This case is primarly about a firm's resources and capabilities, which create a compelitive advantage. Chapter 4 is all about such topic and should be the first reference for this case analysis. Please provide your own answer to the question assigned below: Apply the VRIO framework to assess the source of Netflix's current strategic competitive advantage. How sustainable is its current business model in light of the VOD threat in 2006-7? Question 1. You're required to provide a thorough list of resources and capabilitics (R&Cs) in Netflix (at least 10) and assess each of them with the VRIO frameworks. - After analyzing R\&Cs with the VRIO framework, explain how Netflix would create its competitive advantage Question 2. Whether and how its current competitive advantage which has been created by such existing R\&Cs would be sustainable over time under the threat of VOD in 2006 or 2007. The case is also attached. You're required to answer to the two questions assigned above. Especially, your answer to Question 1 would be at least two pages required with single-spaced while Question 2 would ask you to provide at least one page of your answer. You should provide good quality and number of references at the end of the paper and citations in the text. Willy Shith better satisfy customers. The business that emerged Stephen Kaufman from Hastings' frustration was a rental company that David Spinola used the U.S. Postal Service to deliver DVDs to its subscribers. By year-end 2006 , subseribers could use Late one aftemoon in January 2007, Reed Hastings Netflix's website to choose from among over 70,000 had just concluded a meoting with his senior manage- different titles held on over 55 million DVDs. Through ment team in the King Kong board room at Netfix's its 44 distribation centers across the country, Netflix componte hendquarters in Los Gatos. California. could deliver to more than 90% of its 6.6 million Hastings, the founder and CDO of the company, which subscribers within a single business day. Netflix's pioncered online DVD rentals, was preparing to unveil fagship subseription plan offered unlimited monthly Netflix's highly anticipated entrance into the online rentals, allowing customers to hold up to three movies video market. Many industry observens believed that in their possession at any one time for a monthly fee the ability of customens to order movies through their of $17.99. For the year cnding December 31, 2006, computers for instant viewing, pamonly referred to Netfix had achieved revenues of nearly $1 billion, as video-on-demand (VOD), woulo quickly impact the generating free cash flow of 564million. (See Exhibit large user base for Netflix's core business. Histings looked ncross the third floor of the office. building and the conference rooms named for some The History of Home Video Rental of his staff's favorite films. A love of movies clearly When Netflix was focnded in 1997 , the home vidco mar. tan deep among Nethix employees, and he was confi- ket was a fragmented industry targely popelated with dont that one way or another, his team woold maintain " "mom-and-pop" retail outicts. Castomers rented movthe company's position as a leader in the home video les, primarily on VHS catsette, from a retait location market. But, as he reflected upon the years of invest. for a specified time period, asually between two days ment and discussions surrounding the new feature that and one week, and paid a fee of $3 to $4 for each movie Netllix would be offering its customer, he could not rented. The market leader was rental giant Blockbuster help bat think of the merits of the paths not chosen. Inc. Blockbuster's reccess was hased on the inaight that As the management leam filed out of the board movie sentats were largely impulse decisions. To cusroom atound him, Hastings retumed his thoughts to torsers deciding at the last minute that a given alght was the present. While he believed that the DVD rental "movio night," the ability to quiekly obtain the newmarket would remain healthy for years into the future, est release was a priocity. Statities showed that new he knew that this announcement would impact not jost releases repreiented over 70% of total rentals. the marke's perception of his company but its ability to sustain its position as a giant in the media indattry. With new resolve, Hastinge returned to his desk to review his forthooming anaotincement one more time. Company Background Netflix, an online subscription-based DVD rental service, was fins conceived by Hastings after he discovered an overdue rental copy of Apollo 13 in his closet. Affer paying the $40 late fes, Hastings, a seccessfal entreprencur who had already founded and sold a soffware business, began ta consider alternstive ways to provide a home movie service that would EXHIBIT 1 Netfix Financial Statements copies of popular and 1998, most available movies for rent in video store: h-profile movies, at a cost of about $18 per film or used