Looking strictly at the video rental industry, Netflix faces minimal internal rivalry because the industry is dominated by only a handful of firm in Europe, namely Blockbuster. Although Netflix faces little internal rivalry in its immediate industry, the company faces an intensely competitive broader market. Since home entertainment covers a broad spectrum of technologies and channels of distribution, Netflix is in direct competition with firms in a number of other industries including cable networks, who air movies on television, satellite companies’ VOD services, and websites like Hulu, which provide video content through online streaming. Furthermore, as people transition from consumption of physical DVDs to digitally distributed media, these competitors, who can be grouped as digital distributors, will become Netflix’s greatest threat. However, in the near future, Netflix’s greatest rivals will continue to be traditional “brick-and-mortar” rental stores, like Blockbuster, and will remain a minimal threat to Netflix’s business. Entry and Exit
Entry into the in-home video entertainment industry is unregulated but constrained by the costs of acquiring distribution rights from Studios. However, as delivery of video and television content becomes increasingly distributed through the internet, entry costs to launch a business similar to Netflix’s will decrease because capital costs are relatively lower than “brick and mortar” firms. Nevertheless, in an industry as competitive as video entertainment the viability of a new firm may not be very likely unless that firm can produce an innovative or superior format for media viewing. A firm that could create and popularize a new technology for in-home entertainment viewing could enter the industry and quickly gain significant market share. Exit costs in the video rental industry depend on the structure of the firm. As an online DVD rental service, Netflix has minimal investments in capital because they rent office space and distribution centers, do not own any physical stores, and could sell their inventory of DVDs in a liquidation sale relatively easily. However, a business like Blockbuster has much higher exit costs because Blockbuster has extensive investments in real-estate.
Substitutes & Complements
The threat of substitutes to Netflix’s business model is the highest of the five forces because Netflix competes with a handful of entertainment viewing formats that are relatively interchangeable including VOD, pay-per-view, online streaming etc… Many people simultaneously subscribe to a combination of these services, and since they are close substitutes and there are minimal switching costs, small fluctuations in prices can cause consumers to abandon one viewing format and quickly replace it with another. The greatest substitute threat, which Netflix has begun to address, is the replacement of the physical DVD viewing format with digital viewing formats. In the next 10 to 20 years, it is projected that media consumption will shift away entirely from the DVD to digital streaming and the company that can provide digital media at the lowest price, with the best content, and greatest ease of use may be in the position to dominate the entire market. Therefore, looking forward, Netflix must position itself above rival firms by incorporating its greatest threat and closest substitute, digital streaming, into its business model and then bridge the transition from physical to digital media consumption.
As Netflix transitions into providing streaming content to personal computers and televisions, complements to their business have become products that are compatible with Netflix video streaming. For example, Xbox 360 recently added Netflix streaming capabilities to their gaming console. As a result, a few hundred thousand of new Netflix subscribers last year were also individuals, who had just purchased Netflix compatible Xbox 360s.6 The bundling of Netflix streaming software with televisions, gaming consoles, DVD or Blu ray players etc… increases Netflix subscribers and therefore profits. To capitalize on these profitable complements to their streaming service, it is advantageous for Netflix to enter into joint ventures with companies that produce electronics.
Netflix acquires its video content through direct purchases, revenue sharing agreements, and licensing agreements. These agreements, which allow Netflix to rent DVDs and stream video content, are primarily obtained from studios, networks, and distributors. Therefore, Netflix’s suppliers, e.g. studios, networks, and distributors, control the prices that Netflix must pay for its video content. The First Sale Doctrine, a copyright law stipulating that once a copyright owner sells a copy of their work they relinquish control of the work and the purchaser may redistribute the work as they wish, provides protection for Netflix with regards to redistributing DVD titles. However, the First Sale Doctrine does not apply to streaming content. Therefore, Netflix is especially vulnerable to supplier power during streaming distribution cost negotiations. The studios and distributors who license streaming content are in full control of the terms and conditions with Netflix and may rescind the availability of the content at will. As the DVD format becomes increasingly obsolete and streaming video content grows in popularity, Netflix become more susceptible to the power of their suppliers.
Another aspect of the in-home video entertainment industry, which substantially affects the Netflix business model, is the window of time between theatrical releases and in-home video releases. Studios have complete control over dictating the length of these windows. Currently DVD format releases are given priority over VOD or internet-delivery, because studios earn substantially greater profits from DVD sales. Since studios control the length of these release windows they also control who has the advantage of being the first to provide in-home access to new releases, especially blockbusters. By entering into profit sharing agreements with their suppliers, Netflix may be able to curb supplier power by aligning their profit interests with those of their suppliers.