Netflix- Disruption done right

Submitted to: Prof. Sriparna Basu

Shivendra Singh
FMG 27 271165
Letter of Transmittal

November 28, 2018

To,
Director HR
Netflix India,
Mumbai, Maharashtra- 400051

Dear Ma’am,

Enclosed is my report on the Disruptions in the Digital Entertainment Business by Netflix. The
report contains my analysis of the current environment in the digital entertainment business
and the culture of the company that has enabled it to set itself apart in the changing business
environment. The corporate governance that has been the bedrock for the expansion of Netflix
to 190 countries has also been studied and analyzed. Critical insights of the present policies
have been provided and recommendations for the company for making the most from the listed
opportunities have been made. I am certain that the company shall benefit from these
recommendations.
I take this opportunity to thank Prof. Sriparna Basu for the assistance extended to me by her
and her constant guidance has been valuable to me in concluding my research.

Sincerely,
Shivendra Singh

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Contents

Letter of Transmittal ................................................................................................................................ i

Executive Summary ............................................................................................................................... iii
Introduction ............................................................................................................................................. 1
Discussion ............................................................................................................................................... 2
Netflix- An overview .......................................................................................................................... 2
Corporate Governance in the Midst of Disruption.............................................................................. 3
The Company Culture ......................................................................................................................... 5
Netflix: The Disruptor......................................................................................................................... 6
Changing environment for Digital Entertainment Business ............................................................... 7
Recommendations ................................................................................................................................... 8
Conclusion .............................................................................................................................................. 9
References ............................................................................................................................................. 10
Appendix ............................................................................................................................................... 11

ii
Executive Summary

Netflix has been disrupting the digital entertainment industry since its inception in
1997. The company initiated its business by providing DVDs on mail and later moved into
online streaming of content. In 2014, the company started producing original content thus
making the switch from content distributor to content producer. It has taken a number of radical
decisions on its way which would not have been possible without a robust support from the
company’s Board of Directors and the executive management. The organization culture of the
company which advocated more independent decision making and open information sharing
between the management and employees has been instrumental in helping the company to
capitalize on the opportunities present.
The current business environment for digital services has been favorable for innovation led
companies and has also posed a lot of challenges for the traditional entertainment companies
who have to adapt with the changing technology and consumer preferences. The economic
conditions like growth of disposable income amongst the consumers of emerging markets and
the lowering of trade barriers also provide more opportunities for global expansion.
Netflix is currently fighting for the leisure time of the viewer and is competing against other
streaming providers, linear networks, books, internet browsing and many more. With multiple
innovations like smart downloads, taste clusters, customized content suggestion through data
driven insights and a vast library of attractive original content, Netflix plans to become the
option of choice for its members when they are looking for options to relax and it is in this
moment that Netflix measures its success.

iii
Introduction

A disruptive innovation is not simply a better product, or a more efficient way of doing
something. It’s a new product, or a new way of doing something, that addresses an inherent
problem with an old product or the old way of doing something (Arnold, Thomas. K, 2016).
The technological growth has scaled new heights in recent years and the availability of high-
speed internet has made a favorable environment for the entertainment industry to flourish.
Amidst this, Netflix created disruptions in the digital entertainment industry through its notable
subscription service models for DVDs at low monthly prices and introduction of streaming
services to allow its subscribers to watch television shows and movies on their personal
computers instantly. In 2013, the company identified that the costs associated with licensed
content were high and thus introduced original programming in its portfolio with popular shows
like House of Cards and Orange is the New Black, thus making a shift from a content distributor
to a content producer. It has time and again disrupted its own disruptions and has created a
paradigm shifts in the way companies conduct their businesses in this industry.
Clay Christensen, Professor of Business Administration at the Harvard Business School,
categorizes disruption into two types in his 1995 book The Innovator’s Dilemma vis a vis a
new market disruption and a low-end disruption. In a low-end disruption, a simpler and cheaper
alternative is offered to the consumer in place of the old product. With its subscription-based
DVD by mail model, Netflix allowed the consumer to avoid going to a brick and mortar store
for a movie experience and create vast libraries of movies with the DVDs which was not
possible earlier with the bulky cassettes and higher costs.
In the New Market disruption, the product addresses a market that couldn’t be served earlier.
The streaming services model of Netflix helped in addressing the problems associated with
linear television viewing experience, in which a single slot was provided to a program and the
viewer had to wait for a day or a week to watch the next episode. It cultivated the culture of
binge watching by releasing entire seasons of shows at once and created a new market for itself.
Moreover, with its deft consumer profiling algorithms tracking user activities on its interface,
it is able to recommend and merchandise its content to its viewers tailored to their tastes thus
increasing user engagement and customer retention.
With around 130 million subscribers in over 190 countries over the world in 2017 (Brennan,
Louis, 2018) and a vast library of content and original programming, Netflix is poised to
become one of the leading firms of the internet entertainment era.
In this report, the factors enabling the disruptions made by Netflix shall be investigated which
shall include a detailed analysis of the company’s governance, culture, values along with the
changing external environment. Following which, recommendations are made that will be
instrumental in its success of plans for the future.

