Now that we have considered several macro-environmental factors affecting Netflix, it is beneficial to analyze the attractiveness of the industry. The theoretical framework Porter’s Five Forces is an industry model that highlights the competitive structure of a market, and we will use it to attain an overview of the industry (Kotler et al., 2010). The model includes five forces affecting the competition in the industry, where the strength of the forces determines the attractiveness of the industry. Porter’s Five Forces will help us determine the future possibilities and encounters of the video entertainment industry, including Netflix involvement in existing users, new users, revenue and costs (Porter, 1985).
3.2.1 Threat of new entrants
Due to advances in mobile, video, and wireless technologies, the popularity of streaming services continues to cultivate (PricewaterhouseCoopers, 2018). Industries that yield high returns, like the video entertainment industry, will attract new entrants and this will eventually decrease the profitability in the industry. Unless this can be avoided, abnormal profitability will fall towards zero. Porter points out several important factors to reduce the risk of new entrants; the existence of barriers to entry, capital requirements, economies of scale, high switching costs, product differentiation, and brand equity (Petersen & Plenborg, 2012).
Netflix charges a premium for its services based on its reputation and the quality of its products, which exposes the firm to the risk that a competitor provides the same level of service and quality of the product but at a lower price. Simultaneously, the companies in the industry rely on patents and copyrights, as well as confidentiality procedures, and this reduces the probability of new firms producing perfect substitutes at a lower price.
3.2.1.1 Licensing agreements and tools
Despite the fall in barriers to enter, there are still high costs related to both developing the brand equity of a technology business, as well as it is costly to own content. The streaming content is a significant element for customers when deciding which service to subscribe to. Consequently, an abundance of movies and series will give a firm a tremendous competitive advantage against newcomers. Content ownership requires long-term licensing agreements, and a high number of subscribers allows firms to spend higher amounts on licensing agreements for content. For example, Netflix spent 100 million dollars to continue showing Friends for another year on their streaming service (Bloom, 2018). The high cost of content gives established firms an advantage since the industry has high capital requirements, and it might, therefore, be too expensive for small start-ups with a low customer base to provide the
same amount of content.
The focus on innovation and internal content production indicates a vital entry barrier because the high focus on R&D require both significant investments as well as extensive knowledge about the industry.
Additionally, it is harder to acquire financing to invest in intangible assets because of the uncertainty.
Moreover, the original content produced by streaming services increases product differentiation in the industry since this is usually limited to the respective streaming service. Further, the original content is usually more successful shows further strengthening the streaming services that produce their own content, which can be seen from all the awards the shows have received over the years (Spangler, 2018).
3.2.1.2 New business models
A digitally based business model requires less capital and can achieve significant economies of scale (Evans, 2015). The moderate cost of developing a streaming service business presents a considerable possibility for new entrants to find success in competing in the media entertainment industry. However, the streaming services often include a free trial and no binding contracts, which increases the entry barriers, since this is costly for the competitors.
The constant changes in the business and the high growth leads to a risk of new traditional industry competitors, but also competitors from outside the industry, equipped with new digitally based business models and value propositions. Bode (2018a) predicts that nearly every broadcaster that’s currently in the cable TV industry will offer some direct-to-consumer streaming services by 2022, because of the advantages they already have compared to start-ups.
Disney is launching their streaming services at the end of 2019, called Disney+, which will be the exclusive streaming home of content from Pixar, Marvel, and the Star Wars universe. As a consequence, Disney produced content will be removed from Netflix by the end of 2019. Hence, Disney will have to give up the 300 million dollars in annual revenue it currently receives from Netflix (Hruska, 2018).
Disney’s valuable media properties will give them an advantage in the streaming industry and Disney have already acquired several movie studios to strengthen its base (Spangler, 2017). Likewise, AT&T has announced that they will launch their streaming services at the end of 2019. The company owns blockbuster franchises like Batman and Harry Potter, and famous shows like Friends and The Big Bang Theory (Clifford, 2018).
