Netflix Inc. Case Study

Company Background

Netflix Inc. incorporated in 1997 and made its first public offering in 2002. Netflix is an online movie rental service which provides its 3,000,000 subscribers access to over 40,000 DVD titles. Although Netflix stocks nearly every title available on DVD, it does not stock titles containing adult content. The Netflix program allows subscribers to rent as many DVD’s as they want, and keep them for as long as they want. Three DVD’s can be out at a time, as soon as one is returned the next DVD on the subscriber generated movie list is shipped out. The DVD’s are delivered for free by the United States Postal Service from regional distribution centers located throughout the United States. Netflix can have most titles delivered to 90% of its subscribers within one business day of the shipping date.

The company provides a personalized movie recommendation service that creates customized recommendations for the subscriber. This system is based on customer rental history and the ratings the customers provide to Netflix. The ratings system is a simple 5 star system where 1 star is equal to a bad movie and 5 stars is equal to an excellent movie.

Netflix also provides decision making information to the subscriber about each movie the company provides. This information includes the length, rating, cast and crew, special features, screen formats, and plot synopses. Netflix also provides movie reviews written by Netflix editors, subscribers, and movie critics. In addition Netflix provides the average rating that other subscribers gave the title, and displays other titles that the subscriber might enjoy.

Netflix has revenue sharing agreements with more than 67 studios and distributors, and also purchases titles directly from studios, distributors, and independent producers. The major competitors for Netflix are Movie Gallery, Trans World Entertainment, Blockbuster, and Intermix Media.

Industry Trends

Since 1999 the growth of spending on DVD purchases and rentals has been incredible. According to Alexander & Associates, “Rapidly growing consumer activity and spending has built this industry into a major market phenomenon. The DVD format for enjoying pre-recorded entertainment at home is extraordinarily popular and consumers are changing their behavior to accommodate it.”

• The VHS market totaled nearly $20 billion in 1999 captured less than $6.9 billion in 2004 and will be less than half of that in 2005.

• Consumer spending on rentals of VHS tapes has fallen from nearly $12 billion in 2003 to #3.4 billion in 2004.

• The video rental stores such as Blockbuster and Hollywood Video have suffered from dramatic drops in VHS rental spending. But new companies such as Netflix have enjoyed strong growth.

• Ticket sales for movie theaters are down nearly 6% since 2002. This is due in part by some movie goers deciding to pass on the theatre and wait for the DVD. This is because the average price of a ticket is over $6 today and some markets charge up to $10. With the cost of a DVD falling toward the $15 price range, and unlimited rentals for under $20, many people are opting for the convenience and savings of skipping the theatre.

• The television industry has found that consumer spending on TV programs on DVD can reach $5 million per episode. With programming costs sky-rocketing this revenue will change program development and ownership patterns.

• Hollywood studios are the big winners in the new industry trend. Their home video business is now called home entertainment, and since 2002 has been increasing its focus on the DVD format. This may be the reasoning behind the DVD releases of blockbuster movies shortly after their theatre run.

DVD’s continue to grow more popular with existing users and in 2005 DVD’s are expected to convert more than 15,000 new households to its format every day. These new customers will bring new behaviors and preferences that will continue to restructure the home entertainment industry.

The new high definition DVD’s are scheduled to be introduced this year. The ability to see sporting events in high-def has convinced allot of people that they are ready to pay for high-def DVD’s.

Netflix Financial Ratios

Acid Test

We decided to use the acid test to calculate the short-term solvency of Netflix because it is considered a more accurate measurement. The acid test showed us that in 2003 Netflix could pay its liabilities 2.2 times over without having to rely on the sale of inventory. In 2004 Netflix could pay its liabilities 1.97 times over. We noticed that the ratio fell slightly between 2003 and