In 1997, two software engineers, Reed Hastings and Marc Rudolph, founded Netflix after Hastings was charged a $40 late fee for ‘Apollo 13’ at Blockbuster. Originally Netflix was in the DVD delivery business. Customers would pay to have any one of more than 90,000 DVDs delivered straight to their house. Two years later in 1999 Netflix adopted a monthly subscription structure allowing customers to have unlimited movies delivered to their homes for $19.95.
In 2002 Netflix went public and their IPO doubled their revenue according to Hastings in his annual report. 2007 saw rapid changes in technology and Netflix decided to move into online streaming. Customers were charged a monthly rate for subscriptions that covered unlimited movies and TV shows. Customers could view their movies on numerous devices – Smart Phone, Tablet, Laptop or Smart TV. Throughout these constant changes, Netflix’s subscribers and annual income continually climbed. Reed Hastings, Netflix Co-founder and CEO stated in his annual report “2009 was an amazing year for Netflix” (Hastings, 2009). This was due to Netflix making it possible to online stream through Xbox and Play Station. This new addition added 2.8 million new subscribers in 2009 increasing revenue 22% to $1.7 billion.
Netflix increased its market share with its’ first international move into Canada in 2010. In 2012 Netflix took advantage of its connections in the film industry and started creating its own Tv Series and Movies like ‘House of Cards’ and ‘Narcos’.
Supply and Demand
As Netflix’s product style changed so did their Supply and Demand. To understand how these two major factors changed you must understand the previously stated history. Demand in economics is referred to as the quantity that is desired by the consumers. Supply is the quantity the overall market can offer to those consumers. These two basic concepts are the back bone to economics and a growing company will do what is necessary to increase Supply and Demand as efficiently as possible. That is exactly what Netflix did.
In the beginning Netflix had a limited supply of 90,000 DVDs, if the DVD you wanted was already taken, you had to wait until it was available again. Since Netflix started online streaming, the supply is relatively unlimited. If you subscribe to Netflix, you have thousands of shows to choose from, and so does everyone else. As many people could be watching the same show at once and it would not run out. Netflix’s demand can also be represented by subscribers. No matter who demands an account, it is still available for you to have one.
Since Netflix’s subscribers can represent their Supply and Demand, the graph above shows an increase in Netflix’s number of subscribers in the past 6 years. The number of subscribers is constantly rising as Netflix moves into other markets.
Netflix’s largest competitor would be Blockbuster at the time. At its peak in 2004, Blockbuster employed 84,300 people worldwide with 9,094 stores in total compared to Netflix’s 55 distribution centers across America. Although Netflix could ensure delivery of a customer’s choice of any one of more than 90,000 DVDs within a day, its supply of DVDs was limited. The cost to replace broken or scratched DVDs was a main cost for Netflix. To address the growing costs of expanding to compete with Blockbuster, Netflix began to offer a subscription service. Their most popular plan was $19.95 for unlimited movies to be shipped to your house.
While Blockbuster had the costs of stores and employees to consider in its pricing, Netflix did not. Because of this market advantage, Netflix could provide quality DVDs at a much lower costs. This plan increased revenue for Netflix drastically as well as their demand. Below is a chart of Netflix’s DVD delivery pricing scale.
Plan DVD Price Blu-ray Price Total discs per month Number of discs out at once
Starter $5 $6 2 One
Standard $8 $10 Unlimited One
Premier $12 $15 Unlimited Two
In 2007 Netflix moved into online streaming which changed everything. Customers with Wi-Fi enabled tablets, smartphones or laptops could watch Netflix anywhere at any time. Since Netflix offered their own movies and TV shows, you didn’t have to wait for re-runs, you could watch any show they had as many times as you wanted. Supply was no longer a factor for Netflix. Demand exploded! For a monthly payment of $7.99 which was cheaper then cable you could watch any show instantly. Everybody was leaving cable TV to move to Netflix.