Telecom companies, like AT&T, have a unique advantage in the industry considering they control the content and the network that content travels over. This control gives them an excellent opportunity to hamstring competitors and advantage their services. With a weakened FCC and no net neutrality
rules, ISPs, like AT&T, will be free to suppress or block competing services, drive up competitors costs for essential content and network access, or to punish users that do not use ISP’s services. Corporate consolidation makes the problem even bigger since AT&T have bought DirecTV and Time Warner, giving the telecom giant ownership of programming like HBO and CNN. Without net neutrality’s transparency requirements, ISPs will not have to clarify the limits of a connection, meaning competitors and consumers may not even realize what is occurring (Bode, 2018b). Hence, the competition might become challenging for Netflix in the upcoming years.
3.2.2 Threat of substitutes
A substitute is a product from another industry that offers similar benefits to the customer as the product produced by the firms within the industry (Wilkinson, 2013). The threat of substitutes can arise through new ways to meet the consumers’ needs in the market, or by users substituting themselves away from the product and thus making the product redundant. Substitutes can reduce the online streaming service’s market capitalization. Since 2013, Netflix has aimed to win "moments of truth,"
meaning that Netflix wants to win the time customers spend on entertainment (Gallagher, 2019).
Accordingly, Netflix’s substitutes are other sources of entertainment.
Online streaming services like Netflix competes with a handful of entertainment viewing formats that are relatively interchangeable including Video-On-Demand and pay-per-view. Many people simultaneously subscribe to a combination of these services, and since they are close substitutes and there are minimal switching costs, small fluctuations in prices can cause consumers to abandon one viewing format and quickly replace it with another (Carroll et al., 2009). Additionally, other substitutes are indirect competitors like radio, music, video games, books, articles and other activities such as spending time with family. Netflix has disclosed that Fortnite is one of their biggest competitors, although they produce video games (Patches, 2019). By the end of 2018, Netflix had nearly 139 million paying subscribers worldwide, whereas in November 2018, Epic’s blockbuster battle royale game, Fortnite, had nearly 200 million registered users (Patches, 2019).
3.2.2.1 Digital goods and copyright
The digitalization has led to various changes in the video entertainment industry. One of the critical shifts is in the production function, where digital goods can, unlike non-digital goods, be consumed by one person without reducing the amount or quality available to others. Hence, allowing for information to be shared without diminishing the original information. Digital goods can be copied by anyone, not only the producing firm, at a cheap cost without reducing the quality of the initial good. The
internet can be compared with a giant copying machine (Goldfarb & Tucker, 2017). The conditions of low variable production costs enable individuals to enjoy information-based goods for free (Goldfarb &
Tucker, 2017).
Two prominent examples of free public digital goods are YouTube and Pirate Bay, which affect the cost/benefit ratio that people are evaluating when choosing entertainment. These kinds of services are a significant threat to the video entertainment industry, where YouTube is used way more than any paid subscriptions (Hwong, 2018). As stated in the PESTEL, original content has resulted in more people using piracy to view some of the streaming services’ original content as it is expensive to subscribe to several streaming services. Because of the low reproduction costs of digital information, one posted copyrighted item could be useful to millions of people, potentially replacing sales, as seen in the music business in the early 2000s. Most studies have found that free online copying reduces revenues for the video industry, and this leads to a risk for the video entertainment providers, as customers can switch to no-charge substitutes. Copyright law is essential in digital markets because goods can be copied at zero cost (Goldfarb & Tucker, 2017).
3.2.2.2 Direct user relationship
According to PWC media outlook 2018-2022, those who succeed in the industry are focusing on direct user relationships, shaping commercial bonds with fans, utilizing data to provide superior user experiences. Netflix is already focusing on a direct user relationship, and, as mentioned in PESTEL, they apply data to improve the customers’ experience of their service. Netflix’s recommendation engine direct subscribers to content they might never encounter, and as the subscribers keep watching content, Netflix can enhance the value from the collected data resulting in continuous personalization improvement of the platform. As a result, the time invested by a subscriber on the platform serves as a barrier for any substitutes in the streaming industry. Nevertheless, there is a threat that small or low-cost companies might be better positioned to develop the fan-based user streams that are so vital in a converging world (PricewaterhouseCoopers, 2018).