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Discussion

Netflix- An overview

The company was set up in 1997 by Reed Hastings and Marc Randolph. The company
offered DVD rentals by mail and started offering unlimited DVD titles for a low monthly rental
subscription fee. Its primary competitor at that time was Blockbuster, a settled player in the
video rentals industry. Through its innovative services of providing DVD subscription by mail
and omitting the late return charges on its DVDs unlike Blockbuster, which had a tough stance
on the late penalty on its subscribers, Netflix soon overthrew Blockbuster from the pole
position in the video rentals segment.
In 2002, Netflix made its initial public offering with 600,000 members in its subscriber base.
This further strengthened the financial position of the company allowing more investment in
R&D to adapt to the changing technology in the industry. Consequently, the company was able
to introduce online streaming on its website for the television shows and movies, something
which was not being provided by any company in the digital entertainment space up till then.
In the years to follow, Netflix partnered with consumer electronics companies to stream its
services on Blu-ray disc players, TV Set top boxes, internet connected TVs and gaming
consoles like PS3, XBOX 360 and Nintendo Wii. Providing on- demand entertainment at any
internet connected device to its viewers became the primary focus of the company.
In 2011, the company decided to expand globally with its initial launched throughout the Latin
America and the Caribbean. By 2016, Netflix had marked its presence worldwide by bringing
entertainment services to 190 countries in total. In the meanwhile, it had also initiated original
programming in its services with the Emmy award winning series “House of Cards” and
“Stranger Things”. This helped the company to reduce its dependence on the licensed content
and also attract more people to its services through highly acclaimed exclusive content.
In the year 2017, growth of revenues from the international segment exceeded that of the
domestic segment with the international segment revenues increasing by 58% as compared to
21% growth in the domestic revenues. The total contribution to the consolidated revenues also
increased to 44% as compared to 36% in the year ending December 31, 2016. The global
growth of the company has posed new opportunities as well as challenges to bring engaging
content to the people around the globe. Operations in new geographies require a targeted
strategy for the local audience and a one fit for all content strategy may not be the right strategy
for the new markets. Furthermore, the constant negative cash flow for three years and a huge
debt on the company introduces areas of concern for the company to maintain sustained
profitability in the long run (Exhibit 3).

