Video Rental Developments and the Supply Chain:

Netflix, Inc*.
In an age where everything from dinner to dry cleaning to prescription medication can be
delivered to your home, it should come as no surprise that the entertainment field is
following suit. While in-home on-demand movie entertainment is certainly not new
VCRs have been around since 1976 and by 2000 nearly 90% of homes with televisions
also owned VCRs5 the advent of DVD technology along with sophisticated internet
commerce has allowed for changes in the way rentals, and rental businesses, work.

Traditional Rental Stores

Traditional video rental, perhaps best illustrated by the ubiquitous video store
Blockbuster, Inc. (BBI), involves brick and mortar stores located in strategic locations,
each staffed by about a dozen employees, carrying about 1000 titles in both VHS and
DVD format4. Members arrive at the location, make selections from the available stock,
pay for their selection, about $4 for a new release, $2 for older movies and childrens
movies, and return home to watch their selection. After the designated rental period the
member returns his selection or incurs late fees. These late fees account for 18-20% of
revenues in traditional video rental stores5.
Traditional video stores base their inventory decisions on formulas using
historical rental data, store size, and box office sales among other factors. As titles
become less popular, inventory can be reduced by selling previously viewed copies to
members for a low cost. Titles that are out of stock are often compensated with coupons
good for a free rental when it is available again. Revenue sharing models, pioneered by
Blockbuster and now common throughout the industry, lowered the cost of VHS
inventory allowing for higher rental volume at a lower risk to the storeowner, but also set
minimum and maximum levels for inventory and demand a percentage of rental revenue
for the first six months of release. DVDs are traditionally sold to rental agencies at the
same price consumers see, a low sell-through price, allowing for lower inventory costs
without the revenue sharing contracts. Blockbuster owns all of its DVDs outright.
However, even with higher inventories, rentals are limited by physical inventory and
excess inventory can still be sold at a loss.

This case was prepared by Julie Niederhoff under the supervision of

Professors Lingxiu Dong and Panos Kouvelis. It is intended as the basis
for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation.

Blockbuster Revenue

BlockBuster Worldwide Stores

6000

10000

5000
4000

5000

3000
2000

0
BlockBuster
Worldwide
Stores

(1)

1997

1998

1999

2000

6049

6381

7153

7677

1000
0
1997

1998

1999

2000

Total Revenue in Millions

Average Revenue Per Store in Thousands

(2)

Figure 1. Blockbusters worldwide stores growth. (BBI 2000 Annual Report)

Figure 2. Blockbuster Total Revenue and Average Revenue per store. (BBI 2000 Annual Report)

Netflix
Now add something new, the Internet, and something old, the postal system, and a
new model for movie rentals takes form. Netflix (NFLX), launched in 1998, is the
worlds largest online subscription-based DVD rental service, currently accounting for 35% of all U.S. home video rentals9 but 90% of online DVD rentals. They offer over
15,000 titles to their one million customers12. For $19.95 per month a member can get up
to three titles at a time sent to his house through first class postal service, up to eight for a
higher subscription rate. There are no late fees and no due dates. Members fill out a
rental queue in their online profile and Netflix sends them the first three selections
immediately. When a member finishes with a movie he inserts it in the pre-paid envelope
and drops it in any mailbox; Netflix mails the next movie on the list as soon as they
process the return. Members can rate movies and update their queues as desired, getting
recommendations from Netflixs CineMatch software. If a member chooses to cancel
service, he has seven days to return his current selections or the retail value of the films
will be charged to the credit card on file. Netflix reports about 7% churn monthly.
Netflix offers only DVD format because shipping of DVDs is 37 cents as opposed to
almost $4 for a VHS4. This somewhat limits the selection Netflix can offerfor example
the original Star Wars trilogy is not yet available on DVD. However, even with this
format limitation, the Netflix library of titles far outstrips the selection of any single
video store.

Figure 3. Netflix subscription and Revenue growth. Source: Business 2.0 How Netflix is Fixing Hollywood

