make its shows and movies available worldwide to its viewers. However, several factors moderate the bargaining power of Netflix suppliers. First of all, Netflix’s sheer size as the leading online streaming provider in the world makes it one of the biggest buyers of its suppliers’ services. Apart from that, Netflix creates most of its own technology and content, which reduces its dependence on the suppliers and controls their bargaining power. Overall, the bargaining power of Netflix suppliers is moderate.
The threat of substitutes:
The threat of substitutes for Netflix is low because there are very few players in the market that offer similar products or comparable services. The company has successfully differentiated its brand from the other players in the market and its focus on innovation has helped it establish itself as distinct from the other individual players in the online streaming industry. Of all these players, Netflix enjoys the largest market share. Competition from rival players has continued to grow. However, Netflix has a strong competitive advantage against the other players and also enjoys the largest market share of all the online streaming brands. According to emarketer, its market share stood at 87% in 2019, and over the coming years, it might reduce as competition from other players has increased. The share of Netflix stood at 90% according to the brand in 2014. However, by 2023, it could reduce to 86.7%.
Netflix also enjoys the highest penetration among the Over The Top video providers. It also shows that Netflix enjoys the highest popularity of all the players in the online streaming industry. The threat of substitutes gets minimized by several factors including the strong brand image of Netflix, its vast array of content (larger than the competing players), as well as original content and its focus on customer experience.
The threat of new entrants:
The threat of new entrants is moderately low because of the big barriers to entry and exit. The online streaming industry is seeing increased competition among existing players. For a new player to enter the market, it will need access to good quality content, it will also need to invest a large sum to buy content or create its own and then the technical know-how and other costs also make entry difficult for a new entrant. Achieving growth in the online streaming industry is not easy because the players invest large sums in marketing. Netflix is a highly innovative brand and invests a large sum in research and innovation which is critical to maintaining growth momentum and provide a superior customer experience. Other major challenges that make new players’s entry difficult involve the legal and regulatory challenges. However, the existing players like Netflix, Disney Hotstar, and Amazon Prime are aggressive about maintaining their leadership and the competitive edge they have gained will be difficult for any new player to achieve. Most of the existing players in the online streaming industry are either large technology players or players from the media and entertainment industry. Achieving economies of scale and growing their profitability becomes difficult for new players trying to enter the industry because of the several major expenses involved. However, some smaller players from the media or tech industry have still been able to grow their presence locally in various markets or internationally using their existing capabilities but they cannot match the core competencies of Netflix and therefore do not represent a major threat to its market share.
The Intensity of competitive rivalry in the industry:
The competitive rivalry in the online streaming industry has continued to intensify with the growing number of players providing online streaming services. The leading competitors of Netflix are Amazon Prime, Hulu, YouTube, and Disney Hotstar. Apart from these, there are more players like HBO and Apple that have also released their online streaming services. Some local players in markets like India are also providing their services. Netflix has still maintained its leadership position successfully. Competitive pressure has kept rising over time. It is evident from the reduction in the company’s market share of around 3% since 2014. The marketing expenses of the company have grown faster in the past three years. From $1.4 billion in 2017, its marketing expenses have climbed to $2.7 billion in 2019. Apart from that, the company is also spending a huge sum each year in research and development to maintain its leadership position in the online streaming industry. From $953.7 million in 2017, its R&D expenses climbed to $1.55 billion in 2019 which reflects the increasing competition in the industry. Most of the competition comes from the largest players like Amazon Prime, YouTube, and Disney Hotstar. In the next three years, the overall market share of the company is expected to decrease further. Amazon Prime and other competitors of Netflix have also been adding their original movies and shows to their collections to reduce the market influence of Netflix. While the overall level of competitive rivalry in the industry is moderate, the lead that Netflix has enjoyed over its rivals might reduce in the future.
VRIO Analysis of Netflix
The resources and capabilities of a company are its drivers of competitive advantage. Nearly all that a business owns can be classified as a resource or capability. By understanding the resources and capabilities of different enterprises, one can understand why overall performance differs from one firm to another. To achieve a competitive advantage, the resource or capability that a company owns needs to be valuable, rare, inimitable, and organized.
The VRIO framework helps managers when they are analyzing their company’s resources and capabilities. VRIO is an acronym for Valuable, Rare, Inimitable, and Organized. These are the four bricks of VRIO. They represent the four properties that core competencies must have to give rise to sustainable competitive advantage. When the core competency arising from a combination of resources and capabilities satisfies the four requirements, the competitive advantage thus generated will be sustainable. If it meets fewer standards, the competitive advantage will be temporary.