2
Corporate Governance in the Midst of Disruption

Netflix has been marked as the innovator amongst the players in the entertainment
business. This innovation culture is bolstered by their CEO Reed Hastings who has tried to
bring the Board of directors and the company management together in his vision for becoming
the leading firm in entertainment business. Moreover, a culture committed to independent
decision making, sharing of information and a focus on process rather than results, has been
pivotal in the company’s journey of breaking new grounds in its business.
The corporate governance at Netflix is different from the conventional boardroom dynamics.
In the typical corporate setting, the Board of Directors are appointed to oversee the
management and represent the shareholder’s interests. Their primary responsibilities lie in
hiring and replacing the CEO as needed, monitoring performance, approving strategy,
assessing financial reporting and risk management. This work is done through the periodic
meetings held over the year where the directors are briefed about the company’s performance
through presentations by the top executives of the company. These meetings broadly cover the
entire performance of the company through long presentations which are infused with
comprehensive data and charts leaving less room for analysis for the board to understand the
situation. Moreover, the questions are restricted to one to two, owing to the constraints of time
present. This leaves an information gap between the management and the board and impedes
their ability to take appropriate decisions in the interests of stakeholders. In addition to this,
there are possibilities where the data presented to the Board might be scripted as per the
discretion of the executives, resulting in erroneous decision making by the Board.
Netflix, on the other hand, takes a different approach in handling corporate governance. The
company has focused on increasing the transparency among the CEO, executive teams and the
board of directors in regard to the company performance. It has adopted two main facets in its
corporate governance procedures. Firstly, the board members are invited to attend monthly and
quarterly senior management meetings in observing capacity. Secondly, a 30-page online
memo in narrative form is provided to the Board Members as a part of the board
communications. This document includes the links to the supporting analysis as well as open
access to information on the company’s internal shared systems. The Board members can ask
clarifying questions to the subject authors well before the meeting leaving more time for
analysis and decision making in the periodic Board meetings. This also underlines the
confidence levels of the Board of Directors in the company management allowing them to
understand the company and the market thoroughly.
The executive meetings at Netflix are held across the year in three formats:
1. Reed’s Staff (R-Staff) meetings: These are the monthly meetings of the CEO and the
top seven executives of the company to discuss the strategical challenges and
organizational issues being faced by the company.
2. Executive Staff (E-Staff) meetings: These are the quarterly meetings of the top ninety
executives of the company which involved presentations and breakout sessions to
review strategic issues, competitive threats, workplace issues and policies.
3. Quarterly Business Review (QBR) are two-day gatherings of top 500 employees of the
company that include a quarterly review of the business, presentations, discussions and
group dinners.

3
The R-staff meetings are observed by one board member, E-Staff meetings by one to two Board
members, and two to four board members in case of the Quarterly Business Reviews.
These meetings allow the board members to observe the company business closely and stay
abreast of all the developments taking place in the company. The purpose of their presence is
purely educational and such processes shall help in providing the board with a better
understanding of the issues concerning the company and take sharper strategical decisions.
The second facet in the governance are the Board Memos and open access to data. These
memos are mostly 20-40 pages online documents that are written in narrative style by the senior
management. The business performance, industry trends, strategical issues are highlighted in
the text which are complemented with embedded links to the analyses for the insights for details
and discussions. These memos are received by the board few days prior to the Board meetings
and are carefully studied by them for the preparation of the Board meetings. This process saves
up valuable time for analysis and questions during the board meeting and helps in better
decision making.
Netflix, on its way to disruption made few decisions that would not have been possible without
the present level of synergy between the board and the executives. It faced significant
challenges in its rise with the initial challenges from Blockbuster. Later on, it invested heavily
on licensing third party content for its streaming services and burning cash on original
programming. All these decisions would not have been taken if the Board not been aware of
the company’s business through the Board processes. The Board had confidence on the
management’s strategy and its maverick approach towards the business. However, in light of
the confidentiality issues, the CEO has also cautioned the Board who have a high level of access
to management decision and documentation to show restraint in influencing decisions outside
the boardroom.

