Netflix Case Analysis

Key Strategic Issue
This article is about the past business history and current business situation Netflix company is in. The case begins talking about how Netflix started with a bang making positive profits and revenues, but has recently hit some trouble due to strategic mishaps negatively affecting the company. The article then begins to describe the industry and various competition within it, and how they do business. There is some information on market trends in home viewing of movies, but most importantly the meat of the article discusses Netflix’s business model and strategy in detail. The one primary problem/key issue facing Netflix is how it will continue to remain the subscription-based leader in the instant movie streaming/DVD delivery industry. There are many rival competitors emerging offering a wide variety of services and options to consumers, and it is important Netflix modifies its business model/strategy and uses its brand recognition/positive traits efficiently. The best-case scenario is Netflix modifies its strategy to once again differentiate itself from competition. Also, it would be ideal that for the global markets targeted to generate massive revenue/profits. The likely scenario is that Netflix will steadily improve internationally, but retain a firm hold of those markets before anyone else has. Also, it is likely that Netflix will remain prominent but will be in tough competition with rivals such as Amazon Prime and Hulu. The worse case scenario is the global market completely failing, specifically in central/south America. Additionally, it would be very bad if Netflix maintains its current model with no changes because competition would simply offer a better service than what they currently have.

Alternatives
The first alternative is for Netflix to bring back the unlimited streaming plus 1/2/3-8 DVD title at a time options for a cheaper price. This format is what boosted sales for Netflix initially. The segmentation of DVD rental subscription and streaming subscription had failed. Therefore, Netflix should bring back the combination subscription at lower rates.
A strategic advantage is that this method will help retain Netflix brand loyalists. Also, Netflix will have a competitive edge since they have the most streaming content at one of the lowest prices. Lastly, this strategy gradually filters out DVD renters and promotes the business strategy of ultimately being a subscription-based movie streaming service.
A disadvantage of this is prolonging the business of DVD rentals. This market is slowly eroding, and eventually there will be no market for it. Moreover, this lower price for more services creates a funding problem. Netflix will have to decide what to do to keep these costs low. The second alternative is to buy out Hulu Plus because it is one of the most important subscription-based instant streaming rivals, and to eliminate the DVD delivery service entirely. Hulu is a main competitor because it offers an advertising-supported unlimited streaming service at the same original low cost price Netflix used. Also, Hulu contains a much larger selection of premium movies and primetime TV shows. Netflix’s business strategy is to ultimately end DVD rentals so the sooner the better considering the current technological trend, and there is a potential for large profits from elimination of operating expenses (marketing, general, and administrative) associated with DVD rentals. For example, the postage and distribution centers located all over the country could be shut down creating money to be used in other areas. A strategic advantage for buying out Hulu is utilizing its advertisement connections/strategy to maintain a low subscription price. This is one of the brilliant things the owners of Hulu have done to be such a strong rival. Additionally, buying Hulu gives more licensing rights to more movie content. This would in effect further the attractiveness of the Netflix product with an even larger library to choose from. A disadvantage would be the high cost of bargaining and price to buy such a profitable company like Hulu. Major corporations already have ownership interests in it (including Time Warner), and buying an equal partnership share would be expensive. Additionally, Netflix would have to deal with more bureaucratic red tape when utilizing Hulu’s product because of dealing with these other owners. Recommendation We will consider the following criteria for making our choice: the pros/cons of sole instant streaming services vs. dual streaming and DVD delivery, the pros/cons of buying out Hulu, and the pros/cons of a lower cost with the dual plan. The first consideration is about whether Netflix is ready now to be streaming only. The second consideration is about whether buying a large competitor is cost-effective. The third consideration is about whether Netflix should revert to what made them successful in the first place. With that being said, we choose the buying out Hulu and eliminating DVD delivery alternative. This is the best choice because Hulu is the most similar to Netflix, which offers an easy transition phase with added bonuses from its advertising income generating scheme. Also, the future is now and Netflix needs to get rid of DVD delivery to cut costs and focus on what is important. Additionally, the streaming market is headed towards a situation where movie companies have the leverage with licensing bargaining. Thus, Netflix would have more options to remain the largest and best quality library available. Netflix’s current cash cow is the streaming side, and it no longer relies solely on the once profitable DVD delivery to fund content licensing. One of the biggest reasons Netflix customers still hold on to DVD delivery is because the streaming library did not provide ALL the movies they were looking for. However, Netflix has been making high profile content deals expanding its movie library. Hulu’s media and licensing rights will only further a stream dominant business as the right move. The other alternative is a bit too simple, and it retains a delivery service that is phasing out due to technology and consumer demand. The price structure is a good idea, but that can be accomplished (with funding from advertising) from buying Hulu. The time frame for initiating and closing the deal is 1-½ years. This time frame gives enough leeway for the parties to discuss all relevant terms, and provide enough time to show the projected positive direction Netflix is heading internationally in profits and sales. A specific goal from doing this is to be the dominant leader of the market share within the subscription-based movie streaming industry. Also, Netflix wants to increase annual profits by 25% within a year of buying Hulu. The expected costs of bargaining and purchase are going to be exceedingly high. However, new customers, advertising revenue, more movie content licenses, and a larger market share outweigh temporary acquisition costs.
Implementation/Action Plan This is a merger and acquisition environment we are dealing with. Netflix’s acquisition of Hulu will be accomplished using a “leveraged buyout”. According to Investopedia (2013), a leveraged buyout is defined as “The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company.” This allows Netflix to buy Hulu without spending a lot of capital. A leveraged buyout does pose risks because it generally has a high debt to low equity ratio. However, Netflix will buy Hulu with some of its own equity and not entirely loans. The projection is a 70% debt to 30% equity ratio for acquisition. This eliminates Hulu’s assets as the only collateral being used, but merely a significant amount. Netflix’s CEO Reed Hastings has a net worth of $940 million so using 30% of Netflix’s equity for a potentially groundbreaking acquisition should not be a major issue. Additionally, reasonable interest rates will be sought from whatever monetary source (credit union) Netflix decides to use to avoid crippling interest costs. Netflix should be able to negotiate for lower interest rate loans because of its financial credibility and sound credit history although it is slightly suffering recently. As discussed previously, the time frame to begin and close the deal is 1-1/2 years. Therefore, Netflix will send a proposal January 2015 with the goal of reaching an acceptable deal by June 2016 at the latest. This will require an excellent legal team hired out by a top Big Law firm specializing in corporate takeovers, and hiring excellent financial analysts to calculate the costs and potential profits. Netflix’s legal team will present statistical calculations/predictions to Hulu’s representatives outlining the positive impact of a deal. Our objective is to increase current revenue by two million dollars and current gross profit by three million dollars by 2018. Netflix could run into a problem coordinating and organizing such an important negotiation and takeover. Netflix is currently operating in Central and South America in an attempt to expand globally, and this is very time consuming. Therefore, an expert team needs to be organized for the sole purpose of handling the leveraged buyout process. This team should be diverse, have specific goals, a reasonable size, have delegator powers, and be of superior quality from multiple areas. Areas will include financial experts, legal experts, Netflix operations experts, and so on. The elimination of DVD delivery will be a simpler task to implement. Netflix has 39 operating distribution centers nationwide currently. They are costing money from operating expenses, postage, and employee salaries. This will be done in a phased format. The first phase will be a notification to all Netflix DVD delivery users that there will no longer be a delivery service in two months from the notice. The same notice will contain simple facts and details of how the streaming service is a better alternative with superior selection, low subscription price, and easy account transition.