the VHS cassetie format. In contrast, Netflix conD, in anticipation of high customer demand at the centrated efforts on early-technology adopters who sase date. Blockbaster's financial success depended had recently purchased DVD players. Its marketing maximizing the days that any individual movie stnicgy was to develop crosspromotional programs 5 out for rent. Stores were reluctant to stock large with the manufacturers and sellers of DVD players, nbers of lesserknown and independent films, since providing a source of content for customers. Hastings demand for these titles was inconsistent. With a elaborated on Neiflix's goals in its enrly days: "We atively narrow selection of mosily familiar movics. were targeting people who just bought DVD players. stomers could generally seleet a title with a limited At the time our goal was just to get our coupon in the nount of advice from the sales staff. In time, each box. We didn't have too much competition. The marockbaster retail outlet would begin to sell previewed ket was underserved, and stores didn't cany a wide pies of its new releases at a discount, generating selection of DVDs at the fime." cremental roturn on its imestment and clearing shelf Notlix's website included a seareh engine that ace for the next wave of new movics. allowed its curtomers to casily sort through its selecTraditionally, any movies not returned to the same tions by title, actor, directur, and genre. Uning this eation from which they were rented by the end of search engine, customers built a list of movies, called e specified rental period were subject to exiended a quebe, to be received from Netllix. Nerfix nent iewing fees, or "late fees." In 2004, these fees rep-_ movies to its suberibers based on the order of litles ssented over $600 million for Blockbaser, ob aboat on the list, with subscribers receiving a new movie 00 of revenues. In addition to the revenue benefit, from their queve upon the return of a currently outate fees served a critical asset utilization function standing film. or Blockbuster. They encouraged a timely return of Rather than replicate the model of video rentat ach rented film, allowing it to be rented by another chaias and lease retail locations, Netflix depended on austomer. In their absence, delayed returns conld kead the US. Postal Service to deliver DVDs to its aub. 0 incrensed levels of stockouts, conting Blockbester scriber. DVDs are small and light, enabling inexpenincremental rental opportunities as well as reducing sive delivery and eary receipt by acarly every potential customer atisfaction. US. customer. Hastings related bow be deternited When Netfix went public in 2002 , Blocktaster that the delivecy performance offceed by the USPS was enjoying record levels of revenue and profitabil- Was satisfictory: "I went ont, bonght a whole bunch ity amidat in period of industry expansion. According of CDs and started mailing them to myself to see how to research reports cited in Blockbeater's 2002 pob-_quickly fiey would come back and what condition lic Glings, DVD playen were present is 37% of U.S. they woald be in. I waited for two dins:-and they ail television houscholds, up from 24% the prior year. arrived in perfect condition. All the pieces started to. The incrense in the popalarity of the DVD format had fall into place after that."? helped to grow industry movie rental revenses from Netfix initially used a peicing moplel similar to that 58. 5 billion to $8.7 billion. The year 2002 also repee- offered by traditional video stores. Castomers chose sented Blocktuster's fifth consocutive year of same. their film wing the company's wetrite, were charged store ales gromh, and the Blockbasier brand achieved \$4 per movie rented plas a $2 shipping and handliog nearly 100% rocognition with active rovic renters. Charge, and were expected lo retarn films by a specitic due date or be charsed extended rental fecs. Netflix History Hasings and his team used the models of the most Neifix was founded in 1997 during the emernent days. moceesful Intemet retaiken of the time to lidentify of Intemet retailing. When online competitoes to trav. characteristics they thought might appeal to customens: ditional "hrick-and-martar" rotail silores were gaining - (1) value, (2) convenience, and (3) selection. Hastings 10 a relail location, Netfix offerel'home delivery of to target a zreat deat. Convenience and selection, in DVDs tbrough the mail. contrast, attracted the "Amazon customers," those who used online shopping as an altemative to traveling to bring in a customer, and they would make one $4 retail outlets and choosing among limited in-stock rental. There was no residval value. offerings. Netfix's carly strategy extended beyond DVD Hastings believed that moving to a prepaid subrentals. While marketing a 2000 IPO, management seription service could provide better value to Netflix's described the company as the ultimate online destins- customers and also turn their longer