Scott KnudsenChristina KellmanGrant JonesMedia Economics & TechnologyIMC 461 | 8.11.13

The Business Of The Media SWOT Analysis: Netflix

Section 1: Convergence

Convergence’s ImpactConvergence has had a profound impact on strategic business decisions made by media companies for the last 20 years. According to Eric Pfanner from The New York Times, one of the biggest media mergers in history–between AOL and Time Warner–was fueled by the concept of convergence. He further states the motivation was the same in the merger between NBCand Comcast.1 Convergence and the joining together of devices, most with a screen that can transmit video, has ledto content and advertising being served in a streamlined manner and forced traditional media companies to invest in digital content. Netflix is no exception. But multi-million dollar mergers aside, how do media companies like Netflix adjust to new methods of media delivery and profitable returns in this new world of convergence? Netflix has been trying to answer that question, sometimes successfully, other times, unsuccessfully, for the last 15 years. For older, more traditional media companies, this change of course is not easy. Company infrastructures, business plans and resistance to embrace a digital business has caused several media companies to falter or fail. Netflix was fortunate enough to enter the media market just as the firstglobal truth of convergence was beginning to make an impact.

Netflix’s Vision of Converging Media When Reed Hastings started Netflix in 1997, his vision was aworld of digital streaming. “He predicted his company's transition to Internet streaming 10 years ago, hence the name Netflix,” says Mashable’s Chris Taylor. 2 However, in

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its early years, streaming technology and Internet speeds were not able to deliver a sufficient online streaming experience and DVDs were the medium most used to watch videomovies or television at home. Deals like the one Netflix made with Walmart in 2005 wherein all online DVD rentals on walmart.com were replaced with a Netflix link, helped the DVD-by-mail service to be very profitable. Had Netflix stuckonly with DVD-by-mail, converging media would have negatively impacted the DVD-by-mail offering. However, Netflix saw the decline of DVDs and understood the investment they needed to make, a bigger bet in digital streaming and further embracing the idea of media convergence.

Online streaming was first introduced by Netflix in July of 20073 and initially there were questions about whether or not it was a smart investment. “Netflix is entering a more crowded market that includes not only the likes of Apple and Amazon, but also MovieLink, CinemaNow and video-on-demand services offered by cable companies.”4 But as of June 2013, Netflix accounted for a 90% share on the streaming market.5 However, Netflix’s six-year climb to the top of the online streaming market and a $250 stock price took a bit of a detour.

For And Against Convergence In July of 2011, Netflix CEO Reed Hastings announced (rashlyand to much public ire) that the company he founded would beseparating its streaming and DVD-by-mail service into two companies, two websites and two businesses. Prior to this announcement, subscribers were able to access DVD-by-mail and streaming through the same website and through one of the subscriber options. But now, the streaming service wouldstay as Netflix (as Hastings had always hoped and envisioned) and the DVD-by-mail service would now be called Qwikster. The separating of businesses and digital platformswas frustrating to consumers amidst a world of converging media. Collapsing the Netflix brand into the streaming arm indicated Hastings’s commitment to online streaming. However

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the backlash proved that this plan went against the wants and needs of its consumer base. People didn’t want to managetwo queues, with two credit card statements, and two websites to manage video content. The number of Netflix customers who described themselves as "loyal" to the brand declined 28%—from 76% to 55%.6 Convergence had taught peoplehow convenient consuming content could be with digital technology and the Internet.

Stock prices took a major downturn. In early 2010, Netflix stock began a steady climb from approximately $50 a share toover $300 per share by July 13, 2011—that's the day Netflix announced the change to two sites. And by October of 2011, it was down to $87 per share.7 A massive collapse that also lost Netflix 800,000 subscribers. Why did consumers and WallStreet react so negatively? Setting aside the fact that Netflix’s announcement was poorly executed from a PR standpoint and that they were raising prices while also making things less convenient for their subscribers, why wasthis so poorly received? The number one reason was converging media.

Consuming Content Made EasierHasting’s strategic move to invest in Internet streaming wasthe basis for Netflix’s transition to convergence. Internet distribution of content now allowed people to consume any video on any device with a screen. However, the decision to split Netflix into two companies went very much against the technology-driven trend of convergence. “We used to operate in a world where the media were separate and distinct. We built an entire industry, along with business models and marketing practices, that treated each medium as its own entity. Now the media are coming together.”8 In 2011, when the announcement of the separation between Netflix and Qwikster was made, consumers were experiencing a major acceleration of convergence. Technology was putting smartphones in consumer hands and all forms media was being delivered through these devices. Screens were everywhere andpeople were watching video, reading articles, and looking at

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photos while on the bus, waiting in line at the grocery store and anytime a free moment would arise. It used to be that articles were read in newspapers or magazines, television was watched on a television, and radio was listened to on your radio. However with the rise of convergence, any one of those things could happen on your computer, game console, television, smartphone or tablet. Access to all types media was becoming ubiquitous across alldevices and consumers were growing to expect a certain level convenience and access to content. Netflix and Hastings viewed this as an opportunity to invest further in the idea of online streaming video, which grew by 45% in 2011.9

Between March of 2010 and March of 2011, smartphone sales increased by 79%.10 Most things consumers needed were suddenly in their pocket. With Netflix’s investment in digital distribution, subscribers would be able to watch Netflix streaming on any of these devices and this would ideally lead to more content being consumed and more subscribers. What Hastings didn’t understand was that by separating its offerings into two websites and two businesses, Netflix was resisting the idea of convergence while simultaneously trying to embrace it. Netflix thought this would be a major investment in streaming video, but it was really fighting against another form of digital convergence. This decision was the start of their convergence roller coaster ride that has taken its stock price and subscriber numbers on a wild ride. After the stockprice dipped to $70 per share (down from $300) and more than800,000 cancelations, Netflix renounced Qwikster and broughtback the idea of one website with DVD-in-mail and online streaming. The stock price has rebounded considerably, and as of August 8, 2013 it was trading at just over $250 per share. In April 2013, the company was basking in the criticalglow of its original series, House of Cards, and this month narrowly surpassed HBO in total domestic subscribers.11

Streaming Emmys

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“HBO did it; AMC did it; FX did it. Eventually Netflix will own and control its own content. It’s a natural evolution,” Stated Richard Greenfield, an influential media analyst at BTIG.12 House of Cards, Netflix’s venture into original programming, starring Kevin Spacey and directed by David Fincher, made its debut to critical acclaim in February 2013. In addition to critics liking it, 86% of existing subscribers claimed the show would make them more loyal customers of Netflix.13 Netflix’s investment in original programming (the budget for “HOC” was $100 million dollars) proves that Netflixis trying to differentiate itself from other streaming and online video competitors. Some of this competition already existed (HBO Go, Hulu Plus, and Amazon Prime) and some competition would inevitably be coming (Networks, Cable Companies). However, the 14 Emmy nominations that Netflix received in July of 2013 was a sign that even critics were embracing the concept of convergence. And according to Netflix’s Chief Content Officer Ted Sarandos, television in the traditional sense of the word is gone forever. "I think it blurs the line forever about what television is. Television is what’s on the screen, no matter what size the screen or how the content got to the screen. Television is television is television.”14 Emmy’s are the most prestigiousaward “television” can receive and for them to recognize Netflix’s original programming as television makes a statement about the future of digital content creation. The future is a world where content is content, no matter where it lives.

The 14 Emmy nominations for Netflix proved television and the Internet could compete for the same awards. Could this mean that an original film done by Netflix could also be nominated for an Oscar? Saradonos further commended the Emmy’s and stated they “were forward-looking enough to recognize that there was something new happening. This is a big change—the idea that the Internet is going to deliver content that competes on the same playing field as premium television, network, and broadcast, who have been doing thisfor years."15

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Embracing ConvergenceThe digital streaming service that Netflix offers can be consumed on a smartphone, tablet, game console, computer or Internet ready television. The Netflix app comes already loaded and integrated into Apple TV, Xbox 360, Playstation 3, Roku, Boxee, Google TV and several other digital devices,giving consumers an immediate and easy access point to consume content. New integrations into systems like the Wii U show that Netflix is striving to further evolve its forms of content delivery. The Wii U has a controller that also features a small screen that is used to play the console. Netflix content can be streamed on the TV that the console is plugged into or streamed into the controller itself. As console and device technology evolves, these kinds of integrations will keep Netflix relevant and differentiated from the competition.