4
The Company Culture

The Human resources Department at Netflix has been instrumental in creating an effective
culture that promotes innovation and radical thinking. The company follows a far-out approach
towards its organizational culture and introduces an unusual set of values that are to be
observed in the employees. These are-
 Encouraging independent decision making by the employees
 Open access to information
 Open feedback and criticism system
 Retaining highly effective people and,
 Avoiding rules
The company culture is aligned with its aim to create entertainment content at lowers costs and
greater scales than any company has provided before. For this, a culture underlined by freedom
and openness of ideas is adopted by the employees.
Netflix focuses on creating dream teams of employees who are collaborative and highly
effective. These teams are always in pursuit of common goals and deriving continuous learning
from the process. As much as the company is particular about hiring the right talent, it is also
apathetic in replacing the employees with generous severance packages. It doesn’t focus on
creating families where despite their faults unconditional love amongst the members is
observed. It concentrates on creating excellent teams where every member is driven towards
the common goals and helping their teammates by open sharing of information. But in the
midst of this, there is always a possibility that someone may have to leave the team.
The company also encourages the employees to take responsibility for any problem being faced
by the company and always act in the best interest of the Netflix. Every big and small problem
of Netflix can be attended by any employee and there is no question of by passing the
responsibility for the encountered problem.
Lastly, the company is against structure and process, and does not value conventional routines
and procedures followed by other organizations. There are no rigid spending policies, vacation
policies and parental leave policies directed by the company. The employees are also allowed
to choose their compensation structure as per their requirements, balancing between the stocks
and salary options. The only exception in the “No-Rules” policy is that of observing ethical
and safety issues. In addition to this, the periodic review meetings and the employee
discussions are followed as per the routine and no deviation is observed in regard to this.
It is this set of values that has nurtured the innovative spirit of the employees and driven them
to create disruptions in the digital entertainment business.

5
Netflix: The Disruptor

Netflix initiated its disruption campaign in 1999 when it introduced the DVD by mail
concept in the video on demand business. At that time, its primary competitor was Blockbuster,
which provided movie titles from its brick and mortar stores and was notorious for its late
return charges. Netflix, on the other hand, followed a different business model with a
subscription-based model which allowed the customers to keep movie titles with them as long
as they wanted to and also saved up on the hassles of going to the stores to get the DVDs issued.
This strategy of Netflix of allowing the people to rent DVDs in a more convenient manner
allowed them to acquire a position in the market which was difficult for the present competitors
to respond to. Ultimately, Blockbuster fell prey to the disruption created by Netflix and the
company which once had thousands of retail locations to its name, went bankrupt in 2010.
Netflix made enormous gains from this episode with dominance in the digital entertainment
space without making any major investments in retail locations and was able to serve its
customers with greater variety and convenience.
Later on, in the year 2007, Netflix re-introduced the concept of disruption in its strategy. This
time however, it decided to disrupt its own business of DVD rentals by launching an online
video on demand platform that allowed the customers to view its content on their personal
computers. The DVD business was facing tough competition from companies like Apple,
Walmart and Amazon, therefore, developing a video streaming platform seemed the right move
for the company. Presently, the number of subscribers for the online streaming services is over
117 million while the number of subscribers for the DVD rentals is just over 3 million. In
hindsight, with the growing technological disruptions, switching to the streaming services
deemed to be fruitful for the company.
After moving into the business of streaming licensed content on its platform, the company soon
initiated original programming as a part of its offerings. The company aimed to do away with
the linear television platforms where shows were distributed slots on a weekly or monthly basis.
Netflix identified another opportunity in this and started releasing its television series with the
entire season at once, thus introducing the “binge” culture in the consumption of entertainment
content. Highly engaging content was made available and with features like “smart download”
where the content could be downloaded to the device and viewed offline, eliminating the
dependence on internet connectivity to provide a smooth viewing experience. Moreover, the
company is also testing high quality streaming services on up to four screens simultaneously
to give a better customer experience and increase viewership.

