Netflix — Winning the Moment of Truth
Netflix consistently delivers fresh, compelling, value-creating content to its users with support from its investments in technology and human capital.
Netflix’s market is full of well-funded competitors (Amazon Prime, Hulu, YouTube Red, HBOGO), yet they continue to win by aligning 1) a business model model that creates value via compelling, tailored content and 2) an operating model that invests in technology and maximizes human capital.
Business Model: Winning the ‘moment of truth’
Keeping and acquiring customers is a constant battle. Most subscribers use only one streaming service and switching costs are low [1]. None of the services lock in customers for more than a month at a time and, unlike cable/satellite, there are no additional hardware components. This all means that Netflix’s business model cannot just stream content, it has to consistently win the ‘moment of truth’ (in Netflix parlance) against its competitors: when a user sits down to be entertained, what will they choose? What will be their go-to service [2]?
Netflix has a short window to prove itself: the average Netflix user will spend 1-2 minutes browsing the app before either exiting or committing to watch [3]. The business model is to make sure that, in just those 1-2 minutes, they serve up fresh licensed and original content. Every time the user opens the app, they need to find value in something to watch in any given genre. Making sure that they have value-creating content available and easy to access retains the customer against competitors or convinces new customer to stay after the free trial period expires.
Operating Model: Technology and people
To match the ambition of its business model, Netflix has created an operating model that continually invests in its enablers: technology and people. Anyone with deep enough pockets can buy and develop content. Anyone with the know-how can host content. Their combination of technology and people ensures that Netflix buys and develops the right content and then tailors the content library to an individual user’s preferences.
Technology
Netflix informs its purchases and recommendations via its trove of data. It’s crowd-sourced: users contribute with their ratings knowing that it will get them more personalized results while inadvertently improving the system’s data points for other users. This crowd-sourcing happened on the engineering side as well: they offered a $1M prize in 2006 to come up with a better recommendation algorithm [4]. The engine supports their business model on the content acquisition side (creating and buying content) as well as retention (curating content to keep the content fresh and relevant every time a user logs in). This capability is so critical that Netflix spends $150M per year and has 300 full time employees working exclusively on the recommendations engine [3]. If there’s any doubt as to its efficacy in delivering value, just look to its yearly customer churn: at 9%, it’s less than half of Amazon Prime and less than one-fifth of Hulu Plus [1].
People
Silicon Valley’s relentless focus on top-talent is well-known as are the strategies used to attract it – whimsical office spaces filled with bean bag chairs and ping pong tables, free food, and buses from the peninsula to the valley. Netflix’s approach, however, leaves behind the Valley’s twee trappings to focus on the real drivers of satisfaction and productivity. In its HR manifesto (Sheryl Sandberg believes it’s ‘one of the most important documents ever to come out of Silicon Valley’), they outline a few core tenets:
- Always pay top of market – if the market price goes up, pay people even more
- Output is king – top effort for mediocre work gets you fired; top work gets you promoted regardless of effort
- High trust – there is no expense policy except to ‘act in the best interests of the company’, there is unlimited vacation time (managers are expected to set an example by taking it and completely disconnecting), there is no face time [5]
The business model requires creativity, competitive spirit, forward-thinking, and lean operations to free up capital for investment. They get this by hiring and retaining outstanding people.
Conclusion:
Netflix has had an impressive couple of years. If you had bought a share of Netflix in early 2013, you’d have ~10x your money [6].
Their originally developed content was nominated for 34 Emmys this year [7]. Their revenue per employee ($2.39M) is higher than Apple, Facebook, and Google [8]. In short, they are killing it. They have captured disproportionate value in a highly competitive market, and the credit goes to its aligned business and operating models.
- https://www.parksassociates.com/blog/article/pr-july2015-ott-tracker
- http://ir.netflix.com/long-term-view.cfm
- https://gigaom.com/2014/10/09/netflix-spends-150-million-on-content-recommendations-every-year/
- http://techblog.netflix.com/2012/04/netflix-recommendations-beyond-5-stars.html
- https://hbr.org/2014/01/how-netflix-reinvented-hr
- http://finance.yahoo.com/q?s=NFLX
- http://www.dailydot.com/entertainment/emmys-2015-winners-amazon-netflix/
- http://www.fool.com/investing/general/2014/09/11/what-apple-facebook-google-and-netflix-all-have-in.aspx
Garret,
It is particularly interesting that Netflix has such low churn rates when compared to Amazon Prime, considering the latter gives you a much broader Bundle Deal (by subscribing to Prime you get access to Prime Video, Prime Music, and free 2 day delivery on items purchased on Amazon). It’s likely that the fact that Amazon Prime only works on PCs/Tablets and by using the FireTV or FireStick, while Netflix is compatible with multiple devices and the fact that it actually comes pre-installed in many smart tv’s and game consoles, contributes to Netflix’s current supremacy.
It would be interesting to analyze the effects of Amazon’s new Streaming Partners Program (http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-newsArticle&ID=2121003) in Netflix’s market dominance. Since last week (December 8th, 2015) Amazon Prime subscribers are able to use single account to access not only Amazon Instant Video but also libraries from other services like Showtime and Starz, among dozens more. This “video library consolidation” will make Amazon Prime significantly more convenient and might change the competitive landscape.
I think you make a great point about their two business and operating models. I have talked to some Netflix employees in their Beverly Hills office, and what I think is interesting is that as Netflix started to move into creating original content, one of the key questions that they began asking was: how should Netflix value one hour of content watched on the service? For example, does it matter if a user watches original Netflix programming vs. an older documentary? Does one hour watched have equivalent value across all types of programming, or does the type of content watched matter to Netflix?
I think this question is important to Netflix going forward, as they will have to make tradeoffs between spending on original content vs. rights to other studios’ movies and shows. Even more difficult, they will also have to figure out what genres of shows and which international markets to invest in based on their data.