Netflix’s distribution is currently somewhat siloed within two offerings: streaming and DVD-by-mail. While streaming isavailable across most digital devices, there are other formsof distribution Netflix could be taking advantage of. Netflix’s recent partnership with DreamWorks studios seems to be an indication of further expansion of new forms of distribution. The terms of the deal provide Netflix with 300hours of online streaming content from existing DreamWorks properties, including the characters from the July film, Turbo. Netflix also inked a deal with AMC to assist in financing the show recently taken off the air, The Killing. In the deal, Netflix pays for a portion of production costs andin return, American viewers are able to see episodes of The Killing three months after it airs. For Netflix subscribers inIreland and the U.K. (where the show is very popular) they will be able to watch it the day after it airs on cable TV.16 And while these particular deals still keep the distribution channels within the walls of Netflix, it could be a sign of future investments Netflix would make in the major motion picture market. It also furthers Netflix as a production company and content creator, not just a platform for aggregating existing content. As Netflix’s original

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programming continues to grow, opportunities for other formsof distribution will almost certainly arise. It will be a question of whether or not Netflix wants to make money in things other than subscriber fees and take on Hollywood studios or major TV Networks. As convergence continues to make TV, film, and online streaming all one in the same, there is no question that Netflix will have the opportunity to do so.

The Future of Convergence As Netflix looks at the future of media and the further converging of mediums, it is positioned very well to succeed. “Netflix has the same dual competitive advantages that characterize all of the great media franchises, which are scale and customer captivity,” said Jonathan A. Knee, senior managing director at Evercore Partners and director of the media program at Columbia Business School.17 However, as convergence continues to evolve and affect advertising dollarsand how media companies operate (the rumored investment of Time Warner Cable in Hulu would be one indication of a much more competitive streaming market) Netflix will need to continue to differentiate itself as a brand. HBO is successfulbecause for years it has been creating quality content. Netflix needs to sustain a similar level of quality programming and continue to invest in it. Otherwise, Netflix risks losing market share to other media companies that are just now embracing the world of convergence.

Arizona Senator John McCain wants consumers to watch TV a-la-carte. The Television Consumer Freedom Act would present incentives to both cable operators and television networks to let consumers choose the channels in their subscription plan.18 In the current model of cable networks, consumers pay for all TV channels whether they want to or not. For example, even if you don’t want ESPN on your TV, you pay $5 per month for it. The bill, which has not yet been passed, will likely be met with some resistance among TV executives and high power players from the cable companies, due to their currently very successful operations. Despite public spats between these entities when they negotiate carriage

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fees, the two sides have created a highly lucrative relationship based on the idea of selling consumers more content than they need.19 The passing of this bill could mean more competition for Netflix as digital versions of these cherry picked stations will almost definitely be one of the delivery methods. However, it could also turn Netflixinto a version of what the cable companies currently are. Networks that might not be able to sustain their business ina world of cherry picking networks could possibly license their brand to Netflix, making Netflix the only place to consume a specific network’s content and further differentiating the Netflix brand from the competition.

Section 2: Symbiosis

As new media comes along we make room for it and create new relationships with existing media. By definition, symbiosis presents an opportunity to deepen a relationship with a brand or an organization and also explore how combinations of media support and strengthen each other. Netflix’s DVD-by-mail and Internet streaming services enhance the quality of the experience but do not incorporate transmedia story telling. The Netflix brand does not have a presence in otherforms of media such as network television, books or games, and until recently Netflix was simply a distributor with superior user experience. In order to align with Global Truth #2, Symbiosis, Netflix must embrace the idea that media does not work in isolation; rather they work in relationship to and with other media.20

Does content draw audiences in and across platforms?Netflix’s original brand proposition was on superior user experience and accessibility. As a distributor, Netflix didn’t draw customers from the big screen to their televisions through a process of symbiosis, they simply redistributed the existing work of others on a new platform.Netflix’s entrance into streaming services did not draw customers across platforms but rather offered the same

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content to customers in a new channel, while still maintaining their brand proposition—a superior user experience. Offering the same content from one media channelto the next doesn’t deepen the audience’s experience but rather permits the audience to make choices based on convenience. The audience, in turn, developed a relationshipwith the service and not the content.

Customers can access Netflix on whatever device, wherever they want, whenever they want and as frequently as they want. This, however, does not produce symbiosis, as the content is the same on whatever device, wherever, whenever and no matter how often it’s viewed. Netflix failed to capitalize on using multiple platforms to their advantage indeepening their relationship with their audience. As discussed by Forbes.com in 2011, “Netflix established its relevance as the anti-Blockbuster—devising an interesting way (low cost, no late charges, easy accessibility) to deliver DVDs, no muss, no fuss.” Netflix’s competitive advantage was the ease of access it offered to its consumers.

While the addition of streaming did not result in the immediate erosion of the DVD-by-mail product (underscoring the idea of symbiosis), Netflix underestimated the relationship between the two channels and acted too quickly with their erosion prediction. They jumped the proverbial gun and created a hybrid model with the two service lines that caused Netflix to lose nearly 50% of its value.21 Over800,000 customers terminated their services with Netflix in a short period of time.22 Hastings admitted in a candid apology, "In hindsight, I slid into arrogance based upon past success," he explained that his greatest fear was that Netflix "wouldn't make the leap from success in DVDs to success in streaming." Hastings’ premature, aggressive move into the streaming space cost the company. Confused and frustrated consumers didn't respond kindly to the changes.23

Hastings didn’t understand that the audience wasn’t ready tochoose one service or another.

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In the traditional sense, Netflix as a company does not currently align with the Global Truth of symbiosis. Perhaps the only connection that draws customers from one media channel to another is a superior viewing and user experienceand as a distributor this may be their current strategy to create a symbiotic relationship for their brand amongst the two media outlets.

Netflix is moving from the ugly duckling it used to be back in the Qwikster days toward the kind of HBO swan it seems towant to be lately, by offering original series like House of Cards, Orange is the New Black, and the new Arrested Development that proved popular with users. In a quest to evolve into more than just a distributor of other people’s content, Netflix’shas developed a content mix that includes documentaries, original series, comedy specials, a partnership with DreamWorks for unique content based on well-loved charactersand more. On July 23rd, CEO Reed Hastings wrote, “Netflix has become a big destination for fans of these much loved and often under-distributed genres.” 24

Content made for its streaming product sets the stage for “Netflix The Storyteller,” but in its present state it stillfalls short of the definition of symbiosis or transmedia storytelling. The new partnership with DreamWorks will beginto allow for expanded storytelling via Netflix’s streaming service, as content developed for Netflix will reference existing DreamWorks characters and storylines, but will be customized for the Netflix platform. As part of the deal, DreamWorks will develop shows with some classic TV characters from DreamWorks Classic Media library, which includes titles like "Rocky & Bullwinkle," "Lassie" and "Rudolph, the Red-Nosed Reindeer."25

Does the media company practice transmedia storytelling to deepen audience engagement? Netflix has cross-platform distribution, but it doesn’t utilize the platforms in unique ways that build a symbiotic

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experience. As discussed, the engagement consumers experienced with Netflix as a brand largely lies in convenience and access. A transmedia story includes contributions from an involved collection of media types andplatforms. The relationship between the various media channels enhances the customer experience.

The recent release of Arrested Development does not qualify as a transmedia experience by the traditional definition. The show has only used TV as the platform and hasn’t expanded toother mediums. However, the new content created for the showreferences some of what transmedia entails:

Connection to Pop-Culture: The fourth season increases the amount of references to real life situations and people(such as the 2007 writers strike).26

Plot Structure: Each episode focuses on a separate character from the series. While still using the same medium to tell each character's story, the plot is structured much as a transmedia story is. Transmedia tells a narrative by telling the story across multiple platforms, each designed to give you a different aspectof the story for a well-rounded narrative experience.27

Audience: Arrested Development is targeting a new audience with its fourth season. This new season is not even being shown on "normal" television channels but was released, in full, on Netflix. This brings in a different audience from those that watch traditional television, one that is based in interactivity. This interactive quality is another aspect that is common intransmedia. However, this is only a slight similarity to transmedia and one that Arrested Development could enhance further.28

Never-ending Story: Focus on world-building in addition tostorytelling. In transmedia storytelling there can always be more, and you can learn more about a character or situation by exposing yourself to the other platforms.29

As the number of subscriptions reaches record numbers (29.8Min US30), audience engagement has made way for new

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consumption behaviors. The nature of asynchronous viewing and the fact that entire seasons are available all at once has resulted in a consumer behavior some have described as “binge viewing,” which actually has the potential to decrease brand-customer engagement over time. With respect to audience engagement, binging breaks habits that have longsupported the TV business, built on advertising and syndicated reruns. TV executives are torn by the development: gratified that people are gorging on their product, frustrated because it's a TV party that all-important advertisers aren't invited to. Writers and producers are just starting to confront the challenges of creating TV for an audience that may digest an entire seasonin one sitting.31 Director David Fincher stated during an interview that, “A stake has been driven through its heart, its head has been cut off, and its mouth has been stuffed with garlic. The captive audience is gone. If you give people this opportunity to mainline all in one day, there's reason to believe they will do it."32

Netflix has changed audience engagement, and behaviors such as “binging” actually decrease opportunities for social interactions surrounding the brand and it’s content. Netflix’s DVD-by-mail and streaming products allow users to interact with the content at their leisure and therefore theopportunity to deepen audience engagement with water-cooler discussions has actually diminished.

