Netflix Inc The 2011 Rebranding Price Increase Debacle

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Case Study #2: Netflix, Inc.: The 2011 Rebranding/Price Increase Debacle

Ronald Astrino

Webster University

Executive Summary

Netflix is a global powerhouse in the online streaming content market. From their beginning in 1997 to their arrival of becoming the world’s largest online movie rental service in 2011, they expanded quickly and with very little mistakes along the way. On September 18, 2011 Netflix CEO and co-founder Reed Hastings announced on the Netflix blog that the company would split in to two entities. The company was splitting its “DVD delivery service from its online streaming service, rebranding its DVD service Qwikster as a way to differentiate from its online streaming service, and creating a new Web site for it”. This would prove to be a costly move to the company, and its reputation. In the third quarter of 2011, “Netflix implemented a 60 percent increase, from $10 to $16 a month for unlimited streaming and DVDs by mail, which immediately resulted in the loss of 800,000 subscribers”.

Even with this setback Netflix was still on its way to being the world’s greatest entertainment distribution platform. In 2011, “Netflix surpassed $3.2 billion in sales, an annual revenue growth of 50% over 2010”. Through their 24.4 million subscribers for their online streaming and their top level executives who made it a priority to learn from the Qwickster debacle and to make amends to their customers, Netflix was able to continuing their pursuit of global expansion. Still there was a need to address many issues to maintain the company’s leading position in the home video market.

Historical and Current Information

In 1997 Marc Randolph and Reed Hastings founded the Netflix company. Due to an inability to change with the times, and “competition from Netflix and other video rental companies, Blockbuster LLC, was forced to file for bankruptcy on September 23, 2010”. This left the door open for a new company to become the leader in this market. By 2011 “Netflix was the world’s largest online movie rental service”. Initially, “Netflix provided movies at $6 per rental, but moved to a monthly subscription rate in 1999”. The company initial public offering “was held in 2002 when 5.5 million shares at $15 dollars a share was sold for $82.5 million”. The company turned a profit in the next fiscal year of $6.5 million. Their international market began in 2010 “when they granted streaming content to Canada, and expanded its international operation to the Caribbean, Mexico and Central and South America. By 2012, the company had over 27 million subscribers for their 100,000 plus titles they distributed via more than 50 shipment centers”. They are a leader in developing streaming technologies, increasing its spending on technology and development from “$114 million in 2009, to $258 million in 2011”.

Governance structure

Beginning with the management team, the founder and chief executive officer of Netflix is Reed Hastings. He “founded the company in 1991 and sold the company to Rational Software Corporation in August 1997”. Under him he has seven division chief officers and a general counselor. The Chief Marketing Officer is “Kelly Bennett who came from Warner Bros in 2012”. The “Chief Communications Officer is Jonathan Friedland. Mr. Friedland joined Netflix in February 2011 from the Walt Disney Company”. The Chief Business Development Officer is Bill Holmes, “Bill Holmes joined Netflix in 2008 and has most recently served as Vice President, Business Development, in charge of the company’s global partnership across the consumer electronics, gaming, operator, service provider and retail markets”. “Neil Hunt is the Chief Product Officer and has served in that role since 2002”. Before this role he was Vice President of internal engineering for three years. “Patty McCord has served as the Company’s Chief Talent Officer since 1998” and before that she was the Director of Human Resources at Pure Atria. “Ted Sarandos is the Chief Content Officer and the Vice President of Content”. He has served in this role since 2000. “David Wells has served as the Company’s Chief Financial Officer since December 2010” and before that was the Vice President of Financial Planning and Analysis. Finally, the General Counselor is David Hyman. “David Hyman has served in this position since 2002”.

Moving to the Board of Directors, the Chairman of the Board is Reed Hastings, Chief Executive Officer, President, Chairman of the Board who is also the founder of the company. Next is“Richard Barton, Chief Executive Officer and Chairman of the Board, Zillow, Inc. He has been one of the Company’s directors since May 2002”. Next is an Investor by the name of “A. George (Skip) Battle. He has served as a Director since 2005”. Fourth is “Timothy Haley, Managing Director, Redpoint Ventures. Timothy M. Haley has served as one of the Company’s Directors since June 1998”. The fifth member is “Jay Hoag, General Partner, Technology Crossover Ventures. Jay Hoag has been on the board since June 1999”. After that there is Leslie Kilgore who was the previous Chief Marketing Director before Kelly Bennet took over that duty in 2012. Finally Ann Mather who has been on the board since July 2010.