Simultaneously as we see a growth in demand for a direct user relationship, people also favor services where they not only interact with the supplier but similarly create a network with other users. The rise of several social media platforms reflects the peoples need for interacting with friends and other individuals. The streaming services could be replaced with other platforms where one can interact – or merely spend more face-to-face time with loved ones. In this case, it could be a weakness that online streaming is not an inherently social experience. However, the use of interactive television, as mentioned in the PESTEL, can potentially be the start of a social media platform.
3.2.3 Bargaining power of customers
Customers have countless options when it comes to online streaming services, whether it is Netflix or Amazon Prime, the NBC Sports Gold Cycling Pass or the NBA League Pass, HBO Now, Hulu or CBS All Access (PricewaterhouseCoopers, 2018). The increasing supply of products makes features such as price, ease of use, innovation, functionality, support, reputation, and performance important determinants when deciding subscription service.
An analysis done in December 2018 concluded that a rise of 1 dollar more per month for a Netflix subscription, would lead to 16 % of the subscribers to either downgrade to a lower tier or cancel the subscription (O’Halloran, 2019). The analysis indicates that some of Netflix’s customers are price conscious and this increases the bargaining power of the customers.
3.2.3.1 Switching costs
A challenge Netflix faces is the fact that the cost of switching services is low. There is no annual contract, and the cost of signing up for the service is minimal with no extra required purchases, such as routers for Cable TV. Furthermore, many of the video streaming service providers offer a free trial.
Customers could easily subscribe to one streaming video service one month and then switch to the next when the free trial expires. Netflix has to make sure its selection is compelling enough for subscribers to justify keeping the year-round service (Investopedia, 2016).
3.2.3.2 Original content
As the digitalization continues, the demand for individually tailored entertainment and movie experiences rises (PricewaterhouseCoopers, 2018). With the new data-economy comes a reduction in tracking costs, where the businesses can collect data on the consumer, and use this new amount of data for personalization and customization (Goldfarb & Tucker, 2017). The expectations of a custom-made streaming service might be a way for the distributors to differentiate their services, and data analytics help support better decision-making concerning the content, distribution and user experience (Varian, 2014).
Netflix is the market leader when it comes to the usage of technology, being the company with the most sophisticated technology system in the industry, as mentioned in the PESTEL analysis. Brynjolfsson et al. (2011) find that firms that adopt data-driven decisions have output and productivity that is 5-6%
higher than what would be expected given their other investments and information technology usage.
Furthermore, the relationship between data-driven decisions and performance also appears in other
measures such as asset utilization, return on equity and market value (Brynjolfsson et al., 2011). If Netflix manages to use its data collections efficiently, the firm can reduce the risk of a low renewal rate, where customers switch services to other competitors.
The advantage of having collected humongous data on their customers can also stand as a threat to Netflix. With the data collection, and Big Data analysis comes problems related to the invasion of privacy, and it is crucial to determine the tolerable levels of intrusion, and how to find the right balance between invasion and Big Data value (Günther et al., 2017). Netflix bases many of its decisions on customer data, and if there were to come new laws, for example restraining firms from collecting individuals data, Netflix could suffer from increased content costs.
3.2.3.3 Lower tracking cost
Despite the advantages of tracking an individual’s data, there are likewise challenges for the profitability of firms. Pitfalls for the businesses are that it is easier for customers to find information, and therefore harder to price discriminate (Goldfarb & Tucker, 2017). Consumers have access to a great deal of information about the different services, and they can examine services and platforms based on online information.
3.2.3.4 The value of one customer
Network effects can explain one of the reasons for Netflix´s high user growth. Individual’s willingness to try a service often depends on a perception of how many other individuals are using it, and Netflix has successfully built momentum, which has caused the rate of adoption of the streaming service to accelerate (Mohammed, 2018). Hence, there is a direct network effect for Netflix, where the value of the user network is heightened with each additional adopter (Chesbrough & Appleyard, 2007). In addition to increasing the rate of adoption for new subscribers, Netflix furthermore improves the trust among existing subscribers. These circumstances imply that Netflix’s customers influence the value of the overall service.
Furthermore, as Netflix attracts a wide variety of subscribers, the firm benefits from indirect network effects, where more content creators want to collaborate with Netflix in creating new content, as well as they prioritize Netflix when deciding where to display their shows (Cornell, 2015). As the content library expands, more people are attracted to the service. The more users, the more data, the more user experience, and the more right recommendations are conducted (Mohammed, 2018). These network effects increase the bargaining power of the buyers.