Do the platforms clearly support and reinforce the other?Netflix provides a superior user experience on its mobile application and its in-home streaming products work with themobile versions to create the best user experience. To that end, Netflix’s platforms support and reinforce one another in terms of technical integration, but not necessarily on the basis of a symbiotic content experience. But that may bebeginning to change. Netflix and DreamWorks recently signed a deal to develop an original animated series called Turbo F.A.S.T. based on the feature film Turbo, which will premiere next month.33 The animated series will build upon the

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characters and storyline of the feature film, but will have content that is unique to the Netflix platform. Turbo F.A.S.T the television show will offer consumers additional background and information on the characters introduced in the feature film and will work in a symbiotic relationship to perpetuate the character experience. With developments like the Turbo deal, Netflix may finally begin to express the second global truth of symbiosis.

In addition, a technology announced in June called “Max” will offer users the ability to select content based on their mood and customer ratings and will operate in much thesame way as Apple’s Siri solution. The level of engagement with Netflix will be enhanced and user experience will be optimized. “One of the experiences Max offers is called the "ratings game," where you pick a genre to fit your mood and then rate a few titles on the familiar Netflix five star scale.” For the time being, this solution is only offered toPlayStation 3 users and will be rolled out to the iPad next.34 The advancement increases the support offered by itsvideo console experience and should reinforce the connectionusers have to the brand.Does the company do a good job of directing audiences to content across its various platforms? Restricting a story to a single medium or platform limits the audience. In addition, placing duplicate content in eachplatform does not direct an audience from one platform to another. As discussed previously, Netflix customers choose the platform based on their needs and consumption patterns, not on the content. To that end it’s nearly impossible for Netflix to draw customers from one medium to another predicated on increased engagement with a story, or content.

“Fans are the most active segment of the media audience, onethat refuses to simply accept what they are given, but rather insists on the right to become full participants. Theweb provides a powerful new distribution channel for amateurcultural production.”35 Without the ability to continue the relationship with content (transmedia storytelling)

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audiences are left wanting more but have no where to go. The silos that Netflix has created for its audience is problematic from a more traditional standpoint yet they remain strong in their conviction that it’s not the platformthat draws users but the proliferation of screens and Netflix’s interface. The brand’s Investor Relations page states that over the coming decades and across the world, Internet TV will replace linear TV. Apps will replace channels, remote controls will disappear, and screens will proliferate. As Internet TV grows from millions to billion, Netflix is leading the way.36

What is the monetary relationship among various platforms?Netflix earns revenue on a subscription basis only, and doesnot have the “additive” relationship between platforms basedon increased advertising opportunities. The only relationship (currently) may be a tiered pricing scheme between streaming only and combined services (including DVD-by-mail). Their user experience is device agnostic, as is the content distributed on their various platforms. The content that Netflix purchases the rights to and/or creates is the same from one platform to the next and so no monetaryrelationship can exist between the two outside of the subscription model.

Because Netflix is committed to retaining their subscriptionbased model, they have an opportunity to create additional “tiers” with their subscription pricing that would allow subscribers to access different levels of content that are symbiotic across platforms. While they do not currently express plans to change their pricing model, Netflix does have a considerable opportunity to strengthen the monetary relationships between their various platforms.

Section 3: Circuits

The Walled Off Garden

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Because Netflix is a paid service, access to their content is walled off from those that aren’t subscribers and it is not free to move across platforms. Content aggregators like YouTube and Hulu allow videos to travel freely and encouragethe embedding of video players. However, with Netflix, the video player cannot be embedded and users must watch video within the confines of a Netflix application or the website.The advantage to allowing people to embed video players anywhere is that the audience acts as an accelerant. People are encouraged to share the video with friends and embed it elsewhere. It’s the equivalent of saying, don’t just eat that delicious hamburger here in the restaurant, take it out into the world and share it with everyone. The video content is set free to roam all over the digital landscape, often carrying with it a pre-roll that allows advertisers to still benefit from its sharing and businesses to benefit from the impression. In contrast, MTV doesn’t allow its video player to travel outside its walls (despite being free) and instead wants allof its traffic driven back to their vertical properties. Thereason is increased traffic and exposure to other content from Viacom. I might watch the Real World online but while watching, I also see there is a show about Teen Moms that I’minterested in. In keeping with the restaurant analogy, Viacom doesn’t want you to eat outside the restaurant because it reduces the chance you’ll order something else off the menu. However, keeping consumers contained also limits the affect the audience can have on sharing your content. Consumers are the most powerful generator of reach and in turn, frequency and revenue. The reason Netflix limits content to move freely across platforms is different than Viacom’s. However both are negatively affected because users are not able to act as accelerates.

If you are a paying subscriber, users can travel seamlessly from one device to another to watch content. Netflix’s user interface supports consumers jumping from platform to platform, without losing their spot. A form of cloud computing, the ease of changing devices, without skipping a beat in content consumption, serves almost as a circuit for

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one subscriber. Although this kind of circuit isn’t scalablenor does it increase the subscriber numbers.

Early Circuit ActivityNetflix was one of the first creators that encouraged socialsharing of content in the digital space. However, this was done across its own platform without social media giants MySpace, Facebook or Twitter. When Netflix first started in 1997, and still today, users organized their movie and TV Show watch list in a queue. The DVD-by-mail queue could be seen by other subscribers on Netflix and recommendations on what to watch could be sent via email to friends. Keeping the recommendations within the Netflix platform was limiting. It wasn’t really a way to appeal to new subscribers, but a way to increase frequency of existing subscribers. Unfortunately, within Netflix’s business model,this doesn’t lead to increased revenue. However it was an early iteration on what could become Netflix’s integration into circuits.

Encouraging Social Until recently, the Netflix audience wasn’t given the chanceto act as accelerants for Netflix’s content. Instead, they were only recipients. But in March of 2013, Netflix added the Facebook Open Graph sharing system to its site. This would give users the chance to share movie and TV recommendations with friends in a public forum that would beseen by non-Netflix subscribers. Sharing of this nature would mean that consumers are now acting as accelerates to Netflix’s core business: turning non-subscribers into subscribers. Users have the option to share their watching history or recommendations within the Netflix walled off garden or post it to their Facebook Timeline37. Even though users must click through to watch videos and the video player is still not able to be embedded, this could be the sign of an opportunity for Netflix to allow the sharing of video players outside the walled off garden. If the Netflix player could be shared and watched anywhere, it could createan opportunity for significantly growing its subscriber base

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and gaining more frequency in viewing. A major reason the social circuits were limited for Netflix was an antiquated law that restricted sharing of movie rental without the expressed written consent or a police warrant (further proving how much Netflix has changed the movie rental market.) International users have had social sharing optionsfor Netflix for several years.

Although the Facebook integration is a step in the social direction, Netflix in the United States is behind other content creators in the social sharing space. When compared with their competition, they are still not giving their audience much of a chance to interact with, create, comment,or share their content. And one big reason for this is The Video Privacy Protection Act. This decades old law restricted what video rental behaviors rental companies could publicly share. In early 2013, this act was overturnedby The Senate and signed into law by President Obama. However, despite the reversal of this law, Netflix still hasnot done much to implement social sharing on its platform. On the homepage of the website, social tools are nowhere to be found unless you are logged into the Facebook Open Graph sharing, which must be connected when signing into Netflix. The option to connect through Facebook does not appear againafter users sign in using email. In addition to the homepage, unless users are signed into Netflix through Facebook, there are no share tools on the video player pageseither. Hulu, on the other hand, has sharing options for Facebook, Twitter, comments, and email. Despite Netflix being available only to subscribers and Hulu available to anyone online, this should not preclude Netflix from implementing the same level of sharing and community optionsas Hulu.