External Environment

The external environment is large for Netflix. They have to deal with many different forms of social environments as well as task environments. In each of these categories there are a number of Threats and opportunities that present different opportunities and strategies.

As with most companies Netflix felt the Recession of 2008 but not in a way that really hurt the Netflix company. People cut back on extras during a recession, so many families must make drastic changes to their pre-recession lifestyle. This means “fewer trips, shared experiences, and missed opportunities because of a lack of funds”. In hard times it is the luxury items that go out the door in American households and people really buckle down. However, due to the company’s very reasonable pricing at the time, “Netflix expected to end the year 2008 with an improvement of 8% to 12% over 2007”. This is because when people are cutting items out of there life they are going to start with the most expensive things first like vacations and other expensive events that leave expansion for the cheaper forms of entertainment, like the services provided by Netflix. As the Economy recovers this opportunity may turn in to a threat as people decide to go back to their regular lives and may decide they no longer need Netflix.

Netflix would not be able to provide the services they are able to without the content from television and movie production companies. This puts them at a disadvantage when trying to negotiate for their content because while they are heavily dependent on the production companies, the production companies do not necessarily need them to survive. They are unable to buy the rights to be able to stream and provide all movie and television shows and are sometimes limited by this. In an article by Indiewire, this problem was explained that Netflix is more of a channel than a library of every film that’s ever been made. And, really, it comes down to money and rights to content. In short, “it’s currently cheaper and easier to buy DVD rights, than it is to buy the rights to stream every movie and television show”. This presents a threat if there is a company who would be able to get more sought after content, and could raise the price in the market. However, since Netflix has such a large market share it is able to enjoy an enhanced ability to negotiate their pricing with companies who would like their content to go through Netflix.

The newest set of problems a company like Netflix will face is the rapid expansion of technologies like on demand, and streaming Content. In an age of instant gratification, consumers do not want to wait the allotted time it takes to send a DVD to the customer’s residence. Steaming fixes this problem and is safer for Netflix as well. While it is impossible to know exactly how many packages the USPS loses a year, because they would not be lost if they could be counted, it is safe to assume that it does happen. If a package is lost, and a customer fills out a search request through the USPS site, it says right on the website “Please note, sometimes we cannot find missing mailpieces”. Even without that threat, streaming reduces logistics costs and improves customer service. Like any market and opportunity, if Netflix does not continue to capitalize on this opportunity to protect their share of the market there will be a competitor who will. Cable companies like DirecTV and TIVO are already doing on demand which is essentially the same as streaming, however at the moment they are grossly out maneuvered by Netflix pricing.

The best part about being able to stream is the advancement of technologies and the internet. Internet capabilities get better each and every year with faster download times and better quality streams. On top of that internet is everywhere with the massive expansions of tablets, smartphones and other mobile devices. Netflix is able to put apps in both the Apple Store and Google Play store to broaden their reach to more customers. With the expansion of the internet has also brought along a new threat. Cyber hacking and cybersecurity have become a large threat to technological companies. The federal government is working to help fix this problem but it is a relatively new form of criminal which may take years to get the required regulations and countermeasures in place for. The white house and other government agencies are in an ongoing battle to help defeat these criminals and in the latest cybersecurity briefing can be quoted as saying “Every day, the Federal Government experiences increasingly sophisticated and persistent cyber threats. While the Federal Government has prioritized its efforts to address these threats, several fundamental challenges exist which hinder progress in eliminating cybersecurity risks”. With these growing threats, there is no telling exactly what type of restrictions technological companies, such as Netflix, with foreign customers could face.