APPENDIX
Financial Analysis
In 2009 Netflix’s debt to equity ratio was 226.4/199.1= 1.14 (millions), and in 2011 its debt to equity ratio was 1225.1/642.8= 1.91 (millions). The debt to equity ratio has risen by .77 (million) the past three years. This was caused by Netflix’s international expansion into European, Central American, and South American markets. That expansion cost money to be able to reach out to a lot of people with limited Internet access or lack of credit cards. However, this is still a low ratio compared to the industry average and therefore leaves room for Netflix to finance the Hulu acquisition with 70% debt and 30% equity.
In 2009 Netflix’s Gross profit margin was 34.21%, and in 2011 the Gross profit margin was 39.02%. This 4.81% increase is an indicator of Netflix’s newer strategy to charge a more premium fee for its services (%15.98 a month for streaming and 1 DVD rental compared to $7.99). Thus, Netflix is increasing in its amount of dollar of sales from the past three years. This information will be useful in arguing financial attractiveness for the loan, and at the bargaining table with Hulu.
In 2009 Netflix’s Operating margin was 11.6%, and in 2011 the Operating margin was 11.8%. This 0.2% increase is an indicator that Netflix is beginning to not make as much of a profit in DVD in rental as it did in the past. The DVD rental had been Netflix’s primary business funding the streaming licenses, but now higher profits are being made with the streaming to customer subscriptions. The time frame and the numbers depict the shift of profit, and is another reason why we felt that the DVD delivery should be eliminated with a focus on streaming.