Crowdsourcing is further increasing the value of one subscriber (Kenton, 2018). The definition of crowdsourcing is obtaining work, information or opinions from a large group of people (Kenton, 2018). Previously, every problem was solved internally, but crowdsourcing allows for external parties participating in finding solutions. Netflix previously exploited this opportunity when they incorporated crowdsourcing to develop its recommendation model (Fisher, 2015). If Netflix manages to continue embracing the power of crowdsourcing, the firm can connect deeper with their users, and empower their brand simultaneously as they lower their R&D costs.
In addition to switching costs, and access to information, the bargaining power of consumers is dependent on the concentration of the buyers. A customer group is concentrated when they purchase large volumes relative to the seller’s total sales (Porter, 1985). In the streaming services industry, it is not common to have a small number of customers representing a high percentage of the company’s total annual revenue. Hence, implying that the concentration of the buyer for online streaming services is low, which further weakens the bargaining power of the consumers.
3.2.4 Bargaining power of suppliers
Supplier’s bargaining power is likely to be high when a few large suppliers dominate the market (Porter, 1985). In the video entertainment industry, the competing firms are dependent on content in order to be successful. The streaming service companies purchase distribution rights for content through direct purchases, licensing agreements and revenue sharing agreements. Primarily, the agreements are obtained from studios, networks, and distributors, and the firms content costs are conditional on the price set by these suppliers (Carroll et al., 2009).
3.2.4.1 Contract prices
Netflix is reliant on continuous cost negotiations with the suppliers, which makes them particularly vulnerable. The suppliers who license the content are in full control of the terms and conditions and may withdraw the availability of the content as they please, an example of this is Disney withdrawing all their content from Netflix within 2019. There is a massive rise in streaming services, and in the third quarter of 2017 alone, one million US viewers canceled their multichannel subscription television services (Deloitte, 2019). Hence, the suppliers will have high bargaining power.
Netflix needs to maintain contracts with the most famous studios and networks to assure a high supply of series and movies. The pricing of these contracts is sometimes set depending on the number of subscribers, while some are independent of this. Netflix might end up paying the same price for the contracts if their subscriber base shrinks, which could lead to a more significant loss in downturns. At
the same time, the customers demand a great variety of content, which makes it troublesome for Netflix to cancel the contracts to save costs during tougher times. If the number of subscribers declines below a particular value, Netflix might end up with a negative result.
3.2.4.2 Supplier alliances
Another aspect increasing the power of the suppliers is the opportunity to develop strategic alliances or partnerships. With the data-economy follows a new set in thinking, as the competition transforms into a community of collaboration, where firms partner up (Iansiti & Lakhani, 2014). The effect of partnerships among suppliers and other competitors might be that they can choose to exclude Netflix from getting relevant content – or charge a higher premium.
Large access providers and platform companies are integrating vertically, while established giants are integrating horizontally, and companies that previously offered only technology and distribution are moving into content (PricewaterhouseCoopers, 2018). Several television studios and movie networks debut with competitive products, as mentioned in PESTEL (Investopedia, 2016). This increases the rivalry in the industry, as the suppliers get a much higher bargaining power. The suppliers can choose to keep the content exclusive for their platform, which will give them a competitive advantage compared to firms which are dependent on external content to their services (Sorrentino, 2019).
Another opportunity is for the suppliers to charge a much higher premium on the products, which likewise will have a negative outfall for the firms in the video entertainment industry. The effect of this might be small in the short run, as many of the content contracts are long term (Investopedia, 2016).
The last couple of years, Netflix’s content catalog has been shrinking, indicating that content owners are either removing their content or not renewing licenses, preferring to host them on their platform (MUSO, 2019).
In 2016, Netflix switched from using physical data centers to using the Amazon Web Services Cloud (AWS) as a consequence of the increasing volume of data they were handling (Thelwell, 2016). As of 2018, Netflix runs the vast majority of their computing on AWS. Given this, along with the fact that they cannot easily switch to another cloud provider, any disruption of or interference with Netflix’s use of AWS would impact their operations. Even though Netflix has stated in their annual report that they do not believe that Amazon will use the AWS operations to gain competitive advantages against their services, they still have the opportunity to gain advantages (Netflix, 2019). This competitive advantage may be more necessary for Amazon as the industry will face increased competition from Disney+ and At&T’s streaming service.
