The New Netflix Challenge
Netflix has focused on digitization of their part of the digital supply chain but they need to expand into content creation and content consumption to capture more value as competitors enter the market.
On the Net
Netflix started as a mail order DVD service, but as the name implies, always aspired to be a digital business. In an interview with Inc in 2005, two years before Netflix started offering streaming video, CEO Reed Hastings said, “we want to be ready when video-on-demand happens. That’s why the company is called Netflix, not DVD-by-Mail” [1][2]. Netflix enjoyed a first mover advantage in the late 2000s but must focus on continued digitization of their supply chain as former partners like Disney enter the ring as competitors.
It is to Netflix’s credit that our ability to watch high quality constant instantly is so common now that we largely ignore how it gets to us. The Netflix supply chain, in Figure 1, starts with content that is licensed by Netflix’s buyers or created in house, ingested digitally into Netflix’s database and aggregated with an internal content management system for global distribution [3]. Netflix copies their library onto thousands of servers around the world to reduce the physical distance and time it will take for digital content to travel over the internet to consumers [4]. Local internet service providers (ISPs) have a separate contract with customers to provide access to the internet and these ISPs transmit the content from Netflix’s edge caches to the customer. Finally, customers access the content catalog through a Netflix UI on TVs, computers, phones or other devices and watch content. The figure below makes clear that Netflix (in red) has historically been focused on their role as an aggregator and distributor at the center of the supply chain. As the cost of aggregation and serving decreases with digitization, content creators can start delivering their content directly to consumers. Netflix needs to invest forward, and especially backward, in the supply chain in order to compete.
Expanding their influence
Netflix is integrating forward with partnerships that capture the last mile from servers to consumers. Expanding internationally was a huge milestone for Netflix but international access is merely table stakes in a global digital market with competitors like Disney and Google. In order to compete, Netflix is expanding their partnership with French telecom company Orange to deliver content on set top boxes in Europe, the Middle East and Africa, ensuring that they have a connection directly to these consumers’ homes [5]. More broadly, Netflix has made a conscious decision not to invest directly in building hardware in-house but instead partners with device manufacturers who make it easy to access Netflix on their devices [6]. Every year, Netflix sets new smart TV industry standards and publishes a TV ranking that favors TV sets who integrate with Netflix [7]. In a digital economy that is constantly evolving, this approach of integrating with multiple partners allows Netflix to pass on the risk of keeping up with tech trends while ensuring that Netflix benefits from any advancements.
At the same time, Netflix is expanding backwards in the supply chain by spending $1.5 billion, or 25% of their total programming budget, on original programming this year. They expect both their total spend and the percentage dedicated to original content to grow in 2018 [8]. Netflix’s most defensible asset is their user data and they are well positioned to use this information to develop and target new content tailored to their customers. With the premiere of House of Cards, Netflix revealed that they created 10 different trailers each targeted towards different users and we can expect this data driven content production trend to continue [9]. Building up an internal content creation team also will help Netflix over the long term in their international expansion if they can invest in local content that wouldn’t otherwise be produced. They’ve started down this path by partnering with the Canadian government to produce $400 million worth of new content over the next 5 years in films that target both an English and French speaking audience [10].
The New Netflix Challenge
As Netflix moves into original content to extend their digital supply chain and compete in a world where the cost of distribution is decreasing, they need to be aware of the depth of their content library. Other content creators have a large library of movies that have already been paid for and could be distributed instantaneously. Netflix should consider acquiring digital libraries from smaller studios who would be threatened by Disney’s direct to consumer approach while Netflix is still in a dominant position. In addition, Netflix could use the rise of digitization and the prevalence of sophisticated cameras in everyone’s pockets to create a high volume of user generated content on Netflix. The original Netflix challenge focused on scaling data analysis; could the next generation of the Netflix Challenge focus instead on scaling content creation?
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Citations
[1] Netflix Media Center, “About Netflix,” https://media.netflix.com/en/about-netflix, accessed November 2017.
[2] Reed Hastings, “How I Did It: Reed Hastings, Netflix,” https://www.inc.com/magazine/20051201/qa-hastings.html, December 1, 2005, accessed November 13, 2017.
[3] Kevin McEntee, “Complexity in the Digital Supply Chain,” Netflix Technology Blog, Netflix, December 17, 2012, https://medium.com/netflix-techblog/complexity-in-the-digital-supply-chain-958384cbd70b, accessed November 13, 2017.
[4] Ken Florance, “How Netflix Works With ISPs Around The Globe To Deliver A Great Viewing Experience,” Netflix Media Center, March 17, 2016, https://media.netflix.com/en/company-blog/how-netflix-works-with-isps-around-the-globe-to-deliver-a-great-viewing-experience, accessed November 13, 2017.
[5] Paul Sawers, “Netflix And Orange Extend Distribution Deal To 29 Markets Across Europe, Africa, And The Middle East,” VentureBeat, September 14, 2017, https://venturebeat.com/2017/09/14/netflix-extends-distribution-deal-with-telecom-giant-orange-to-cover-29-markets/, accessed November 13, 2017.