Netflix announced in April of 2013 that it will be using social media as the primary way to deliver major company news. And in fact, Netflix shared its Q2 2013 financial results and business outlook through Facebook and Twitter.38 Ironically and perhaps appropriately, this decision came

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from a 2012 mistake from CEO Reed Hastings. Hastings announced that monthly viewing exceeded 1 billion hours in the month of June for the first time ever. Because this milestone lifted Netflix stock, the SEC said it would press charges.39 No charges were pressed and the SEC eventually changed their stance on social sharing of company news. Thiskind of trailblazing in social proves that Netflix is committed to social media. And it also proves to its audience that it wants them to know what they are doing. In turn, their audience will become circuits of sharing Netflixcorporate news.

Television Goes SocialSecond screens have infiltrated the family room. According to a 2012 study, one out of every three Americans over the age of 18 own a tablet.40 And out of those tablet owners, 86% say that they watch TV while actively using their tablet. This means as people watch TV, they are also readingabout what they are watching and sharing it with friends. This kind of activity makes accelerants out of consumers. Because social media is built on the idea of real time sharing, especially with television, Netflix misses an opportunity to utilize consumers as accelerants. Think aboutwhen the series finale of Sopranos aired. The moment when theshow cut to black was infamous and immediately discussed andargued across social media and the Internet. That kind of orchestrated viewing event, that generates buzz coming from the second screen, doesn’t currently exist on Netflix. When House of Cards came out, it was all released at once. Some people watched all 13 episodes within the first week, othersmight have watched one per day for 13 days. This makes it more difficult for the conversations to be shared. This limits acceleration of content and the ability for consumersto act as circuits for the content. Netflix should see this as an opportunity for experimenting with live programs or different rollout strategies. Doing so could give them more social buzz and audience acceleration than they are currently seeing.

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Section 4: Transmedia Brands

USC Annenberg professor Henry Jenkins describes transmedia branding as a “communication process in which information about a brand is packaged into an integrated narrative, which is dispersed in unique contributions across multiple media channels for the purpose of creating an interactive and engaging brand experience.”41 To become a transmedia brand, the idea of the brand must transcend it’s original medium and be able to exist without its primary medium.

To the extent that Netflix has created a superior user experience with DVD-by-mail services and streaming services they have an opportunity to transcend as a company that provides superior accessibility solutions to customers. Its narrative could be focused on accessibility and ease as consumers experience the afore mentioned proliferation of screens. Netflix is one of very, very few companies with theswagger and manpower to be on everything. It’s on your PC. It’s on your Xbox. It’s on your PS3. It’s on your iPhone, your iPad, and a zillion different Android phones. Windows Phone. Roku. It’s everywhere.42 Netflix has failed to capitalize on this “swagger”, and the focus of the company has shifted to storytelling from their historic core competency of service. To that end, Netflix is not currentlya transmedia brand because it has yet to define in consumers’ minds a clear value proposition and brand positioning that transcends its media platform.

To what extent does the media company qualify as a transmedia brand? In its corporate communication, Netflix is setting the stageto become a transmedia brand. Talk of screen convergence andthe disappearance of traditional TV foreshadow where the company is heading. Netflix has the potential to become a

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transmedia brand, but with the segmentation that still exists in media consumption (TV, PC, tablet, mobile, video console etc.) it has yet to attain that goal. They fall short of the transmedia brand definition that assumes an integrated narrative that is dispersed across multiple mediachannels. From channel to channel, Netflix content is the same and their user experience is simply tailored.

The lack of social interaction on the Netflix platform prohibits the audience’s ability to accelerate the details about the brand. Audiences can create their own brand stories via social media and blogs, which help a brand transcend. In March of 2013 Netflix finally embraced the idea that social insight is a factor in online commerce. Their partnership with Facebook now allows subscribers to see what their friends are watching, but this social interaction is still only accessible to subscribers of Netflix. Yet again, the audience is limited and the stage for transmedia storytelling offered by social media is limited.

Beyond it’s accessibility, Netflix as a brand has created a fan base of movie lovers. One social community titled, “Movie Fans—A Netflix Community” has no affiliation with thebrand but claims to be a “diverse collection of movie loverswith varied tastes and styles, gathered together to discuss one thing we all love, MOVIES (oh and TV SHOWS too).43 A possibility does exist that Netflix may transcend predicatedupon it’s relentless quest to provide access to the movie experience. Newly created content such as House of Cards, Orangeis the New Black and Arrested Development have yet to continue theirnarratives on other platforms in any significant manner. Thepossibility does exist that Netflix’s move into the content creation world may provoke additional opportunities for Netflix to transcend but in its present state, Netflix is not a Transmedia Brand and would not exist without it’s primary medium.

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If the company's primary distribution platform were to disappear tomorrow, would the company survive? If streaming and mail services were to disappear tomorrow, the current version of Netflix would not survive because it is still tied to its distribution model. Netflix has not historically done a good job of building a defined brand that transcends its distribution platforms. However, the recent move towards original content creation is laying the groundwork for the brand to survive in the future. The content game places Netflix in direct competition with companies like HBO and Showtime and other sophisticated storytellers.

CEO Reed Hastings sees the future of streaming as fragmentedas cable television. After a recent earnings report Hastings predicted that we’re moving to a world where “apps replace channels.” Hastings mentions apps nearly 3 dozen times in his essay, and makes it clear that he sees Netflix first and foremost as an app provider. Hastings supposes that lots of other video services will figure the same thingout. And he goes out of his way to mention others that are already there or close to it, citing ESPN, HBO and the BBC. But those who don’t get it are in trouble, he says: “Existing networks, such as ESPN and HBO, that offer amazingapps will get more viewing than in the past, and be more valuable. Existing networks that fail to develop first-classapps will lose viewing and revenue.”44 These predictions speak to Reed Hastings’ understanding of transmedia brandingand their need to establish themselves as an innovative storyteller and not just a distributor.

People want to interact with stories, and they help to retell stories within their communities. Audience participation covers a wide spectrum of activities, ranging from passing on conversation to leaving comments on blogs orarticles, to the creation of parodies and additional storylines.45 When fans are provided the opportunity to develop a personal or emotional connection to a brand it cansurvive beyond it’s relative medium. The success of House of

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Cards and other original content affiliated with the brand might just take Netflix from distributor to storyteller. With 42,250 followers and tweets, primarily related to presscoverage for House of Cards, Netflix hasn’t dispersed new storylines or character tidbits for fans to consume, but at least it’s established a presence on the social platform.

Can the brand make sense in any platform, known or unknown?As long as consumers can get their fix of movies and television shows, Netflix can make sense in any platform. Jenkins’ Convergence Culture discusses how the public has shownlimited interest in hyper-contexts, and has developed hyper-textual relationships to existing media content. Younger consumers are information hunters and gatherers, taking pleasure in tracking down character backgrounds and plot points and making connections between different texts withinthe same franchise.46 While Netflix original content is generating a substantial following on it’s own, Netflix entered the scene by making accessing movies easy. They continue to make it easy by offering them on any device and the success of their original content shows is continuing the Netflix conversation.

Netflix has become a part of the current generation’s culture. While Netflix isn’t a transmedia brand in the traditional sense, the concept of Netflix has transcended. More and more, storytelling has become the art of world building, as artists create compelling environments that cannot be fully explored or exhausted within a single work or even a single medium. The world is bigger than the film, and fan speculations and elaborations expand this world in avariety of directions.47 Today’s culture sees movies becauseof Netflix, and while not a device itself, people regularly answer the question “Where did you watch that show?” with the answer “on Netflix.”

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Section 5: Content Economics

How does the company make money?From the beginning, Netflix has always made its money exclusively through subscription fees for access to professionally produced content. This model differs from thead-supported monetization model used by many other media companies in which they offer “free” content as a means of attracting consumer audiences that they can then sell to advertisers who are seeking the attention of potential consumers for their products or services.48 While the principles of content economics potentially apply to any content monetization scheme, subscription based revenue models do require a monetary cost of entry (or pay wall) that makes delivery of high quality content even more necessary. In this section we’ll trace the evolution of Netflix’s content distribution system, its recent content development efforts and ultimately the alignment of its revenue stream with the principles of content economics.