delivery times tion for movie enthusiasts. Along with the DVD-by. _into an advantage. The first itention of the subseripmail service, Netflix was offering its recommendation tion model allowed customers to have four movies in system to any user, whether they were a subseriber or their possession at once and receive up to four new not, ereating a Wob portal rather than simply a sub- films each month. Hunt explained the effectiveness of seriptiou service. Hastings described this carly strat- the new pricing model: "We turned the disadvantage egy: "Our 2000 prospectus was spun towards things of delivery time into having a movie at home all the that were hot... it reflected a tension in our strategy. time. The value to Netllix of having our movies in the We would offer price comparisons, theater tickets. _customers' homes at all times was our key insight." That strategic tension didn't resolve itseif until the Very soon afterwards, Netllix adjusted its pricing bubble erashed, That summer we realized we weren't system again, offering unlimited rentals for the first going to make it unless we did it on rentals.... It was time. Subscribers could now keep three movies at a a cach-induced strategic focusing." This focus was forced in part by the rapid adop- Hunt explained the reasons behind this quick adjusttion rate of DVD players among U.S, houscholds, which became the fasteat technology adoption in history. U.S. houschold penetration, at 5% in 1999 , leept to 13% by 2000,n level that attracted the atreation of other channels. DVDs started being sold at large retaitens such as Best Buy and Walmatt and began replocing VHS cussettes on the shelves of traditional video rental oullets. As this transition occurred, the cotive. nicece advantage that Netflix offered to DVD vieyment in stategy: ers suffered in comparison to the video stores. The analysis. We hat to make some beus and aot wory Wo made the obiervation that this change would company shelved its plans for an 170 and struggled dranatically simplify the program and make it easthrough a large layoff as it began to adjust its basiness ier to explain the service. It also allowed us to mar. sat if righe woald weceed, and the ones who got it model in an effort to reach profitability. Clief anoee? ket a more conpelling vulue proposition. The tena Hasings' concerms were the gencral curtomer disat- With this change in pricing, the compiny added isfaction with Netlix's value propositioe ans the high a now group of fans for whom movie rentals were a cost of tailding a DVD library to sappont the growing regular part of their daily entectainanent. Maiy, of subserber base. theie high-volume customen were turned off by the Feedbeck from eadly customers revealed a fruste- ligh cost of paying for cach movie being rented yet tion wiel Netlix elarging rental prices in thac with still chose to rent from video stores lyecause of linited coupeting retail locations while peoviding a slower alternatives. Ollers were dissatiafied with how large delivery' service. Neil Hant, the conipany's chief late fees inhibited their abtlity to view movies at the product officer, described Neffla' 's motivation for times most convenient to them. If "movic Inghi" "was alining to its popular no-late-fee subscription model not an eveat bat an ordinary form of eatertatiment, the in 1999: option to hold movies beyund a two-day rental period Fricing had been s dicension point for a long tibie. Wat important. For these trequent viewer. Netilix's Wo and wtract new caviones, and the woilder ine the inpact that curtorier dernand had or mataging the repeat seauer We were upeoding 5160 no 5200v cost of beilding their filiu Ilbrary: have their tastes and preferences accurately reflected Reed and I connecied on before I even joined Netflix in recommendations from Netflix's site than any other was the promise of a business model that promoled offerod by a competitor. Bven with the increased customer awareness of not distributed widely. If you didn't sce a movie within Jower-profile fitms that Netfix's recommendation sys. six months of when it was in the theaters, it often disIeen generated, building the company's movie library still represented a major use of cash. As a small player appeared forever." in the video rental maket, Nethix had no direct rela. satisfy the diverse demands of movie watehers, serv. tioaships with the mnjor studios. It filled its film library _ ing the same number of cusfomers as a local network through relationships with a small number of movie of Blockbester retail locations with far fewer copies of distributors, at prices that refiected minimal discounts. a given movie title. Sarandos explained the difference Up-front costs forced Netfix to choose carefully when in economics: stocking new flms and often resulted in fewer than the desired number of copies of a title being acquired. As a result, one of the major sources of customer dis. Half the equation of peckiged media is allocation