Netflix: The Video On Demand Decision

Founded in 1997, Netflix has succeeded by delivering movies to customers with greater value, convenience, and selection than brick and mortar competitors.  Netflix has effectively merged new and old technologies to create a customer experience that has crippled many traditional competitors.  The company has developed an advanced set of algorithms that predict what movies users will like based on past reviews and similar patterns of other users and married that with the distribution system of the USPS.   The combined model enables Netflix to service more users with fewer copies of movies.  However, by 2007, video on demand was becoming more of legitimate means of distributing content.  Netflix would have to determine whether to enter the new market and potentially risk cannibalizing its DVD by mail business or not enter and risk losing margins to cable providers or other video on demand providers.

            The decision to enter is the easy part, Netflix must enter the market.  In keeping with the company’s value proposition, Netflix delivers greater value, convenience, and selection.  In 2007, greater convenience will soon mean no longer having to wait even a day to watch a movie.  Netflix must enter the video on demand market to retain its position as a leader in providing convenient access to movies.  The real question is how to enter.  Netflix can partner with a cable company as they already have access to a viewer’s tv.  It can spin off a company to compete in the video on demand market to keep the businesses clearly separate and protect Netflix from piracy in the video on demand market.  Or Netflix could dive head first to the video on demand market and use its advanced selection tool as a key differentiator in the new market.

            While the answer is obvious now (Netflix entered the video on demand market on its own), in early 2007 the path ahead was not as clear.  However, the choice of competing on its own was the choice with the least risk.  Partnering with local cable providers would not have yielded any significant long term advantage to Netflix.  The company would have most likely offered its algorithms to cable providers to enable their subscribers to select movies.  This would have provided Netflix a revenue stream in the way of licensing fees but also open some of its proprietary data to partners.  Additionally, cable providers are local.  Netflix would have to have hundreds of partnerships to compete in the video on demand market this way.  It is too costly and too risky to form and manage that many partnerships so that option should not be pursued.   

Similarly, spinning off a separate business is also too costly and too risky.  Costs are in the form of talent in this instance because Netflix would have to part with some of its top management to ensure the spin-off’s success.  It would likely need to jumpstart the new entity with seed money as well.  Worse yet, if the newly formed business took off it would prove to be a competitor with Netflix.  The risk of Netflix customers leaving in mass for a new video on demand provider is real and likely.  Spinning off a new company to enter this market only hastens the parent company’s demise.

Netflix must compete in the new market on its own.  It must protect its key asset and competitive advantage, the algorithms that recommend movies further down the long tail of its inventory.  Risking that technology in any partnership will likely hinder the company’s ability to retain its market leading position. 

Netflix must adapt and enter the video on demand market and be prepared to enter whatever markets come next as well.