According to its 2013 10-K Annual Report filing, Netflix generated $3.6 billion in revenue domestically and internationally from subscription fees to its two media distribution services: online content streaming and a DVD-by-mail service.49 The domestic and international streaming segments derive revenues from monthly subscription services consisting solely of streaming content. The majority of U.S.domestic subscribers pay $7.99 a month for access to its library of streaming movies and TV shows. Netflix’s DVD-by-mail business contributes about a third of the company’s domestic revenue, but is more profitable than the streaming service due in part to lower subscriber acquisition costs (as Netflix is not investing in acquiring new DVD-by-mail subscribers). Domestic streaming revenues at the beginning of 2013 were about $2.2 billion with a contribution margin

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of 16% vs. DVD-by-mail revenues of $1.1 billion at a 47% contribution margin. The international streaming business generates annual revenues of about $287 million and currently operates at a loss of about $389 million due to investments in building the subscriber base.

In a subscription model such as the one employed by Netflix,content is available only to subscribers who pay on a monthly or annual basis.50 Since Netflix generates its revenue directly from subscribers, the size of its subscriber base does not dictate ad rates (such as CPM), as would be the case in an ad-supported model. Instead, the subscription model provides Netflix with a relatively predictable revenue stream as compared to advertising-based revenue models because it generates a consistent monthly annuity stream and does not entail risk factors such as “make goods” which can introduce uncertainty into the advertising-based revenue model. The subscription-based revenue model also shields Netflix from other potentially negative forces common in the advertising-based world, including advertisers’ influences on content decisions, the fickleness of media buyers and the complexities of managing both up-front and scatter markets.

From the consumer’s perspective, the strength of a subscription model is that it is simple and transparent. However, putting all content behind a pay wall usually meansthat the service will generate a smaller total audience thana “free” (or ad-supported) service will, because not all consumers will want to pay to access the content. This reality is one factor that drives the need to offer more unique and high quality content to subscribers as an incentive to pay a monthly subscription fee.

Does its revenue stream align with the principles of contenteconomics? Or, is revenue tied to technology/distribution?According to the global truth of content economics, once media became digitized it turned the supply equation upside down. Media distribution capacity in the digital era is

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nearly unlimited and far exceeds our ability to fill all thebandwidth. The result is that high quality content experiences drive value in the economics of media chaos.51 As Netflix shifted its content distribution strategy in 2007to focus almost exclusively on Internet streaming (except for limited domestic DVD-by-mail service) it had no choice but to align its revenue stream with the principles of content economics. There are numerous large competitors who also stream video content to consumers, such as Amazon, Huluand Apple to name a few. In order to entice consumers to payits monthly subscription fee, Netflix had to focus on delivering a compelling and unique content experience. But it could be argued that Netflix’s alignment with content economics began even before its streaming service.

Netflix’s domestic DVD business launched in 1999 with DVD-by-mail subscription plans.52 This service was an innovativealternative to typical bricks and mortar video rental stores. Its early business model, based on its DVD-by-mail service (pre-streaming era), added consumer value in three key ways:

1. Large content selection: Because its DVD selection was not limited by the physical space of a bricks and mortar storefront, Netflix could offer a much larger selectionof movies to its subscribers than a typical neighborhood or chain video rental store.

2. Content recommendations: Netflix leveraged its large scaleand subscriber viewing data and algorithms in order to tailor its content recommendations to each individual user.

3. Convenience: Subscribers were able to select content choices online and have DVDs shipped directly to their home or office, without the need to visit a bricks and mortar store. This capability required Netflix to develop substantial capabilities in logistics, warehousing and distribution.

In this pre-streaming era, Netflix was in fact subject to the constraints of limited bandwidth. Because DVDs are

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physical media, they represent an inherently limited “pipeline” for content (even though the content is encoded digitally). Netflix subscribers were only able to check out a limited number of DVDs at any one time, the DVDs had to beordered well in advance of the actual viewing experience, and there was lag time between ordering a title and receiving the DVD in the mail.

Netflix’s competitors were also constrained in terms of the “pipeline” of content that they could deliver to consumers. Local video rental stores were constrained by the physical limitations of their retail space. Broadcast and cable content providers were limited by the program schedule, which had to fit within a 24 hour period and was limited by the number of channels available. Even pay per view providers were limited because they could only play movies sequentially, and consumers had to pay to watch movies that were scheduled to play on a particular channel at a particular time, limiting the range of content that could beaccessed at any point in time.

However, even in this early environment of limited content bandwidth, Netflix’s unique business model and technologies did allow it to transcend some of the limitations of its competitors, and it used at least two forms of content monetization to drive its revenue stream. First, it providedsubstantially increased entertainment value to is subscribers because of its large content selection, which exceeded anything that a local video rental store could match. This provided the company with a unique competitive advantage and even allowed it to offer niche content optionsthat satisfied customers in “the long tail” as opposed to just mainstream titles targeted at the “head”. Second, it was able to differentiate its delivery experience through the value-added content recommendations that it was able to offer subscribers because of its user database and proprietary algorithms. As Sarah Roman states: “Content that’s worth paying for sometimes isn’t about the content atall, it’s about the delivery experience.”53 While these two

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forms of content monetization allowed Netflix to align its revenue stream to the delivery of high quality content (bothas a product and as a user experience), the company was still encumbered by the physical limitations of DVDs and thefact that the titles it offered did not represent exclusive or original content.

With the launch of its Internet streaming service in 2007, Netflix was finally able to fully align its business strategy with the principles of content economics. With its video content now in a pure digital form, it was no longer subject to the constraints of a limited distribution pipeline. This changed the content supply equation considerably, as Netflix could no longer rely upon its extensive DVD library and mail order distribution system to differentiate it from competitors. It had to evolve its strategy to turn content into its primary differentiator, which also meant substantial new investments in exclusive and original content.

The most telling indicator that Netflix has now fully aligned its strategic focus and revenue stream with the principles of content economics is the fact that all five ofthe “Growth Drivers” it identifies in its 2013 Annual Reportrelate in one way or another to the economic value of high quality content. The number one growth driver that they identify in their 2013 Annual Report is Investment in Streaming Content: “We believe that our investments in streaming content lead to more subscriber viewing, delight, and positive consumer word-of-mouth. This, in turn, leads to subscriber acquisition and revenue growth, which allows us to invest in more streaming content, which enables the growth cycle to continue. With more than 33 million global subscribers and our increasingly exclusive and original programming that differentiates us from competitors, we believe we are well positioned to capitalize upon this virtuous cycle.”54 The other growth drivers identified include continuous service improvements, overall adoption and growth of Internet TV, the future of the consumer

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electronic ecosystem (“Internet on every screen”) and international market expansion. In describing all of these growth drivers, Netflix management emphasizes the interplay between digital broadband streaming and the value of high quality content in providing a superior consumer experience.

To back up its vision as outlined in its Annual Report, Netflix has pursued a number of specified strategies to growthe value of its streaming content offerings, and therefore align its revenue stream with the principles of content economics. Netflix has committed to spend at least $5 billion over the next five years to license TV shows and movies, including Disney’s animated hits.55 They’ve used this sizable war chest to not only license syndicated content, but they’ve also developed several highly acclaimedoriginal-content series, including House of Cards, Orange is the New Black and Hemlock Grove. The 13 episodes of House of Cards alone cost Netflix $100 million to make.

These investments are beginning to pay off, as Netflix original-content programs just received 14 Emmy nominations—a first for an Internet-based content provider.56 While the relationship between Emmy nominations and increased subscriber numbers is not necessarily direct, Dan Cryan withI.H.S. Screen Digest claimed the Emmy nominations helped increase the distance between Netflix and its online competitors, Amazon.com and Hulu, which also have been investing in original programming.57 Emmy nominations provide another potential advantage: “It makes it acceptablefor A-list creatives to work for you. They like awards and the acclaim of their fellows,” says Tim Brooks, a former network executive.58 The take-away is that good programming can beget good programming, and potentially generate more revenue-producing subscribers.

In a significant move, Netflix just announced a multi-year deal with DreamWorks Animation to supply 300 hours of original programming to its platform, and is set to leveragea new feature-length animated movie called Turbo.59 The New

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York Times described the deal as “perhaps the biggest commitment yet to bring Hollywood-caliber content to the webfirst.” The new original content will be inspired by characters from various DreamWorks Animation franchises, such as Shrek and The Croods. Netflix will have exclusive rights to the new original content in all of the countries in which it operates. This deal will provide a strong draw for an important demographic of the streaming audience: kids. Children are avid content streamers, and cartoons allow the company to pitch itself to parents as a commercial-free alternative to television. This family-friendly content will provide a good complement to Netflix’sother original content shows that are more adult oriented, such as House of Cards.