Basic (streaming) $8 1 SD
Standard (streaming) $11 2 HD
Premium (streaming) $14 4 HD + Ultra HD
The chart above is Netflix’s current online streaming pricing system per month. It has slowly changed over the years as sales increased also to cover production costs of the Netflix Originals.
Early on Netflix was doing everything it could to just break even. In 2002, when Netflix first went public Reed Hasting states in his first annual report to investors “we doubled our revenue to $152.8 million, from $75.9 million in 2001. We ended the year with approximately 857,000 total subscribers” (Hastings, 2002). This was a major improvement but not enough. 2003 was Netflix’s first year of profitability. Hastings in his annual report records the numbers that made it possible, “The Company recorded revenues of $272.2 million, up 78 percent compared with $152.8 million for 2002” (Hastings, 2003). This was possible due to subscribers being “nearly 1.5 million members, up 74 percent over 2002” (Hastings, 2003). That was in the beginning, before Netflix did online streaming. Four years later in 2007, Netflix’s first year of online streaming, the company “added 1.2 million new subscribers ending the year with 7.5 million” (Hastings, 2007) and “Revenue grew 21% to 1.2 billion” (Hastings, 2007). Netflix has since then made an app, moved in to the international market, updated and changed their website constantly and started producing films. Through all this Netflix has had constant increasing revenue through the years due to rising numbers of subscribers. Fast forward to 2017, Netflix’s latest annual report states “Netflix, Inc.- is the world’s leading internet television network with over 117 million streaming memberships in over 190 countries enjoying more than 140 million hours of TV shows and movies per day, including original series, documentaries and feature films” (Netflix, 2017).
Elasticity of Demand
Elasticity is defined as the measurement of how responsive demand is to a change in price, the more elastic a good the more responsive it is to a change in price, the less elastic or inelastic a good is means it is unresponsive to a price change. The main types of elasticity are perfectly elastic, elastic, unit elastic, inelastic and perfectly inelastic. Netflix’s Streaming services are considered inelastic. Netflix has a loyal “cult” following in a since but originally that wasn’t the case. It has become a normal good, many people are moving away from cable solely to get Netflix. It has changed how people watch movies and TV. You can watch a whole series in order and not have to wait for re-runs.
In May of 2014 you can see where Netflix increased its price $1 from $7.99 to $8.99. This price increase caused Netflix to go from 1.3 million that quarter to 1 million. That is a loss of 300,000 subscribers for a $1 increase. To calculate the percent change in demand the equation would be (1.3 Mil- 300,000/ 1.3 MilX100) which equals a 23% decrease. Then you would take the percent change in price from $7.99 to $8.99 which would be an increase of 12.5%. Finally, the percent change in quantity demanded/ the percent change in price, 23%/12.5% which would out to equal 1.84. Since the elasticity is greater than one, Netflix’s Elasticity of Demand it is considered relatively elastic. This means that Netflix should not increase prices too much since it could really affect their sales. $1 cost Netflix 300,000 subscribers imagine if it were $5.
Costs of Production
The initial cost of production for Netflix was a lot more expensive then it is today. With 55 distribution centers for their DVDs and around 25,000 employees Netflix spent a lot of money getting their product out, not mentioning the cost of the 90,000 DVDs and all the packaging. A year after going public in 2002, Netflix, “achieved profitability for the first time in 2003” (Hastings 2003).
When Netflix got into streaming it cost them a lot for the initial algorithm, but they didn’t have to keep making DVD’s, as many subscribers could watch the same thing as much as they wanted before online streaming if Netflix was out of copies of the movie you wanted it was too bad, and you would hopefully be the first one to get the next available copy.
