Arena: Market Conditions Before Netflix
Households renting films to watch at home · 1998 · United States
Limited local selectionEnabling technology shift
In 1998 an American household that wanted to watch a film at home rented it from a video store such as Blockbuster or Movie Gallery, one title at a time, with a due date and a late fee if it came back late NF38 NF13. Late fees were the complaint renters felt most; Blockbuster's own chief executive later called them the number one cause of customer dissatisfaction NBX-1, and in 2000 they brought the chain about $800 million NBX-2. A store had shelf space for fewer than 3,000 DVD titles, so what a renter could find depended on what the local store chose to stock NF38. Households were adopting the new DVD format quickly NF13.
How each step happened
Step 1 of 5 · 1999–2007
Rental by mail from a website, with no late fees
Netflix's innovation was a rental store with no shelves and no due dates. Members chose DVDs on a website, kept them with no late fees, and a queue mailed the next disc when one came back NF13 NF25. From September 1999 they paid a monthly fee, and from February 2000 that fee was $19.95 for unlimited rentals NF38. It removed the fee Blockbuster lived on: Marc Randolph, co-founder and first chief executive, recalls that Blockbuster collected $800 million in late fees in 2000 NBX-2.
Netflix had opened in April 1998 selling and renting DVDs one at a time; expecting Amazon to sell DVDs as a commodity, the founders dropped sales, nearly all their revenue NF38 NF25. The fee turned each rental into a continuing relationship. Revenue-sharing deals with more than 50 studios supplied copies cheaply, and about 90 percent of free-trial members went on to pay NF38. Subscribers grew from 857,000 at the end of 2002 to 6.3 million at the end of 2006 NF13.
Why Blockbuster could not follow
Copying Netflix meant giving up that income. Dropping late fees in January 2005 cost Blockbuster about $400 million of revenue NBX-1. Its Total Access program of late 2006, online rental with store returns at aggressive prices, hurt Netflix NF23 NBX-2, but it also drove Blockbuster to a $46.4 million loss in the first quarter of 2007 NBX-4. John Antioco, its chief executive, says the board was unmoved by data showing that franchisees without late fees did better NBX-3. His successor, Jim Keyes, stepped back from online subscribers in late 2007, and late fees returned in 2010 NBX-5 NBX-2.
Rivals Blockbuster Online reached 2 million subscribers by the end of 2006, against Netflix's 6 million NBX-2. Randolph recalls that Blockbuster executives laughed when Hastings proposed selling them Netflix for $50 million NF25.
Subscription PricingCounter-positioningTransparent PricingFree Trial
Step 2 of 5 · 2000–06
Ratings-based recommendations spread demand across the library
Alongside the subscription, Netflix built the tool that made a large library worth paying for. Members rated titles, and an in-house recommendation service compared each member's ratings with everyone else's to predict what that member would enjoy NF13 NF38. In the fourth quarter of 2002 members chose 97 percent of more than 14,500 titles; a video store stocked fewer than 3,000 NF38. By the end of 2006 Netflix held about 1.7 billion ratings and said the service let it create demand for its entire library NF13. Netflix could carry a deep catalog because it could find a viewer for each title.
The approach carried into streaming, where Netflix could see what each member watched, not only star ratings NF30. By 2012 about 75 percent of viewing started from a recommendation NF29. Neil Hunt, chief product officer, and Carlos Gomez-Uribe valued it at more than $1 billion a year in members kept NF30.
Rivals Blockbuster's stores still carried about 10,000 films each in 2010 NBX-8, and a video store merchandised the new releases on its shelves NF38.
Personalization
Step 3 of 5 · 2007–11
Unlimited streaming inside the subscription creates new viewing
Netflix's second new offer was streaming, free inside the subscription. In January 2007 members got about 1,000 films on their PCs at no extra charge; Jay Hoag, a director, says missing streaming could have been fatal NF24 NF35. The discs carried the plan while streaming was small; in the fourth quarter of 2009 more than 48 percent of over 12 million subscribers streamed NF22. A new streaming service would have had to win each of those households on its own.