The biggest opportunity could become the biggest threat if Netflix continues to stray away from the strategies that their loyal customers have become accustom to. In 2011 the company did not do enough of an analysis in to how their base customers would react to a price increase. In the third quarter of 2011, “Netflix implemented a 60 percent increase, from $10 to $16 a month for unlimited streaming and DVDs by mail, which immediately resulted in the loss of 800,000 subscribers”. Their core strength is the low prices they provide and without that remaining constant in their strategies, they will lose their stronghold on the market. Just as, if not more, important was the fact that the “botched rebranding led to a dilution of Netflix’s brand and its loss of customer trust”. It has since rescinded this decision and apologized but they have a long way to go to regain their customer’s loyalty.

This misjudgment has opened the door to new threats. One of the largest being the threat of new entrants into this market. Most companies can get access to the same streams that Netflix has and at the same price. To counter Netflix will need to offer original programming and specials just for their services. On top of the threat of new entrants, there is a serious upward trend in piracy and more access to substitute services like the Popcorn time app which offers all of the latest movies and television shows for free. This added with the rival companies like Hulu all are reasons that this increase in price was terribly judged. Before any changes were made there should have been much more market research and a strategic plan to follow through with this rebranding. The company must look for internal strengths and weaknesses to attempt to revitalize their brand.

Internal Environment

Netflix has a corporate structure that is set up for success. On top of their management team with a plethora of experience they also have a seven-member board who have secondary duties in either the Audit committee, the Compensation committee, or the Nominating and Governance Committee. These committees are all set up for accountability and decentralization of power. The Audit committee is led by Ann Mather and also has Richard Barton and Timothy Haley on from the board. The Committee purpose is to “provide oversight and monitoring of (i) the Company’s accounting and financial reporting process (ii) the Company’s systems of internal controls over financial reporting, (iii) the integrity of the Company’s financial statements, (iv) audits of the Company’s financial statements and (v) the independent auditors’ qualifications, independence and performance”. Then there is the Compensation committee which is made up of A. George (Skip) Battle, Timothy Haley and Jay Hoag. The committee is responsible for “reviewing and approving the compensation and compensation policy for executive officers of the Company, and such other employees of the Company as directed by the Board” Finally there is the Nominating and Governance committee which only has two members, Richard Barton and Jay Hoag, who are responsible for The “Nominating and Governance Committee (the “Committee”) shall, (i) in consultation with the Chief Executive Officer (CEO), evaluate, nominate and approve director nominees for election by the stockholders and for appointment by the Board to fill vacancies and (ii) provide a leadership role with respect to corporate governance of the Company”. This is a concrete structure and easily understood by the company.

The ability for the leaders of this company to work as an organized and cohesive unit allows for that same kind of structure and culture to trickle down. The middle managers will be given their own departments and work together to achieve the goals set by the board of directors and senior management. As the Harvard Business Journal says “The buck stops at the middle manager, who must assume the bilingual role of translating the strategic language of his or her superiors into the operational language of subordinates in order to get results. He or she must turn the abstract guidance of, say, more earnings per share or meeting the budget into the concrete action required to achieve the results”. The type of divisional structure will separate the functions into separate divisions such as marketing, finance, research and development, operations and logistics and human resources. The divisional organizational structure is set up with these “relatively autonomous units, or divisions, governed by a central corporate office but where each operating division has its own functional specialist”.

These middle managers should instill the corporate culture in all of their subordinates. Not only the main mission of the company, which is “becoming the best global entertainment distribution service, licensing entertainment content around the world, creating markets that are accessible to filmmakers and helping content creators around the world to find a global audience”. They also need to work to meet the new goals set by the executive leadership after the price increase/rebranding debacle. Those goals are presented as “repair the PR damage from the rebranding and price increases of 2011, focus on growing its subscriber base both at home and abroad, maintain a healthy cash position to meet the growing content cost obligations, and invest in innovative user interface and streaming technologies to create a solid platform for the shift from DVD delivery to streaming”.