Although the cost of production sky rocketed when Netflix decided to make their own series. After taking a huge risk of $100 million to make two 13-episode seasons of House of Cards, Netflix was weary. Although it payed off when the first season was nominated for 8 Emmy’s and the second season was nominated for 13. Those nominations justified everything they had done over the past few years with the creation of the show. Netflix went on to produce many more originals such as Orange is the New Black, House of Cards, Stranger Things and Narcos to name a few. Now all of Netflix’s most popular shows are their original series so they keep on making them which costs a lot but also pays off since so many
In the beginning when Netflix first started, Blockbuster was their main competitor. Other than getting DVD’s from Walmart, if you wanted a larger selection it was Blockbuster and Netflix. Although, Netflix had a few key advantages. First off Netflix could guarantee your movies within a day, their prices were cheaper per DVD especially when they adopted the monthly rate, and this could all be done from the comfort of your home. Then in 2002 a new company joined in, Redbox. Redbox had a unique design of DVD “Kiosks” that could be put in shopping centers, convenient stores, malls etc. Redbox had the cheapest prices and most of the newest releases but not quite the selection that Netflix did.
Amazon Prime video started online streaming in late 2006 and Netflix quickly followed in early 2007. A few months after Netflix got into streaming Hulu joined the competition that was pretty much a bidding war. This was the newest form of entertainment. No Ads, Quick access, you could pause and resume whenever, and it was all way cheaper than cable. People stopped going to DVD stores, which ultimately resulted in Blockbusters demise in 2010. Redbox isn’t a real threat to Amazon, Netflix or Hulu but it has stayed consistent with its sales since it has the newer movies when they get released. A few smaller streaming services have come a long such as HBO Go, STARZ and very recently YouTubes Red TV, none of which are true threats to the major three.
As of 2017 it is clear who in the top three firms dominates the market. As previously stated in the Sales section, Netflix’s annual report states, it is “the world’s leading internet television network with over 117 million streaming memberships in over 190 countries” (Netflix, 2017). According to a recent study done by Leichtman Research Group, “54% of U.S. adults said they have Netflix in their household” (Spangler, 2017). This statistically states that over half of the U.S. adult population has Netflix.
There are multiple types of market structures that exist; Monopolies, Oligopolies, Perfect Competition and Monopolistic competition, each with key, distinctive characteristics. It can be argued that Netflix is in a Monopolistically competitive market considering they control over 50% of the market and twice have changed how we watch TV and Movies. Although there are very few producers in the market there still are other major producers that all influence the market. Also, there are very high barriers to entry and exit which is another reason this points to an Oligopoly. Meriam Webster defines an Oligopoly as “a market situation in which each of a few producers affects but does not control the market” (Meriam, n.d.). This definition very accurately describe this market that Netflix has found themselves in, considering they have a little bit of control over the market, but not enough due to the competition they face.
Conclusion and Recommendations
1n 1997, Netflix started out as a good that was sometimes more convenient than going to your local DVD store, more of a luxury item. It was a slow start for Netflix in the beginning, taking 6 years just to gain a profit. Then when Netflix moved into the online streaming business in 2007, everything changed, it became where Netflix was now a normal good. Many people stopped using cable and turned to Netflix, in a process they refer to as “Cord-Cutting”. Netflix stock, subscribers, income and demand have all constantly been rising. There have been a few dips when Netflix raised their prices proving they have a relatively Elastic good, although revenue increased, just at a decreasing rate. Netflix has tapped into the international market starting with Canada and is constantly finding new countries to move to. All of this said, it is not surprising that Netflix dominated the online streaming market by controlling over 50% of it alone.
With all that was previously stated I would say that Netflix has a grip on what they are doing, although I would recommend that they constantly widen that gap in the market share by adding shows the rest cannot. If all three had the same show, a consumer could go to all three and get the same good, so if Netflix was the only one with a certain show the consumer would have to go to them. Netflix already does this with their “Netflix Originals” and I would say keep investing in the shows, because it is giving them a solid advantage over the market. Another recommendation would be for Netflix to keep moving into different countries and expanding the audience they have in the 190 countries Netflix is already in.
Whether it be DVD delivery or Online Streaming, Netflix has dominated with their business plan. Netflix was not the first one to the Online Streaming game and that did not stop them from being 50% of the market. Netflix has proven that a strong business plan and product adaptation will put you above the rest.