6
Changing environment for Digital Entertainment Business

The recent developments in technology have unsettled the conventional players in the
digital entertainment business. This has also marked the rise of innovators like Netflix, Spotify,
Amazon and Apple, who were the early movers and adapted to the changing dynamics of the
business. However, more opportunities lie for these companies to grow and capitalize on the
early lead they have taken.
Presently, the Digital streaming business is highly dependent on various factors like internet
connectivity, availability of mobile devices and original programming by the streaming
services. According to an analysis by Euromonitor International (Bindels, Dominque, August
2018), the number of internet users have doubled in the last decade with the developed nations
leading in internet access. The connectivity in the emerging markets has been driven by the
mobile devices with China and UAE leading the way for high quality and fast internet services
(Exhibit 4). However, 5G services are yet to reach the markets of India, Brazil and South Africa
which provide a huge subscriber base for any of the companies to tap in. As per statistics,
mobile devices are key drivers of growth of digital services across the world as an average
internet user is more likely to access internet through his smartphone than any other device. As
per the data in the above analyses report, it is seen that countries like India, Mexico, South
Africa and Indonesia have large fractions of their population who are not yet online and are
likely to access internet in the coming years (Exhibit 5). This introduces an opportunity for the
streaming companies to create a market for their products in these countries and achieve
growth.
The recent technological advances have also seen the traditional entertainment companies like
Disney, Comcast, ABC to flock up against the innovators like Netflix, Spotify and Apple
(Exhibit 6). The innovators must identify the opportunities in this turbulent environment in
order to attain sustained profitability and achieve economic growth.
The challenges that are identified for the companies in digital entertainment business are-
1. Internet connectivity issues
2. Piracy and illegal downloads of content
3. Licensing issues of content between competing players
4. Development of original content to retain the existing subscribers as well as attract more
subscribers through word of mouth or network marketing
The opportunities for the companies lie in the following areas-
1. Live sports streaming
2. Vertical integration of companies to expand its content libraries and resources
3. Technological advances in developing algorithms for suggesting content tailored to the
user activities using technologies like Big Data and Artificial Intelligence

7
Recommendations

1. The rising trend of access of internet services through mobile devices highlight the
importance of mobile based user interface for delivery of streaming services to the
subscribers of Netflix. More research and development should be focused on providing
quality streaming services on these devices and areas of readjustment of quality in
response to available signals.
2. Local content plays a big role in attracting more subscribers to the services. However,
with debts increasing and constant negative cash flow over the period of three years,
the company should limit the expenditure on original programming in order to service
its debts and focus on licensing exclusive content till optimum financial leverage levels
are attained.
3. The company’s organization culture is in line with its radical approach towards decision
making. The board of directors are well aware of the business of the company which
result in more confidence on company’s management. In light of the extensive data
sharing with the Board for the review meetings, it should be ensured that the integrity
of the company is not compromised and the members of the Board do not misuse the
information available to them outside the Boardroom.

8
Conclusion

The growth of the technology has introduced a plethora of opportunities for the digital
streaming services in the developed and developing world. In view of the technological
challenges for the company, retaining talent can be one of the major hinderance to the
company’s goal of providing on demand entertainment content. Moreover, the content
development according to the local preferences plays a major role in its success in the
international segment.
The company culture of Netflix has created a sound environment for innovation led growth in
the current business environment. Its culture is in line with the demand of the disruptions in
the industry and allows the company to grow its business with the help of the effective
employees and an able Board of Directors. However, the challenges introduced by this radical
approach have to be addressed through proper monitoring and data security mechanisms so
that the integrity of the company is not compromised.

9
References

Company Annual Report, Form 10-K, Netflix, 2017-18

“The Power of Disruption”, Thomas K. Arnold, Home Media Magazine; Newton Vol 38, Iss
5, May 2016
“How Netflix expanded to 190 countries in 7 years”, Louis Brennan, Harvard Business Review,
October 12 ,2018
“Disruptors: Digital revolution disrupts Media Industry, inspires new competitors”, Dominique
Bindels, Euromonitor International, August 2018
“Netflix approach to governance: Genuine transparency with the board”, David F. Larcker,
Stanford Closer Look Series, May 1, 2018
Netflix. (2018, January 25). Culture at Netflix. Retrieved November 27, 2018, from Netflix:
ir.netflix.com

10
Appendix

Exhibit 1: Variation of Netflix Stock Price over the period 2017-18

Image Credits: Investor relations, Netflix.com

Exhibit 2: Consolidated Revenue statement of Netflix for the period 2017-18

Image Credits: Annual Report Netflix, 2017-18

Exhibit 3: Cash flow statement of Netflix for the period 2017-18

Image Credits: Annual Report Netflix, 2017-18

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Exhibit 4: Quality of Fixed Broadband services in select countries 2017

Image Credits: Euromonitor International, 2017

Exhibit 5: Penetration of Broadband services in select countries 2017

Image Credits: Euromonitor International, 2017

Exhibit 6: Global Market Scenario in the Digital entertainment industry

Image Credits: Euromonitor International, 2017

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