satisfuction was the inability to rent new releases in a timely maneer. Netflix took steps to addreas this by getting the right anovint of product in the rieht loss hiring Ted Sarandos as chier content officer to man: fioms. This was mere of a chatlenge for prodacts that age content acquisition. Sarandos, who joined Netllix did aot enjoy brod promotion. The trade rullias of in May 2000 from Vidce City, a major U.S. vidco. a single vibeo store was so amalif thit even a single rental chain, led Netnix's traasitiou to revenue-tharing copy of a lesierkaown film has lossy economica. Agrecments with the major atudios: By aing a nativea inventory, we avoid that iasee. We were hambleapped wilh vewios nefen 1 fire We acver have ovcrilocks on ene side of town with undentocks on the other silde. Using the aubicrib. not teen nocessifu, As a pois rental tesinese that wat 100% rumcription based and 100 w lnernet tused, we me' qeacs provike a grat deal of deta. ly lookitg were ieinventing te whed ce tiree diecaibus for the line the deauad in the near future, we can iepliatodios. Howerec, if ia vey nach a ieletionstip turi. cabe near perfoct imvedory. Ovenall, we can aatiefy nes warking widi the uteflon, and thed nokked with deniad is an ares will about one thind to ene fifh of the inentary neceded by a eenit chinin. those people atl of any carce, vo f masend on tring ny iclailandipe widi nie from ny pior conipang? Wubia * year, Netlic had neptiated iliece ievone Ahaving serecincets widi nexty all fle imger ahulies. In the sumener of 2001 . Netlix operated out of a ving de ditntbution center located in Sunnyvale. Califonia. While sevenal years of operations had allowed for inprovements in this center. the majosify of the country was still not able to enjoy heatday detivery of their rented movics. These extended Rather than pay an up-fruat price of $20 per DVD, and retaiaing customers in those reations atracting the sudion would reduce their unit up front price in explainet "Poer Ofice variability was long en crosreturn for a fee based on the tilic's sotal aumber of couatry muil. ... It essentially meast one-weck deliv. rentals for a given period of tiane. Hatings dcseribed ery times. So ia the summer of 2001, we realired that thin tranibion with the company's spplien: "We regient with ovenight delivecy were beiag tisproperspent more nivony, not less, with the stadios bet got tionately suceessful. We heated the Alenery by upgradbigger customer satisfaction. It was like paying 200 . ing Sacmanento. The mambers popped quickly" more and getling two bimes the mamber of copies" Neilis's Suanyvale distrilution ceater conld aerve The benelit of the new ielationatips with the ste the San Prancisco Bay Area with overuight delivery. dios exiended beyond lowerieg the acquaition costs But while oubewnd mail from Stanyvale could reach. for hich-denand relenses. Hastiags resognired early Sacramento overnight, tefumis often thek weveral days. of the nurbber of custouiens who woe frustrated Nctlix sested Sacrancnto by arrauging with the Poital with the poor selection offered at many video stores. Service to intereept returns it a Sornuento anail-tort Whece shelf mace is focused on hit memics and acw. - ecater and thent ifuck thea to Sanievale. This wouls releaces. Cusyemers intceened in exploring a nech sthaten the turnaround dranatically. Alded Hastings. broader range of movie tilkes were lefl uneatiafied "As we adked centers in Hotoh. New York, and D.C. by theirnopione. Sansdor explaiged. "The thing that they started performing like the Bay Area" Armed with this evidence of success, Netflix mail, Netflix represented its fastest-growing first-elass quickly opened more distribation centers across the customer. Along with receiving the atandard discount conatry, and subscriber numbers continued to respond for presorting of its outbound envelopes by zip code, to the improved delivery service. The company prom- Netflix worked with the USPS to reduce the time it ised 500,000 subseribers to its investors in its 2002 took to receive a movie return. Rather than deliver prospectus and delivered 700,000 at the time of the returns to the distribution center of origin, the USPS May 2002IPO. These changes in Netfix's pricing brought the casily recognizable red Netfix envelopes and cost structure allowed the company to reach prof- to the closest Netflix distribution center. And recently, itability for the first time in the quarter ending June Netflix began using multiple "truck routes," supporting 2003. After establishing the viability of this busi- each distribution center to expedite returns. This shortness model, Netfix continued to build its subscriber ened turnaround time for new movies and improved base and upgrade the customer experience by open- the overall customer experience. ing new centers (see Exhibit 2 for Netfix's operating As the company added subseribens, content acquistatistics). The centers themselves were inexpensive sition