Netflix has also become a financier and a launch pad for high quality programs that have had a hard time making it onother platforms. Netflix revived the acclaimed show Arrested Development that was canceled on Fox. Netflix CEO Reed Hastings has called Arrested Development and other Netflix originals “Integral to his strategy of transforming the company from a purveyor of rerun programming into a web-based television network offering a mix of Hollywood movies and new shows, comparable to Time Warner’s HBO.”60 Netflix also provided an injection of cash for the PBS children’s show “Super Why” (an animated series that teaches reading skills) in exchange for exclusive streaming rights.61

Netflix has also become more discerning regarding the content that it will pay for and offer to its subscribers, and has dropped shows that fail to attract enough viewers tojustify the price.62 For instance, last fall Netflix droppedsome content from A+E Networks, including Pawn Stars and Ice Road Truckers, because the shows weren’t popular on Netflix’s site. It now targets exclusive deals for high-quality programming, opting not to pay for as much old library content as it once did.63 Netflix is also using its massive database of subscriber viewing behavior to make data-driven programming decisions. Jonathan Friedland, the company’s

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chief communications officer, said, “Because we have a direct relationship with consumers, we know what people liketo watch and that helps us understand how big the interest is going to be for a given show. It gave us some confidence that we could find an audience for a show like House of Cards.”64 From its data, Netflix knew that a many of its subscribers had streamed the work of Mr. Fincher, the director of The Social Network, from beginning to end. It also knew that films featuring Kevin Spacey had always done well,as had the British version of House of Cards. With those threecircles of interest, Netflix was able to find a Venn diagramintersection that suggested that buying the series would be a very good bet on original programming.

Netflix has proven itself to be an agile and visionary mediacompany. It has successfully pivoted from being a mail ordersubscription business into a pioneer in the world of Internet content streaming. Netflix realized several years ago that Internet streaming of digital video content would become ubiquitous, rendering the delivery platform a commodity. Netflix also understood that it does not “sell” its audience to advertisers as do many other media companies, so they do not value audiences in the same way advertising supported media companies must. Instead, Netflixhas focused on developing a deep relationship with its subscribers—who are its primary source of revenue—by creating a superior content experience that is both high quality and differentiated. Indeed, Netflix stated that its content advantage was the biggest driver of its U.S. streaming subscriber growth in the first quarter of 2013.65 To sum it up, Dan Cryan with I.H.S. Screen Digest put it this way: “The more things change, the more they stay the same. We have a subscription-funded provider of high qualityprogramming picking up a lot of Emmy nominations. That’s been happening in conventional TV for quite a long time now.What’s new, of course, is the fact that it’s not reliant on the traditional TV infrastructure for distribution.”66

Section 6: Netflix Investment Analysis/SWOT

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Whether one decides to invest in Netflix or not going forward, one thing is for certain—it’s going to be a wild ride. Over the past five years Netflix’s stock price has bounced dramatically: $50 in 2010, $295 in 2011, $54 in 2012, and back to over $250 in 2013. But if you had the stomach to remain on this wild ride you would have earned anamazing $630% gain (see chart in Appendix A).67 The key factors to weigh in evaluating a Netflix stock investment include the following: price to earnings ratio, strategic positioning, subscription growth potential, content development expenses and competitive threats. Any one of these factors could spell trouble for the company and its investors, but the upside potential is tremendous.

From a price to earnings ratio perspective, Netflix is very expensive. Based on its current stock price and its second quarter earnings, Netflix is trading at over 100 times earnings.68 When you consider that the average P/E ratio forthe sector is about 14, the company’s stock price seems exceedingly high.69 But stock price is based on a number of factors, both rational and emotional, so it’s important to consider all the factors before deciding whether investing in Netflix makes sense.

One of the most important factors to consider is the company’s long term strategic plan and positioning. Does thecompany’s strategic plan align with the five global truths driving the future of the media world? Does it appear well positioned to compete and grow against a host of current andpotential competitors? This past April, Reed Hastings published what many have called his “manifesto” on the investor relations section of the company’s website.70 In the opening “Summary” section of the document, he outlines three key predictions that underlie Netflix’s long-term strategy:

1. Over the coming decades and across the world, Internet TV will replace linear TV. 

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2. Apps will replace channels, remote controls will disappear, and screens will proliferate.  

3. As Internet TV grows from millions to billions, Netflixis leading the way.

He goes on to outline the “Netflix Singular Focus,” or what you might describe as “What we want to be when we grow up.” Specifically, he states: “Simplicity is at our core. We are commercial-free unlimited-viewing subscription TV. We don’t have pay-per-view and we don’t have advertisements. We choose to be the best at our model, and to have our brand stand for commercial-free, unlimited viewing, low flat monthly fee. For us to be hugely successful we have to be a focused passion brand. Starbucks, not 7-Eleven. Southwest, not United. HBO, not Dish. We are not a generic “video” company that streams all types of video such as news, user-generated, sports, music video, or reality. We are a movie and TV series network. We are about the flexibility of any screen anywhere any time. We are about fantastic content that is only available on Netflix.”

In describing the company’s long term vision, Reed Hastings directly hits on three of the five global truths: convergence, brands and content economics. In saying that: “We are about the flexibility of any screen anywhere any time,” he proclaims the company’s fundamental understanding and embrace of convergence. In saying: “For us to be hugely successful we have to be a focused passion brand,” he demonstrates his commitment to use a brand management approach to growing and strengthening the Netflix brand worldwide. And finally, in saying: “We are about fantastic content that is only available on Netflix,” he demonstrates his understanding of, and commitment to content economics. What he does not address are the global truths of symbiosis or circuits, and this failing is evident in the earlier detailed descriptions of these truths in this paper. However, it may not be realistic or even necessary for a company to fundamentally embrace all five global truths simultaneously, and we believe that the truths that the

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company does embrace are critical to long-term success for Netflix.

Given the company’s long-term commitment to being “commercial-free unlimited-viewing subscription TV,” what then becomes extremely important to analyze are the company’s long-term prospects for growing its subscriber base. This is because subscription fees are the company’s primary source of revenue. For its most recent quarter, Q2 2013, Netflix reported domestic subscription growth of 630,000 vs. 528,000 for the same quarter in 2012, and international growth of 610,000 subscribers.71 The numbers were in line with its guidance, but lower than what investors were hoping for, and the stock price suffered. Butwhen you look at the bigger picture—Netflix’s total addressable market—the picture appears brighter. According to a December 2012 ABI Research report, worldwide pay-TV subscribers will exceed 900 million in 2013. Netflix currently has only about 36 million subscribers worldwide.72

While it’s not realistic to think that Netflix will capture all of those potential pay-TV subscribers, it does point to the potential for a huge future subscription base opportunity. As a comparison, HBO alone has 114 million subscribers worldwide, with about 30 million in the U.S.73 For the company that is first to market there can be great rewards. As Reed Hastings states: “One of the reasons we areinvesting so heavily in international expansion is we believe that once a subscription video service has achieved profitability and scale in a market (20% to 30% of households), it is very likely to be able to sustain that profit stream for many decades.”74

In his letter, Reed Hastings states: “Our strategy is to expand as quickly as possible while staying profitable on a global basis, as long as there are compelling markets to expand into, and we are continuing to see growth in our current markets.” They are estimating reaching about 60 to 90 million subscribers in the U.S., and even greater numbersinternationally. So how big does Netflix need to get to

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justify its stock price? Moody’s analyst Neil Begley says that Netflix needs to sustain 40 million U.S. streaming subscribers to become “a very solid, sound business.”75 Given the fact that the company is already at 30 million U.S. subscribers, that goal does not seem hard to reach. In his letter, Reed Hastings describes the relationship betweensubscription revenue and profitability: “Our domestic marginstructure is mostly set top down. For any given future period, we estimate revenue, and decide what we want to spend, and how much margin we want in that period. The margin structure we have chosen is to grow content spending plus marketing slightly more slowly than we grow revenue, and in the US to target about 400 basis points of contribution margin improvement per year. As long as we continue to grow as we have been, we are likely to be able to continue this margin expansion.” The relative predictability of a subscription model allows the company toestimate marketing, content and administrative costs in advance, and balance profitability as they go without too many surprises.

