Netflix (NFLX): From Disruption to Defending its Competitive Advantage

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The Rise of Netflix: Disruption

Netflix was known as a DVD movie rental company competing directly with the giant “brick and mortar” Blockbuster in the 1990s. The business model had very little differentiation from Blockbuster, except the customers did not have to walk to the store nearby to collect and return the DVD.

It provided convenience, time-saving, and no late fees, which was why Reed Hastings founded Netflix. Disruptive innovation was an unknown term at that time. It was a theory written in 1995 by Clay Christensen, a Harvard Business School Professor, in a book called Innovator’s Dilemma.

The theory describes that a small new entrant enters the industry directly competing with the incumbent by taking the low end of the market, which is often overlooked by the incumbent. The incumbent often focuses on profitability and only makes sustaining innovation to make the same products and services cheaper and better with very little innovation.

There is almost no differentiation from the original creation. However, the new entrance tends to focus on new technology and innovation to compete in the same market. It is often easier for the new entrants to experiment and change their business model completely due to its small size, less bureaucracy, and fewer politics than larger organizations.

Netflix falls under the category of disruptive innovation due to the low end of the market entrance, its ability to adjust its business model quickly with technology and innovation, and less focus on sustaining innovation. As the internet infrastructure snowballed, Netflix could capture the opportunity by launching video streaming platforms as we know them today.

Netflix was able to provide the same movie quality, faster, and at a lower cost. Netflix does not even have the movies or the infrastructure to support the video streaming business. But thanks to Amazon Web Services, a cloud company, and a long-term contract with Hollywood Studios, Netflix was able to gain significant market share against the incumbent and its primary competitor Blockbuster.

Ironically, Blockbuster had the opportunity to buy Netflix for $50 Million before the internet era as Netflix struggled to compete directly in brick-and-mortar space. However, Blockbuster’s Board believed that Netflix was not a good fit for the company at that time.

That was the end of Blockbuster.

A $3 Billion company eventually had to fall on its knee and file for bankruptcy because the company refused to innovate, was reluctant to evolve, and failed to see the disruption before the ground was shifting below them.

Blockbuster was comfortable, complacent, and overconfident. Disruption occurs everywhere in any business, from oil and gas to electric mobility, camera film to digital photography, brick-and-mortar retail stores to online shopping, cash payment to digital payment, and many more.

The disruption evidence clearly shows how the top S&P 500 list has changed to technology from energy companies just a little over ten years ago.

The Future of Netflix: Defending its Competitive Advantage

Google has a famous dinosaur statue in its main headquarter. Google wants to make it a daily reminder to every Google person that they will become extinct the moment they stop innovating and evolving. It is not Blockbuster’s fault to become extinct, but it is their culture, organization, and leadership’s decision to refuse to adapt to the new reality. They don’t even know what disruption is.

Steve Jobs did amazing things with Apple. He hired someone with no background in technology to head their consumer product division. Why? Because he wanted something different, not better. Steve Jobs wanted someone with a different perspective to bridge the gap between what the consumers want and what Apple can deliver.

The stories from Google and Apple apply the same way to Netflix. The end of a business is started the day it stops innovating. Netflix has won the battle against Blockbuster, but the story does not end here. In microeconomics theory, new entrants will be flocking to the industry as soon as there is economic profit.

In other words, there will be copycats and weeds competing in the industry as long as the industry is profitable.

Please take a few names such as Crave, Hulu, Apple TV, Disney+, and even their key partner who provides their cloud infrastructure that came up with Prime Videos. These competitors are coming hard and eroding Netflix’s market share and profit margin. The disruptor becomes disrupted. How does Netflix survive the competition?

In the five years stock return performance, Netflix has gained 370% in return, second behind Amazon at 567%. Apple is in 3rd place at 341%, followed by Google at 156% and Disney at 30%. Netflix is still performing well among its peers with a narrow margin. Netflix’s operating margin is 14.5% compared to Apple’s of 24%, Google’s of 21%, Facebook’s of 38%, Amazon’s of 4%, and Disney’s of 11%. 

In simple words, investors prefer to invest in Google, Apple, and Facebook rather than Netflix because their operating margins are far more competitive than Netflix. For every dollar invested, the investors almost doubled with Apple and Google or tripled with Facebook in returns. However, in the video streaming segment, Netflix is still the dominant market player ahead of Disney and Amazon.

How does Netflix defend its competitive advantage? Their biggest moat so far is their original series.

Netflix has successfully financed the studios to make box-office movies and series exclusively for its platforms such as House of Cards, Mindhunter, Stranger Things, and many more. It can also expand into a global audience, bring global culture back to the platform, and enrich the movie and television experience.

The streaming service brought series from Australia, Norway, France, Spain, and Asia that were not available on any platform, movie, or television. Netflix’s platform is also available on any mobile device and beyond stay-at-home television. Netflix’s current business model disrupts cable channels as more customers cancel their cable subscriptions. The customers are satisfied with Netflix’s content and the ability to watch the show on mobile devices.

How would Netflix defend its competitive advantage in the ever-growing rivalry in original content from major competitors such as Amazon Prime Video, Disney+, Apple TV, or even YouTube?

Reference

Photo by YTCount on Unsplash

BBC (2015). Five Jony Ive Designs You Probably Don’t Know. Retrieved from: BBC

Christensen, C., Raynor, M., McDonald, R. (2015). What Is Disruptive Innovation? Retrieved from: Harvard Business Review.

Zentlin, Minda (2019). Blockbuster Could Have Bought Netflix for $50 Million, but the CEO Thought It Was a Joke. Retrieved from: inc.com.