continued to grow in importance for Netfix. investments; it cost about $60,000 to convert an Sarandos explained: existing warehouse to Netflix's needc. The company continually added centers to improve upon its nation- For a sechaology company like Nethix, we are the wide coverage and reduce delivery time to its cussrove that is most dependent on ant. What we do tomers. With the number reaching 44 by carfy 2097 , is probably 70% science, 30% ant. Our beying ataff over 90% of suberibers could he reached witais one has to have their finger on ihe petse of the market to. Welivery day. The make their decision. A high bet-office performer. vide next-day delivery to more regions of the country sise vera. The box office is an indicatos, as a praxy. allowed it to compeie more suceessfutly with retat for wwarenes, but aot for demand.... If rental video stores for new cuatomers drawit by all three demand for a title is lower than we forecaut, It is of the targeted characteristics of convenience, value, 2 a tax en the overall economict of Neifix's madel. find selection. Bwen with the beefit of pooft sharlafi it is a margin Netllix considered delivery tirne to be the key mea- eroder. If we inderforecast deinsad, the preblem it sure of customer ratikfaction and continually songlit cocienable, bat it taker time. to imptove the operations within each of ils existing As Neffix built its fitm library, it grew in impordistribution center. Much of the process of opening. tance as a distribution chanel for many smalf and retorn envelopes and filling oufgoing mailen with independent fitm sudios. Por lower-profilo and inde: DVDs was sill performed inasually. However, with pendent films that did not cajoy the advertising sup: careful hiring practices and thorough tino and motion port of major releases, generating customer awareness stadies, Nethix's erapleyee conll open and ieatuff as Wat a major priority. As Netfix became known as average of 800 DVD per hout, allowing the entire die. the best aouree for lesser-known movies, the stivlios Iributiou center network to stip aver 1.6 million DVDs began to look apos this partnerhip with increasing per day. (See Exlibis 3 for photos of the distribotion favor. Sarandos esplained. center operations.) Neiflix's relationslip with the USPS grow. While It wana't all alvat fulening deraind fr maninatrean the USPS was facine A generat dpcliae is firsticlait. vilee. We arre also proviflag the atefion thene navecta fer thels foum that ticg loere hys ing trmable EXHIBIT 2 Iotf x Subqcidies girownts. reachling, And for the lakepeadent films, Neifix can ont service. We realired, "This is stupld, ft's a falee save bo the dominant channed, represeoting between 60% inge." Wo turncd it off, enabline the customer to unsuband 75% of the carelass for aome fims, At Netfix. icribe ae the webtite. We had a 30 -day burat of chum. a lesier/known filen cas really cwoceed on its merits. bet we are convinced that it led to retarn visitors." Hove Rowama, the Den Cheadle filma about the gcooIndeal of making Netflix a difficult service to oide in Rwanda. it at excellent example. It cejoyed leave, Hastings wanted to make it a service that forsome bot-oflice iales, tat generally it was a difficult mer custosers woald return to. Customers apprecitopis and a difficul film to market, with s low viewerated the personalized aspet of Netflix's service, a Mip. At Nethis, however, it is our fourth-most rened dimension that continacd to improve. The proprietary film. The rest of the top 10 are movies yoa wosily recomanendstion system gntw more accurate in preexpect, fat there it the wonderful indepeudent file dicting a user's tasfe as the number of films fated by rebt there at number fore Mere people have sece it a subecriber increased. Ilastingt also cmphasined the at Nesfis than in the box effice. role of the cuitomer's queue as a major rolention tool: In 2006. Netfix tvolved from its de facto makkef"Oour explicit strategy is to invest in things that are ing efforts and begas acguiring the distribution riehts strafegically relevant to cuatomer anisfoction potento certsin independent fims through its Red Bavelope tial. The key inveotion behind our subseription model Butetainment subuidiany, Sarandos, who led this inj- in the queae. One average quease length is 50 movies. It tiative, explained the shift in atrateey: tarned out lo be an amazing lavention. It's our biggest Red flneloge Entevtainment is 90% obout contost switching cost." we dia this to tring meve escelient aovics io DVD. - Return. everything was alrendy in place, as if they kad Or the 100 filma ihat are featured at a feitival mech never left. Hastiags found that growing the businesa an Sundence, anly 10 will wike is to DVD. We are in the face of a higly charit rate was casier if many fost looking througk the other 90 films for toptier cee-. cuatomers cventailly returned. ient to tring bo eter contomers. By belping lo bring high-jxstential fitine to market. Bloclibuster