Marketing has been one of the strongest resources for Netflix in its company’s short history. They are leading the way in their quest to give consumers an economical substitute to traditional television. There is a saturation of competitors entering the streaming market trying to break customers away from Netflix however according to the company’s shareholder letter, Netflix executives don’t view the new entrants as competitive threats. In fact, “Netflix sees the new streaming services as just more encouragement for consumers to cut the cord on traditional pay TV”.Netflix uses very targeted marketing and “spends about $51.54 on marketing for each new domestic streaming subscriber”. All this while remaining a household name and combating losing growth on American soil. The marketing for local customers is significantly less due to their well-recognized band and only “spent $7.50 per total subscribers in the U.S. (The marketing expense figures Netflix discloses are primarily for advertising but also include payments to affiliates and consumer electronics partners)”.

From top to bottom the company needs to put a serious emphasis on marketing to repair the damage done by the 2011 incident. While they were caught completely off guard by the loss of over 800,000 subscribers in the 3rd quarter of 2011, the should use this as a learning experience to not repeat this in the future. Netflix CEO Reed Hastings wrote in a letter to shareholders that shows the seriousness of thisfaux pas “The last few months have been difficult for shareholders, employees, and most unfortunately, many members of Netflix. We’ve hurt our hard-earned reputation, and stalled our domestic growth”. The company continued by issuing a statement saying “Our primary issue is many of our long-term members felt shocked by the pricing changes, and more of them have expressed that by canceling Netflix than we expected” . Some of the waysthe marketing division has been able to begin to repair their tattered image is by going to online streaming and expanding internationally. While both of these present many challenges, the reward heavily outweighs the barriers they will need to accommodate.

Analysis of Strategic Factors

Current economic conditions have allowed Netflix to thrive due to the lack of money for other forms of entertainment in the average American household. Current political administrations have raised taxes to an all-time high and left Americans looking for cheap substitutes to normal more expensive activities. Netflix has very competitive pricing and remains one of, if not the best in the online streaming field. Currently, “Netflix has three different plans when it comes to streaming: basic, standard, and premium. Plans start at $8 and increase incrementally by $2, rendering the standard and premium plans $10 and $12, respectively”. While it is almost a forgotten aspect of their business, Digital Trends points out Netflix certainly pride themselves on their streaming plans, but that doesn’t mean the service ditched discs altogether. The company still “offers DVD and Blu-ray plans — none of which include streaming access — beginning at $5 and going up from there. The monthly cost just depends on how many discs you have check out at a time, or how many you want per month”.

Netflix has really pushed their research and development team to help expand in to the foreign markets. They have a lot of competitors in this area but they have done well as the company has “65 million subscribers worldwide streaming 100 million hours of content a day — making it the clear leader in the sector,the company continues to invest heavily in technology and research and development”. They have also introduced new original content as, “since 2013, with the launch of House of Cards, Netflix has become one of the best producers of original content with multiple hits and crowd-pleasers”. This is a key in keeping ahead of the low entrant barriers that their future competitors have to contend with.

Their executive leadership has made their position and intentions clear and have presented a path in which to maintain growth while seeking expansion. If Netflix employees and management continue to address these issues in the analysis,the company will continue to develop into a dominant entertainment brand, while gaining access to markets accessible to their current and future customers.

Recommendations of strategic initiatives

Tiered pricing is the next logical step for the Netflix brand. Consider a gym member, if that member wants to come in and just use the equipment and leave, they do not want to pay the price that the person who is using the equipment, Zumba and yoga area, and the hot sauna is using. This is the same with Netflix customers. If a customer just wants to use the DVD/Blue Ray service, they do not want to pay for the streaming or original content that they are not using. Hope King of Black-Tie babysitting explains “If one flat, advertised price doesn’t fit your budget, you won’t call,” she says. “With tiered pricing, it gives us the opportunity to explain the value of our services and validate our prices.”.

This strategy provides a lot of advantages to the company. First, it would justify the brand name change that they sought to accomplish while actually maintaining the customers whom are happy with their current content. It is also a growth strategy that can compete directly against the high and low end entrants who try to take their customers away. On top of this if they offer the full package at lower rates for a new member trial they will gain customers whom would never have sought out the originally offered prices. There would be no need to change the corporate culture or structure as these initiatives are building off of what the company already provides.

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