For the individuals who want to replace their cable TV with an online streaming service, the offering of live or new content might be necessary. Several of Netflix’s competitor offer next day viewing of current hits (Investopedia, 2016). Studios have control over the window of time between theatrical release and in-home video releases, and because they earn substantially more on DVD sales, they often give priority to DVD formats over online streaming services. If Netflix manages to change to outcome-based models with the suppliers, they might be able to align their interests with the suppliers. This way they can convince the suppliers that a shorter window between theatrical release and online release is beneficial for both parties (Iansiti & Lakhani, 2014).
3.2.4.3 Internal production
The fact that video entertainment services have begun to produce content reduces the suppliers bargaining power, as the firms can choose to substitute suppliers’ contents with their own productions.
In cases where the suppliers charge unreasonable prices for content and contracts, some firms might choose to invest in in-house production. We see several examples of Netflix providing successful series, where they have won numerous Emmys, Golden Globe and Academy Award prices (Spangler, 2018).
Additionally, with Netflix’s high budget on internal production, the bargaining power of the studios, networks, and distributors will be lower in the future.
The content officer at Netflix, Ted Sarandos, stated that in 2018 more than 90 % of Netflix’s customers regularly watch original content (Spangler, 2018). Netflix has stated that content comes at a 30-50
% markup when outside studios are used (Lovely, 2018). Hence, the original content will allow the company to increase subscriber numbers and decrease the cost in the long run, and consequently becoming more profitable. 11 % of all the titles existing on Netflix in the US are original programs.
That is significantly more than Hulu and Amazon Prime, each having 1 % original content in their libraries (Anderton, 2019).
3.2.5 Industry rivalry
The internal rivalry among the competitors is of great importance for the competitiveness and profit margin of the industry. Several surroundings will impact the industry rivalry, among some, are the numbers of actors in the industry, the similarity between the firms, the industry growth, the barriers to entry, the threat of substitutes, and the switching costs for the customers and suppliers.
In the last couple of years, the world wide web has led to changes. Industries such as the video entertainment industry are experimenting with new business models based on joining collective creativity through open innovation (Chesbrough & Appleyard, 2007). Despite openness in the industry and the
collaboration among video entertainment providers, there is a considerable number of corporations providing similar types of online streaming services. Besides, the customers switching costs are insubstantial. These circumstances will according to Porter (1985) contribute to increased industry rivalry.
The number of subscribers is highly dependent on the content provided by the streaming service, which makes the corporations vulnerable towards the bargaining power of the studios, networks, and distributors. For the corporations to capture a larger market share, they need to offer a diverse media center of content. The use of Big Data analytics will be highly influential in the future as the industry will face more competitiveness from new entrants, and the need for firms to differentiate themselves with personalized and exclusive content is essential.
Regardless of firms’ differentiation themselves from other streaming services, a threat of substitutes can still arise through new ways to meet the consumers’ needs. The low cost of replication and reproduction has led to several substitutes to video entertainment, for example, social media services. If customers get accustomed to watching videos for free on for example Facebook Inc., rather than subscribing to Netflix requiring monthly fees, this could potentially reduce the demand for video streaming subscriptions in the future.
Overall, the video entertainment industry is characterized by a moderate to high rivalry. Moderate barriers to entry, suppliers becoming competitors, a high threat of substitutes, low switching costs as well as high exit barriers through high investments and regulations all contribute to increasing the rivalry among the streaming services. There are relatively many actors in the industry, but the correspondingly high customer growth and the opportunity to differentiate their content allows the firm to remain profitable. Furthermore, openness and collaboration among distributors and content producers can expose the firms to both a threat and an opportunity, depending on how the firms access the circumstances.
3.2.6 Conclusion
Table 3.3: Porters Five Forces Summary
FORCE STRENGTH
Threat of new entrants 6/8
Threat of substitutes 7/8
Bargaining power of suppliers 5/8 Bargaining power of customers 6/8
Industry rivalry 6/8