Responds Netilix hoped to enhance its repatation as the hiphes. Haty public- staremeiats by Blockbaster Aismissed quality soniroe of indepenalcnt films, a desienalion that othe notich that ita custoiners would benefit from an At it was for inany mincription-hased ecrvises, cu6: adkessed the entine reatal narkef: "Obviounly, we. temer chuas was s critical isute for Netfix. fa an aver- pay attention to acy wiry poople are geting heme ape month is 2006,3,6% of cusloners wonht cancel coteatainaxen. Wo always look at all those things. We their subseription. In 2002 , that charn rate was even have not sees a besiness nodel that a financially viar. bighec, at 6,3%. Since cuntenen acquisitioe was a ble lons teme in thix arena. Oaline reatal rervices are imajor expense, sctating existing custonsers, and "servieg a aiche marhet."3) reelnimaing old ones whe laxd previously messheritied Three months later, clarifyiag that Alockbister did was s bey opportanity. mod intend to laameh an enline business to compele Customatr conild nenberibe onite frum Netfir as of the dreat pesed by oaliue reatal websites, with Were on the MCX. styk of it being really lant so cakcel antil the intradixtion of Illockbuster Ontine in 2004. C134 CASE 11 I Netflix The offering first appeared in the company's divelo- delivcry methods ach as high-definition pay-per-view sures in 2003, which included a tersely worded intent and streaming Internet video, as well as tho particito taunch an online subseription service during 2004. pation of some significant well-funded playen in the This service, closely matching Netlix's business media industry, suggested that a VOD service fully model, offered subseribers a far greater selection of integrating personal computen and television was not movies than was available in stores. When Blockbunter ( a question of "if" but "when." finally did enter the markecplace, it did to with what Hastings described as a "land grab" mentality, under- ONLNE VIDEO ALTERNATIVES. Netfix had been cutting Netllix's pricing in at aggressive effort to following the development of VOD since the comrecover lost market share. Blockbester alvo tried to pany's inception, and Hastings sorted the available inprove the performance of its service and distinguish forms of Intenet video into three groups. The first was itself from Netflix by integrating its online offering advertisiag-supponted video. Comparable to standard with its traditional store-based busines. By using netwokk televinion, acwrpapes, and magatines, this eroes-promotions, giving in-store rental cotpons to would include content that would be interupted by online customen, and stocking online rental requents regular advertising. Due to the gap between potential out of its store inventory, Blockbuiter attenpted to advertising revenue and content acquisition costs, this find ways to productively wilitre its exiating iesoureen channel would have difficulty supporting now-release and improve perfermance for its cantonen. While by feature-length fitus. More commen coutent was the end of 2006- Blockbusier Online had groen to expected to be user-generated video, television-style 2.2 million member, the 2006 annual report reported programaing, and older films. Online participants in that Blocktuser Online still required meaningfol itis space in eaty 2007 inclubed You'Tube and varladverising support and continued to siffer froms "sig. ous nctiverk websises that contained streaming video nificent" openting losses. In the wodr of llasings in (sach at ABC com and CBS com). 2005: "We're just thankfal Bleckbaner dida't enter The kccoed charnel nould offer digital file owneefour years ago, Biocktwster also unveiled its "he late fecs" pro- bentselks at a bookstore or a DVD fron a triditional gram, effective at all of its sores on Jamuary 1, 2005: retaiker and would focus on feature-length films. Sites Netlis, were differentiating their basines offering a timited number of devices, sinilar to the purchase. fiom Hlocktxinter's due to the abience of tate foes in Tof minic files on popelar niter nuch as Apple'siTunes. their service offering. This change is bevinew statefy Revense would mo be generated through ailvertiving Was not without a coic. le addition to the 960 million bet through the actual ale of content, at prices coapa? of marketing and inplementation conts of the peo-. natle to the retail price of DVDr. gram, Blockbater diose to foggo boet 5600 mition Tie faal channel was the paline video reatal and of teveuve by clininating late foes. While eilly signt pay TV. This channel was claracterized by limitied base movic tratal revenue erew oaly 5% primarily feature-length filma with linited adverising Video-on-Demand icppent. Revenee would be seserited through lowpriced (eronend 53) teinporay dewalinde This was the Daring. Netlis's rise, inducty obscren mointed iegencat of the giaiket in which Neclix espected to video-omdemand (v00) as the hext big thing" in 5=5 5=5 5=5 5=5 5=5