Core Competencies of Netflix:
One of the key competencies that support the fast growth of the platform is its focus on technological innovation. The growth of Netflix has been driven mainly by the company’s focus on continuous improvement of its platform through innovation. The most critical difference comes from technological innovation. While good quality content is essential to attract a large audience, the entire user experience matters. Netflix offers a superior customer experience made possible through recommendation systems that make it easier for the users to select the best titles to watch from. Its recommendation system is admired industry-wide for its level of precision. Innovation also affects user engagement and continuous innovation is essential so users do not grow disengaged. While a vast array of quality content is at the core of the Netflix experience, it’s the design of the platform and its other features that distinguish the experience from others. Netflix is known industry-wide as an innovative brand that has established an organizational culture fostering innovation and creativity. However, to foster faster growth, it spends a heavy sum each year on research and development. Focus on innovation has helped the firm build a source of sustainable competitive advantage.
The brand equity of a business is also a leading core competency driving superior growth through stronger brand recognition and higher user loyalty. It is the users’ perception of the brand that has a long term effect on demand and sales globally. Netflix enjoys stronger publicity and word of mouth driven by stronger brand equity. The company has proved excellent in terms of marketing an innovative and customer-oriented image. Its focus has remained on catering to diverse choices of people from various regions. With time, as it continues to add more good quality and original content, the brand equity of Netflix keeps growing stronger. Over time, stronger brand equity has started translating into higher brand recognition and brand recall. Netflix finds it easier compared to its rivals to grow its penetration of existing markets, attract new suppliers, and to retain subscribers for longer. Apart from its positioning strategy right, the company also got its branding strategy right. Brand equity also rests on brand identity and how your customers recognize your brand. While there are more brands in the market, that are serving the entertainment needs of millennial users, Netflix has proved itself more dynamic and customer-oriented in terms of understanding their expectations. Through a higher focus on user experience, the company achieved higher credibility and reliability, resulting in strengthening brand equity over time. It gained a significant lead over its competitors and this will have a stronger impact in the longer term. The result is a strong and lasting source of competitive advantage for the online streaming platform. The level of resonance that Netflix gained among its users will be difficult for its rivals to imitate. Overall, in the longer term, Netflix will be less vulnerable to competitive pressure and to pricing changes or competitive marketing by its rivals.
Large user base:
A large user base is also a critical source of competitive advantage for the brand. The company has experienced a sharp improvement in its user base through recent years. In the second quarter of 2020, its net number of memberships has reached 193 million and could be past 200 by the third quarter. This is a lot larger compared to any other rival. Netflix is a global brand and so is Prime, but the competitive advantage of Netflix is stronger. Matching its large user base will remain difficult for the competing players and the subscriber base of some rivals is a lot smaller compared to Netflix. While YouTube has a vast user base, most of it spends its time watching the user-generated content on the platform.
Moreover, YouTube’s core product is not movies and shows despite its large collection of movies. With the growth in its user base, the revenue and operating margins of the company have expanded. Another major factor that favors Netflix is the higher user engagement and retention rate. Overall, it has achieved a sustainable competitive advantage which will grow stronger as the company produces more localized content to engage users worldwide in various regions.
Netflix streams its movies and shows worldwide in 190 regions. There are few rivals streaming globally. The reading rivals that serve the global markets include Prime, YouTube, and Disney+. The global presence of the brand also offers it an extra advantage over rival players trying to grow locally in the US or one of the emerging markets like Voot in India. The paid subscriber base of the company has grown to 193 million from around the world. However, the company has achieved deeper penetration of most of the leading markets. While America and Canada account for the largest part of its revenue or around 50%, the company has also experienced substantial growth in its revenue from the other market regions. The global expansion of the brand has also helped it overcome the competitive pressure from rival brands.
The product mix of Netflix is also a critical source of competitive advantage for the online streaming platform. It is one of the core sources of competitive advantage for Netflix and also one of the main differentiators that differentiates Netflix from the other online streaming brands. Netflix offers a large number of movies and shows in around 30 languages targeted at audiences in different regions of the world. It has more than 13,900 titles overall. The company has focused on developing its own original content that stands out from the content available on the other platforms. While Amazon Prime and Disney+ also offer original content, their libraries of originals are comparatively a lot smaller. It offers movies in several genres that suit the preferences of various segments of users. Apart from that, there are TV shows and documentaries. Several of its originals have achieved very high popularity among both the eastern and western audiences.