[6] Austin Carr, “Inside Netflix’s Project Griffin: The Forgotten History Of Roku Under Reed Hastings”, Fast Company, January 23, 2013, https://www.fastcompany.com/3004709/inside-netflixs-project-griffin-forgotten-history-roku-under-reed-hastings, accessed November 13, 2017.
[7] Todd Spangler, “Netflix Unveils 2017 Recommended Smart TVs With ‘Instant On’ Features,“ Variety, March 20, 2017, http://variety.com/2017/digital/news/netflix-2017-smart-tvs-recommended-instant-on-1202011889/, accessed November 13, 2017.
[8] John Koblin, “Netflix Says It Will Spend Up To $8 Billion On Content Next Year” The New York Times, October 16, 2017, https://www.nytimes.com/2017/10/16/business/media/netflix-earnings.html, accessed November 13, 2017.
[9] David Carr, “Giving Viewers What They Want,” The New York Times, February 24, 2013, http://www.nytimes.com/2013/02/25/business/media/for-house-of-cards-using-big-data-to-guarantee-its-popularity.html, accessed November 13, 2017.
[10] Paul Vieira, Joe Flint, “Netflix Makes Canada Pledge,” The Wall Street Journal, September 28, 2017, https://www.wsj.com/articles/netflix-makes-canada-pledge-1506626315, accessed November 13, 2017.
Image: “Film Sunset Landscape Mood” by geralt is licensed under CC0 1.0
Cool topic! I’ve always been interested in learning how Netflix uses data to predict content production. However, I wonder how much of content production is art vs. science and what Netflix’s competitors (mainly Amazon Video, HBO NOW) are considering when it comes to production and scaling. Richard Plepler, CEO of HBO, has recently stated (https://www.bloomberg.com/news/features/2017-11-21/hbo-ceo-richard-plepler-on-growth-sexual-harassment-and-life-after-game-of-thrones) that in addition to a multilateral distribution strategy, HBO really focuses on its core values about the creative process. They constantly think about the unique content they can produce and trust the artists’ voices, enabling them to make killer shows such as Veep, Game of Thrones, Silicon Valley, and Girls. No amount of data could predict that dragons would become the next big thing 🙂
Interesting essay about a topic that is going to define the digital media creation and distribution industries in the following years. I think that Netflix has done the right thing by moving up the value chain and starting to create its own content. Moreover, Netflix data analytics, but still human-based, approach to content creation is the right one and is giving the company good results.
Threats from big content creators to go direct-to-consumers by-passing Netflix or other content distributors must be taken seriously. However the industry structure is not willing to be sustainable if every content creator intends to go direct to consumer. No matter how digital or technology advanced consumers become, they won’t be willing to have dozens of accounts, one per content creator. Therefore, companies such as Netflix must keep working on increasing their biggest asset: its customer base of millions of viewers.
Even the biggest content creators such as Warner and Disney will find it difficult to reach a certain critical mass based only on their productions. Once they realize how difficult to reach that critical mass is, it will be even more difficult for them to renounce to such an important source of revenues as selling their rights to Netflix, or other content distributors.
Great summary of the content supply chain Netflix delivers to its customers. While content creation will remain a large piece of the puzzle for Netflix going forward, I see a lot of risk further downstream in Netflix’s supply chain. Thus far, Netflix has built up a large subscriber base by delivering content in great technical quality through broadband and wifi networks into consumers’ homes. The issue of net neutrality aside, as consumers inevitably continue to demand more content in better quality faster, it’s imperative for Netflix to continue to improve its delivery system.
One of the portfolio companies of my prior firm built large data centers at the edge of major urban areas so that companies like Netflix can store data closer to the end consumer and significantly reduce data transport costs. While this addresses the short-term concerns for Netflix, can this model be scalable enough to satisfy escalating future demand?
Very interesting topic! I agree content acquisition can be helpful as Netflix moves upstream to expand content library, especially with quality contents that can generate higher margin and commercial values. As the largest online distribution platform, Netflix has established formidable competitive strength which gives them very high bargain power with upstream and downstream players.
However, I do think quality of their internally generated contents or Netflix labeled contents is something Netflix needs to be aware of. UGC is an interesting idea to establish social network and enhance stickiness, but content quality is definitely not guaranteed and direct competition with Youtube may not be a good idea.
In terms of variety of contents, Netflix can also work on it as for their in-house content creation. Taking the leading online media distribution platform in China as examples, they have produced movie, reality show and even sports contents, which may be some interesting areas Netflix can start or continue to develop.
While Netflix was on campus several weeks ago, representatives from their content planning team said that, despite the fact that the media often pits Netflix against traditional content creators, Netflix will never move away from its partnerships with those content creators. Netflix benefits from increased supply for its content library since consumers are won over by the diversity of titles available through Netflix. It is unlikely that Netflix can sustain the same volume within its content library purely from its own, original productions. Netflix relies on its relationships with content producers.