Given the company’s strategic use of content as a draw for new subscribers and as a competitive differentiator, it’s also important to look at how content could either drive or derail Netflix’s long-term success. For Netflix, content comes in two basic forms: licensed content and original content. Reed Hastings claims that Netflix is currently spending over $2 billion per year in content licensing and creation. Netflix’s rich database of subscriber data allows it to make informed content licensing and creation decisions. On the licensing front, Reed Hastings states: “Ineach market, we license content from multiple suppliers, mirroring the fragmentation of the content industry. Our licensing is generally time-based, so that we might pay, forexample, $200,000 for a 4-year exclusive subscription video-on-demand (SVOD) license for a given title. At the time of renewal, we evaluate how much the title is getting viewed aswell as member rating feedback to determine how much we are willing to pay.” Netflix also uses its technology to serve

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up the most relevant and desirable content for each user, with the goal of building loyalty and driving positive word of mouth: “Our aim is to keep inventing and tuning algorithms to generate higher satisfaction, viewing, and retention, for whatever the level of content we can afford in that territory.”76 Jim Cramer, the well-known host of CNBC’s “Mad Money” recently ranked Netflix stock as a “Buy”,citing its content licensing deals with CBS and PBS among others.77

Regarding the development of original content, Reed Hastingshas this to say: “We’re now at the scale where we can economically create original content, debuting on and fully-exclusive to Netflix. At a basic level, we aim with our originals strategy to have shows as compelling as Mad Men and Breaking Bad. In those cases, Netflix can only offer complete prior seasons, which is great for members who are discovering or want to catch up with these series. Ultimately, though, they’ll switch over to AMC to watch the latest episodes and don’t identify these series with Netflix. With a great original like House of Cards we have created a series of equal perceived quality and have generated the excitement around Netflix. This helps both retention and acquisition of members in a way that previously seen series do not.” Many analysts and industry observers seem to agree with Netflix’s original content development strategy. TREFIS, a stock research site founded by MIT engineers, predicted that Arrested Development and otheroriginal content would support U.S. subscriber growth for Netflix.78

Finally, we need to evaluate competitive threats. Reed Hastings identifies HBO as their biggest long-term competitor: “The network that we think likely to be our biggest long-term competitor-for-content is HBO. HBO recently won, for example, long-term exclusive domestic movie output deals with Universal and Fox. They bid against us on many Original projects. They have global reach and strengthening technology capacity.” He goes on to outline

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Netflix’s broader competitive landscape in this way: “In addition to HBO, there are Amazon, Hulu, Now TV, and many cable and broadcast networks in various territories. Many consumers will subscribe to multiple services if they each have unique compelling content. Success relative to these competitors-for-content would be us having substantially larger revenue and therefore sustainable increasing content,tech and marketing spending, leading to further growth, and a virtuous cycle.” One of Netflix’s key competitive advantages is that it is a pioneer in Internet TV, and therefore has first mover advantage. Many analysts agree that it is in Netflix’s best interest to invest heavily in subscriber acquisition in order to lock in network effects. The idea is to scoop up consumers and make them believers inthe service, then worry about margins later.79 In the U.S. streaming market, Netflix is dominant with a 90 percent share of the subscriber base, with Hulu Plus and Amazon holding much smaller shares. As long as Netflix can maintainits aggressive expansion plans while not diminishing the quality of the user experience, there’s good reason to believe that Netflix can continue to be a dominant competitor in the Internet TV industry globally and continueto develop the “virtuous cycle” that is at the heart of its competitive strategy.

In conclusion, even though Netflix’s price to earning ratio makes the stock extremely expensive, there are strong reasons to believe that the company has huge upside potential. For this reason we recommend investment in Netflix, and we’re not alone. Daniel Sparks, a writer for The Motley Fool recently stated: “Don’t get caught up on valuation metrics with disruptors like Netflix. On the basisof valuation, Netflix stock is a sell. But if you take a close look at the company’s potential market and its massivegrowth trends, the stock is a buy.”80 Victor Mora from Wall Street Cheat Sheet also states, “Relative to its peers and sector, Netflix has been a year-to-date performance leader. Look for Netflix to continue to OUTPERFORM.”81 And Morningstar says, “We think there is plenty of room for

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Netflix, especially in the U.S., where most households have a healthy appetite for supplemental video content to pay-TV subscriptions.”82 We believe in Netflix’s future, and are exciting to join them on their wild ride.

SWOT ANALYSIS

Strengths: Netflix’s move from DVD-by-mail distribution to

Internet streaming enabled content to be available across multiple platforms/screens (convergence).

Superior user experience due to technological advancements and ad-free viewing.

Largest streaming library, largest streaming content licensing budget and largest original content development player in the streaming space ($5 billion over next five years).

Strategic relationship with DreamWorks to develop 300 hours of original and exclusive content (transmedia storytelling).

No added pressure from advertisers with regard to content decisions (i.e. production decisions are based on more favorable subscriber engagement levels.)

Control content development and content distribution (content economics).

Proven ability to develop critically acclaimed and popular original content programs (14 Emmy nominations).

Access to data and the ability to make data-driven content development decisions because of their extensive user database.

Cultural implications of “Netflix”, general perception that streaming is equivalent to Netflix (much the same way that Rollerblades were synonymous with in-line skate and tissue/Kleenex).

Weaknesses: Access to audiences will fundamentally be limited

because of their pay wall/subscription model.

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Only have one revenue model (subscriptions) so do not supplement revenue with advertising or other content monetization models.

Late to the game with social TV integration; Netflix needs to catch up with Hulu in the social space.

2007 announcement to split the company left a black eyeon the company.

Do not use their audience as accelerators because they don’t provide ways to share and promote their content across subscribers’ social networks.

Notorious for not having latest releases for both movies and TV shows, provides a disadvantage vs. Hulu.

Asynchronous nature of content distribution on Netflix means that it misses opportunities to capitalize on “live events” and social sharing.

Have not fully developed Netflix as a unique and differentiated brand that consumers understand and are loyal to.

Have to answer to stockholders on a quarterly basis, which limits ability to make longer-term strategic decisions.

Do not do a good job of transmedia storytelling, directing audiences to content across its various platforms (same content experience across platforms).

Opportunities: Opportunity to better utilize circuits and allow the

largest subscriber base to become accelerators for the brand.

Create a tiered subscription model with differentiated pricing structures (creating easier access for customers who don’t want to pay monthly subscription fees)

Opportunity to create a freemium version with a paywall.

Opportunity to create a symbiotic relationship across their different platforms, making some content unique to one channel (making way for transmedia storytelling).

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Opportunity to license their original content into syndication.

Opportunity to license TV shows and new release movies as soon as they are available rather than delayed to DVD release timing.

Opportunities to release original content feature filmson Netflix before released at theaters as an “exclusive” for subscribers.

Develop Netflix as a must-have content provider that consumers are willing to pay extra for (like HBO).

Embed the Netflix app on all new media devices to make it easier for consumers to join the service.

Implement new content monetization models other than just a subscription-based model in order to offer more consumer options and monetization opportunities.

Threats: Potential for content fatigue because the same content

is delivered across multiple screens, instead of different content optimized to different platforms.

Not available through cable networks, so misses a majordistribution channel.

Broadcast, cable and movie studio content providers could refuse to license their content to Netflix in favor of competitors (such as Hulu) or their own websites, severely limiting premium content options forsubscribers.

Because of binging, may not be able to develop originalcontent fast enough to keep subscribers continuously engaged.

A few poorly received original content programs could damage their perception as a premium content provider and erode differentiation.

Red Box or Blockbuster could erode DVD-by-mail businessand profitability in the U.S.

John McCain bill that would unbundle prices for cable distribution.

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Appendix A

Netflix Stock Performance Over the Past Five Years: 632.9% Gain.