Netflix reached the television through other companies' hardware. In December 2007 Reed Hastings stopped a Netflix-built player weeks from launch, because it would compete with Sony, LG and Samsung, whose devices Netflix needed to carry the service NF31. The team became Roku, whose player brought the service to the television in May 2008 with, in Hastings's words, "no extra charges and no viewing restrictions" NF14. By late 2010 more than 200 devices, from game consoles to internet TVs, streamed Netflix, so households watched on hardware they already owned, and Netflix sold streaming alone for $7.99 a month NF22 NF15 NF37. A 2011 plan to split off the DVD service as Qwikster was dropped after members objected NF16.
Streaming created viewing that disc rental never had. By early 2011 members streamed TV shows in nearly the same volume as films, and Netflix called itself a supplement to pay television NBX-10. It was the largest source of peak US internet traffic, at 29.7 percent NBX-12, and in the fourth quarter of 2011 about 20 million members streamed more than 2 billion hours NBX-11.
Rivals Blockbuster bought Movielink, which sold and rented downloads of about 3,300 titles one at a time, in August 2007 NBX-6. In November 2008 it launched MediaPoint, its own $99 box with rentals at $1.99 to $3.99 each and no subscription NBX-7.
Blue Ocean StrategyMulti-ProductOEM LicensingDrop-In Adoption
Step 4 of 5 · 2008–13
Fixed-fee and exclusive programming bought for the whole base
From 2008, while streaming was still spreading to televisions, Netflix bought programming for it the way it sold the service: for a flat price. Streaming rights were separate from DVD rights and were generally licensed for a fixed fee NF22. In October 2008 Starz Play brought about 1,000 films a year to members at no extra cost NF21, under a deal reported at about $30 million a year NF19. A flat fee cost the same however many members watched.
Exclusive programs came next. Like a television network, Netflix wanted programs viewers could get only there, and in 2011 signed exclusive licenses with DreamWorks Animation and Relativity NF18. HBO would not sell it streaming rights, so in March 2011 Ted Sarandos, head of content, committed to two seasons of House of Cards without a pilot NF26. Hastings found the $100 million commitment close to reckless, but Sarandos wanted a content network, not an Amazon-like retailer NF27. Starz ended renewal talks that September to protect its own pay-television pricing, despite a reported offer of ten times the old fee NF20 NF19. House of Cards arrived with all 13 episodes in every Netflix market on February 1, 2013 NF11 NF40, and Netflix credited it with a halo effect on the whole service NF39.
Rivals Blockbuster never built a subscription streaming catalog; it kept its store-based model and filed for Chapter 11 in September 2010 with nearly $1 billion of debt NBX-8. The bidders Netflix actually faced were HBO and Starz, which kept their programs for pay television NF26 NF20.
Exclusive contractual accessHow to win
Step 5 of 5 · 2011–16
Scale economies
Steps 3 and 4 together gave Netflix its cost advantage: fixed programming costs over the largest streaming base. In Hamilton Helmer's account of scale economies, content paid per play is a variable cost, content licensed outright or commissioned is fixed, so cost per member falls as members rise and a smaller rival must pay more per member for a comparable catalog NF34. By the third quarter of 2011 Netflix spread them over 21.4 million US streaming subscriptions NF18.
Netflix widened the base one market at a time, tied to profit: Canada in 2010, 43 Latin American countries in 2011, the United Kingdom and Ireland in 2012, then the Nordics, expecting international losses to shrink as member growth outpaced content spending NF37 NF18 NF40. From 2012 it replaced Akamai, Limelight and Level 3 with Open Connect, its own delivery network, because at its size one made economic sense NF32 NF33. In January 2016 it launched in 130 more countries at once, reaching more than 70 million members NF5. The 2022 ad tier and 2023 household-sharing rules later added revenue to the same fixed catalog NF9 NF10.
Rivals Blockbuster left before this advantage formed: its 2010 rental share was 19.9 percent against Netflix's 34.8 percent, and in April 2011 Dish Network bought it, with about 1,700 stores, for $320 million NBX-9. Netflix then expected Dish to launch subscription streaming under the Blockbuster brand NBX-10, and a smaller service would have paid more per member for a comparable catalog NF34.
Scale economiesVertical Integration Strategy