As Dong alluded to above, Netflix does have much to worry about from its downstream supply chain partners. Net neutrality regulates ISPs control over end customers access to various websites. Prior to net neutrality laws, ISPs could slow down a websites speed to a consumer unless the website paid the ISP, effectively holding the websites ransom. For websites like Netflix, ISPs hoped to push back the additional costs related with the infrastructure investments and maintenance required to stream large amounts of data at speeds acceptable to end consumers onto media streaming services. Government regulations, however, prohibited this, but there is ongoing conversation about whether net neutrality regulations will be removed.
Definitively an interesting subject and agree with the need for Netflix to explore both sides of the value chain to find opportunities to hold its competitive position. A couple interesting questions as they begin to move into content creation would be: is it possible for Netflix to use their big data capabilities to support this process in this next phase?, and also, should they do so in the first place given their incumbent core business?. On the first question we have seen a few examples in class, as well as in other papers in this TOM challenge, about the challenges of leveraging data for content or artistic creation beyond the “if you liked this you’ll like that” model, interestingly, when reviewing the average rating on rotten tomatoes for movies released each year, there’s a slightly increase from the 2000s where the average rating for movies was 50%, up to 60% in 2010 onwards (http://www.slate.com/articles/arts/culturebox/2011/06/slates_hollywood_careeromatic.html). The trend shows correlation (not causation) with the broader availability of data on consumer tastes, but the mechanisms through which big data can actually help create better content are still to be widely proven.
On the second question around whether Netflix should even move to content creation in the first place, rather than partnering with dedicated, specialized content creators, my opinion is that given the point you make on the diminishing value of content distribution, the only remaining high-value item in this supply chain is the quality of the content itself, and thus it is of Netflix to enter this space in order to support its competitive position in the longer term given the lack of barriers to entry on the distribution side.
Thinking about Netflix’s content creation approach reminds me a bit of learnings from design thinking. Creating content is a form of innovation, a combination of art and science that produces a creative output that is new for the consumer. In the same way that you can explicitly design for innovation, you cannot explicitly design for creativity. However, as we saw with IDEO, you can create an approach and process that increases the odds of finding breakthroughs. As Netflix seeks to continue to win in the content creation game, it will be critical that they continue to refine their process to create an environment that fosters new, creative content. The ability to foster creativity is not typically thought of as a supply chain differentiator, but for Netflix I believe it will be.
Thank you for explaining the Netflix supply chain because I had no idea they were both moving “forward” into content consumption. I remember from our FRC case that they are actually not yet generating huge profit and investing much more in the content “assets.” I wonder how much this decision to move forward in the chain has to do with an effort to finance those projects. I also contemplate the decision to expand offerings or stick to one core competency (in this case aggregation). The long-term profitability of media content comes in the form of advertising and licensing revenues, two streams for which Netflix is not using its original content at the moment. Currently in their model, the original content and partnerships with consumption device companies are both driving more people to become Netflix subscribers as opposed to increasing their profit as a percentage of sales. I don’t know what goal they’re chasing in investing so heavily in original content.
Thank you for your incredibly clear description of all the players in the digital content supply chain! I would like to address your suggestion that Netflix should look into acquiring a smaller studio’s movie catalogue in response to Disney’s upcoming direct to consumer service. This would probably not make sense for Netflix because it has purposely reduced the volume of movies in its US library by 40% over the last 4 years (http://bgr.com/2016/12/06/netflix-movies-list-library-shrinking/). This is likely because acquiring movies is less efficient on a consumer viewing hours / $ paid basis and a larger portion of subscribers prefer to watch shorter episodic content and comedy specials instead. Secondly, many of the direct to consumer services (HBO Now, Showtime Anytime, upcoming Disney service) rely much more on branded, high quality movie content rather than movies produced by these smaller indie studios.
Very interesting topic. The first thing that comes to mind is the Netflix network effect. This can be exemplified in the fact that the term “Netflix” has become a part of millennial colloquialisms. The Netflix customer promise has historically been low prices, no commercials, and a wide-variety of content selection. Old content can arguably be considered a commodity, and while some customers might be disappointed with the Netflix’s decreasing selection, their new content simply amplifies their network effect. House of Cards and Orange is the New Black were viral hits that spread through word of mouth and social media. I think continuing to invest in their own content is the most salient business strategy as it sets them apart from the fierce competition in Hulu and Amazon. In terms of integrating forward, I think Netflix could burst into the virtual reality space. I could see them creating specific hardware for their original content, bringing in additional revenue from product sales, and providing an even more differentiated experience to their end user.
Content creation is an inherently fickle business since it is fundamentally driven by the media interests of consumers which can change rapidly. This makes the digitization in the supply chain of Netflix inherently challenging since as more of their business becomes content-driven, their business will become more subject to the whims and pressures of consumer interests. I’d imagine Netflix is a uniquely positioned player to compete and win in this new era, however, since their core competency has always been the data-driven approach they bring to media. The same algorithms that recommended to consumers which shows they are likely to enjoy based on their interests and viewing history can also be used to help them predictably architect headline-grabbing content at scale. They should look to aggressively build algorithms to automate portions of the content creation process in their supply chain based on predictive algorithms on meta-data about consumer interests. This approach is particularly attractive given that they arguably have better data than any of the competition, making this a tough-to-replicate strategy that could yield huge returns.