Source: http://www.fool.com/investing/general/2013/05/28/netflix-stock-can-still-make-you-rich.aspx

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1  Pfanner, E “A Second Stab At Convergence” NYTimes, 20102 Taylor, C “Qwikster From Netflix: The Worst Product Launch Since New Coke?” Mashable, 20113 Anderson, N “Netflix Offers Streaming Movies to Its Subscribers” Ars Tecnica 20074 Helft, M “Netflix To Deliver Movies to PC” NYTimes 20075 Chen, B “Apple and Netflix Dominate Online Video” NYTimes 20136 Edwards, J “Netflix Qwikster Mess Doubles The Number of People Who Dislike it” CBS News 20117 Kepcher, C Netflix provides good example of what not to do in big business strategic changes NY Daily News, 20118 Franks, J “Media: From Chaos to Clarity”, 20119 “January 2011 Video Usage Up 45%” Neilson 201110

Savov, V IDC: smartphone market grows 80 percent year-on-year, Samsung shipments rise 350 percent11

Stewart, J “Netflix Looks Back on Its Near-Death Spiral” NYTimes 2013

12 Stewart, J “Netflix Looks Back on Its Near-Death Spiral” NYTimes

201313 Lieberman, D “House of Cards Make Members More Loyal” Deadline, 201314 Karapel, A DO NETFLIX’S EMMY NOMINATIONS “BLUR THE LINE FOREVER ABOUT WHAT IS TELEVISION”? FAST COMPANY , 201315 Karapel, A DO NETFLIX’S EMMY NOMINATIONS “BLUR THE LINE FOREVER ABOUT WHAT IS TELEVISION”? FAST COMPANY , 201316 Ludwig, S “Some Netflix members will get new episodes of AMC’sThe Killing the day after they air on TV” VentureBeat 201317

Stewart, J “Netflix Looks Back on Its Near-Death Spiral” NYTimes 201318 Luckerson, V “John McCain Wants To Lower Your Cable Bill” Time 201319 Luckerson, V “John McCain Wants To Lower Your Cable Bill” Time 201320 Franks, Judy U. Media: From Chaos to Clarity Five Global Truths That Make Sense of a Messy Media World. Chicago: The Marketing Democracy, Ltd. 2011. Print21 Parr, B. “Netflix Apologizes to Customers & Rebrand Its DVD Service”, Mashable Online, September 18, 2011

22 Seidman, D. “Netflix, The Sequel: From Customer Revolt to Emmy Breakthrough”, Huffington Post Online, August 6, 201323 Parr, B. “Netflix Apologizes to Customers & Rebrand Its DVD Service”, Mashable Online, September 18, 201124 Quirk, M. “Netflix To Start Making Documentaries & Stand-Up Comedy Specials”, Consumerist Online, July 23, 201325 Pepitone, J. “Netflix to debut original DreamWorks Animation Shows”, CNNMoney Online, July 17, 201326 Hamilton, J. “Arrested Development as Transmedia…which it isn’t”, Story Hobby Online, May 28, 201327 Hamilton, J. “Arrested Development as Transmedia…which it isn’t”, Story Hobby Online, May 28, 201328 Hamilton, J. “Arrested Development as Transmedia…which it isn’t”, Story Hobby Online, May 28, 201329 Hamilton, J. “Arrested Development as Transmedia…which it isn’t”, Story Hobby Online, May 28, 201330 Associated Press, Yahoo News! July 22, 201331 Jurgensen, J., “Binge Viewing: TV’s Lost Weekends”, Wall Street Journal Online, July 13, 201232 Abele, R. “Playing with a New Deck”, Directors Guild of America Online, Winter 201333 Pepitone, J. “Netflix to debut original DreamWorks Animation Shows”, CNNMoney Online, July 17, 201334 Clover, J. “Netflix Debuts New Conversational Content Guide “Max” for PS3, Coming to iPad Next, June 28, 201335 Jenkins, H. Convergence Culture Where Old and New Media Collide: New York University Press. 2006. Print.36 Netflix.com, Investor Relations, Web, July 15 2013.37 Wasserman, T “Netflix Adds Facebook Integration In The US” Mashable, 201338 Shih, C “What Every Business Can Learn from Netflix: The Power of Social Media and Transparency” LinkedIn 201339 Shih, C “What Every Business Can Learn from Netflix: The Power of Social Media and Transparency” LinkedIn 201340 http://pewinternet.org/Reports/2013/Tablet-Ownership-2013/Findings.aspx41 Tenderich, B. “Design Elements of Transmedia Branding”, USC Annenberg Innovation Lab Online. January 2013.42 Kumparak, G. “Netflix, Please Fix Your User Interface On…Everything”, Pandodaily Online, March 14 2012.

43 Droidmaker, Netlflix Community Online, 2013.44 Kafka, P. “How Netflix CEO Reed Hastings Sees the Future: Netflix Wins, Apps Win and so Do HBO, ESPN and the Cable Guys”, All Things D,April 24, 201345 Tenderich, B. “Design Elements of Transmedia Branding”, USC Annenberg Innovation Lab Online. January 2013.46 Jenkins, H. Convergence Culture Where Old and New Media Collide: New York University Press. 2006. Print.47 Jenkins, H. Convergence Culture Where Old and New Media Collide: New York University Press. 2006. Print.48 Napoli, P., Audience Economics, New York, P. 2.49 Form 10-K Annual Report, Netflix, Inc., February 1, 2013.50 Epps, S., “Eight Models for Monetizing Digital Content”, Forrester,2009.51 Franks, J., Media: From Chaos to Clarity, The Marketing Democracy, Chicago, 2011.52 Form 10-K Annual Report, Netflix, Inc., February 1, 2013.53 Epps, S., “Eight Models for Monetizing Digital Content”, Forrester,2009.54 Form 10-K Annual Report, Netflix, Inc., February 1, 201355 Laporte, N., “A Tale of Two Netflix”, FastCompany, July/August 2013.56 Chmielewski, D., “Netflix’s Emmy Nods Bolster its Claim as Web’s Leading TV Network”, L.A. Times, July 18, 2013.57 Chmielewski, D., “Netflix’s Emmy Nods Bolster its Claim as Web’s Leading TV Network”, L.A. Times, July 18, 2013.58 “Emmys? Netflix Shows May Be First Online Contenders to Nab Nominations,” abc15.com, July 17, 2013.59 Barnes, B., “DreamWorks and Netflix in Deal for New TV Shows”, New York Times, June 17, 2013.60 “Netflix in Talks for Another Season of ‘Arrested Development,’” AdAge, July 12, 2013.61 Sharma, A., “How Netflix is Shaking Up Hollywood”, Wall Street Journal Online, July 7, 2013.62 Sharma, A., “How Netflix is Shaking Up Hollywood”, Wall Street Journal Online, July 7, 2013.63 Gottfried, M., “Netflix Should Read Amazon’s Script”, Wall Street Journal Online, July 15, 2013.64 Carr, D., “Giving Viewers What They Want,” The New York Times, February 24, 2013.65 Form 10-K Annual Report, Netflix, Inc., February 1, 2013.

66 Chmielewski, D., “Netflix’s Emmy Nods Bolster its Claim as Web’s Leading TV Network”, L.A. Times, July 18, 2013.67 Sparks, D., “Netflix Stock Can Still Make You Rich,” The Motley Fool, May 28, 2013.68 Doiron, M., “Is Netflix Stock a Good Buy?” Insider Monkey, July 25,2013. 69 Neiger, C., “Is Now the Right Time to Buy Netflix Stock?” The Motley Fool, April 25, 2013. 70 Hastings, R., “Long Term View,” http://ir.netflix.com/long-term-view.cfm.71

Lawler, R., “etflix’s Q2 Misses Due To Lower-Than-Expected Subscriber Adds, Earns 49 Cents Per Share On $1.07B In Revenue,” TechCrunch, July 22, 2013.72 Sparks, D., “Netflix Stock Can Still Make You Rich,” The Motley Fool, May 28, 2013.73 Sparks, D., “Netflix Stock Can Still Make You Rich,” The Motley Fool, May 28, 2013.74 Hastings, R., “Long Term View,” http://ir.netflix.com/long-term-view.cfm.75 Laporte, N., “A Tale of Two Netflix,” Fast Company, July/August 2013. Given 76 Hastings, R., “Long Term View,” http://ir.netflix.com/long-term-view.cfm.77 Capel, A., “Cramer: Buy Microsoft, Neflix, Pepsi and These 2 Stocks”, Wall Street Cheat Sheet, July 17, 2013.78 Trefis Team, “Netflix Earnings Preview: Content Investments to Drive Growth”, July 17, 2013.79 Reeves, J., “Netflix Will Suffer an Earnings Letdown”, Investors Place, July 17, 2013. 80 Sparks, D., “Netflix Stock Can Still Make You Rich,” The Motley Fool, May 28, 2013.81 Mora, V., “Can Netflix Remain a Blockbuster Stock?” Wall Street Cheat Sheet, May 27, 2013. 82 Morningstar’s Take on Netflix, http://quotes.morningstar.com/stock/s?t=NFLX