Until now, the company has invested most of its revenues and profits in producing original content. However, that has helped it draw people from all over the world to its platform in larger numbers. During the pandemic, the number of subscribers of Netflix grew sharply. However, quality content plays a central role in driving memberships and user loyalty. Overall, the competitive advantage it has gained by focusing on producing original content has helped it take a substantial lead over the rivals.
User experience is also a major source of competitive advantage for digital entertainment brands. A large number of users are accessing entertainment and other products and services through digital channels. However, the user experience offered by a platform marks the main difference. It depends on several factors including the quality of content, its variety as well as the overall quality of the user interface. While Netflix has already accumulated a vast library of great quality content, it has also continued to improve the user experienced through the use of algorithms. Its recommendation system is the best of all the streaming content providers and has helped the company grow its user retention. The users can watch Netflix shows and movies on various internet-enabled screens. The company makes content available around the globe using cloud technology. It ensures a seamless user experience and higher user satisfaction.
The human capital of a tech organization is also a fundamental driver of competitive advantage for the company. For many tech organizations, managing their human capital strategically has helped them grow their competitive advantage stronger. Netflix has also focused on managing its human capital strategically and engaging employees so they can deliver superior results. It has established an organizational culture that fosters innovation and higher creativity. Apart from that, its focus is also on maximizing employee satisfaction through training, performance management, and a better work life balance. Overall, the company has been able to gain higher loyalty from its employees while also ensuring that they find faster career growth and success.
Financial Performance of Netflix:
Netflix’s financial performance has improved sharply over the past five years. Its revenue has more than trebled since 2015. The operating margin also more than doubled in the meantime. The company’s operating margin grew to 13% in 2019 from 10% in 2018. Its profitability is expected to grow faster in the future. Netflix generated $11.7 billion in 2017 in net revenues. Its net revenue grew to $15.8 billion in 2018 and then $20.16 billion in 2019. The company’s net income rose to $1.9 billion in 2019 from $1.2 billion in 2018. Its EPS (diluted) rose to $4.13 in 2019 from $2.68 in 2018.
However, while the company’s net revenue has grown substantially in recent years, Netflix has also accumulated massive debt. It can be a cause of worry for the company in the future. Still, its growing operating margin is a positive sign, and the company could successfully service its debt in the future. Netflix has invested most of its revenues and profits in creating original content. This will only improve its competitive moat. While Netflix has accumulated a lot of debt to create original content, it is still a smart move. Its debt to equity ratio has improved since 2015. With an audience size of close to 200 million, its profitability is poised to improve significantly in 2020. So, even if the company accumulates more debt to create more original content, it has strong leverage in its subscriber base. Content costs are fixed costs, and an enormous audience size guarantees enormous returns. So, the chances are thin that its debt could become a major burden in the future. While Netflix can exercise some caution in this area, by 2020–2021, its operating margins can be expected to grow more impressive. Overall, Netflix is in a financially strong position. More than its debt, its competition is a cause of worry for Netflix.
A few last words:
Netflix has enjoyed superb growth in recent years driven mainly by a higher focus on customer experience, a vast amount of original content, and a shifting focus on digital experiences. The pandemic has also brought some changes to consumer behavior, which indicates a larger number of people will depend on their smartphones and the internet for entertainment. This change was already underway and the pandemic has only sped up the transition.
For Netflix, member satisfaction is above everything else. It is serving an audience of around 195 million from 190 countries. This audience is highly diverse, and from France to India and the US, Netflix has to worry about the taste of people from all regions and cultures. The company invests in projects that are good enough to please its diverse membership base. Its investment has successfully drawn subscribers. For Netflix, there is no reason to stop spending on original content, even at the cost of accumulating more debt. The company expects to start generating positive cash flow by 2021. Its operating margins are expanding, and its leverage is growing. In emerging economies like India and Brazil, it could draw more subscribers using more competitive plans. However, Netflix is investing in strengthening its competitive moat and investing where it matters the most. From now and before the end of 2020, it plans to bring around 150 more original titles, and then more original content will follow in 2021. Even if its debt is large, with the current growth rate, there is reason to expect that it will not remain a worry in the future.
Originally published at https://notesmatic.com on October 20, 2020.