Cost Comparison
Revenue Sharing Contracts: Inventory Costs
For Netflix to effectively compete with Blockbuster in new releases, the fill rate on high
demand blockbuster movies must be high. Customers will quickly become frustrated
by a long wait status on a new release from Netflix when the local Blockbuster has a
surplus of copies. While Blockbuster owns its DVDs outright, Netflix has established
contracts with most studios wherein Netflix agrees to kickback a percentage of
subscription fees for every movie rented in exchange for the opportunity to purchase
DVDs at cost10. The lower purchase costs allow Netflix to purchase a deeper copy depth
on a title and better meet demand for a title without the substantial capital investment of
full ownership. According to Netflixs March 6, 2002 SEC filing, page 36:
After the revenue sharing period expires for a title, the agreements
generally grant us the right to acquire for a minimal fee a percentage of the
units for retention or sale by us. The balance of the units are destroyed or
returned to the originating studio. The principal terms of each agreement
are similar in nature but are generally unique to each studio. In addition to
revenue sharing agreements, we also purchase titles from various studios
and distributors, including Paramount and MGM, and other suppliers,
including Ingram Entertainment, Inc. and Video Product Distributors, on a
purchase order basis.
Under the agreements with most of the top studios, Netflix pays on average $1.40 to the
studios each time a new release is sent to a subscribers home, a significantly higher cost
than the $1.00 Blockbuster shares with studios for a new release rental on VHS.11 See
Table 1 for more information on revenue sharing agreements.
According to Fortune Small Business, these costs account for about 20% of
subscription revenues, making the partnerships costly. The contracts generally expire
one year after a films street date, meaning only new movies are factored into the

revenue sharing costs. Using the CineMatch software, Netflix can guide members to rent
older movies or those released by independent studios, increasing their bottom line and
improving customer service by guiding members toward movies that are more likely to
be in-stock. This leads to the argument that perhaps Netflix should focus more on the
niche market of older, foreign, and independent movies and leave the high demand new
releases to Blockbuster.
Operational Costs: Distribution Centers versus Stores
Netflixs distribution system has cost advantages (Table 2). As opposed to the
over 8000 retail locations for Blockbuster, Netflix has just 20 distribution centers across
the nation, with plans to open one or two more each month in 20036 based on the movie
market in that region. According to Reed Hastings, founder and CEO, the company is
able to keep overhead low as the small distribution center facilities have low rent and
require a low number of employees to operate.7 Each is staffed by approximately 12
employees and each processes about 15,000 DVDs per day9. As distribution centers
move into areas, members in close proximity can expect to see turnaround drop from
about one week to just two days, increasing the number of DVDs they can possibly view
in a month. Netflix has experienced a popularity surge in cities with new local
distribution centers. The drawback, however, is that faster turnover and higher viewing
rates result in more postage fees for Netflix, creating a tradeoff between increased
customer satisfaction and increased costs. Also, a typical revenue sharing agreement
requires payouts for each rental of a new release during the first year, so a higher rental
rate will result in more rentals of a film and therein more revenue sharing costs.

Traditional Revenue Sharing Economics for VHS Rentals*:

For the Retailer
A. Number of Tapes Purchased
B. Price Per Tape
C. Purchase Cost (AxB)
D. Number of Rentals
E. Total Rental Revenue (Dx$4)
F. Retailers Share of Revenue
G. Retailer Profit:
H. Profit per Dollar of Inventory
For the Supplier
I. Number of Tapes Purchased
J. Price Per Tape
K. Revenue From Selling Tapes
L. Number of Rentals
M. Total Rental Revenue (Dx$4)
N. Suppliers Share of Revenue
O. Suppliers Total Revenue:
P. Suppliers Production Costs I x $10
Q. Suppliers Profit

Traditional Pricing
10
$60
$600
300
1200
$1200 (100%)
$600
$1.00
Traditional Pricing
10
$60
$600
300
1200
$0 (0%)
$600
$100
$500

Revenue Sharing
30
$9
$270
500
2000
$1000 (50%)
$730
$2.70
Revenue Sharing
30
$9
$270
500
2000
$1000 (50%)
$1270
$300
$930

Revenue Sharing for DVDs

For the Retailer
A. Number of DVDs Purchased
B. Price Per DVD
C. Purchase Cost (AxB)
D. Number of Rentals**
E. Total Rental Revenue (Dx$4) **
F. Retailers Share of Revenue***
G. Retailer Profit:
H. Profit per Dollar of Inventory
For the Supplier
I. Number of DVDs Purchased
J. Price Per DVD
K. Revenue From Selling DVDs
L. Number of Rentals
M. Total Rental Revenue (Dx$4)
N. Suppliers Share of Revenue
O. Suppliers Total Revenue:
P. Suppliers Production Costs I x $1
Q. Suppliers Profit

Traditional Pricing (BBI)

10
$15
$150
300
$1200
$1200 (100%)
$1050
$7.00
Traditional Pricing (BBI)
10
$15
$150
300
1200
$0 (0%)
$150
$10
$140

Revenue Sharing (NFLX)

30
$1
$30
500
$2000
$1000 (50%)
$970
$32.33
Revenue Sharing (NFLX
30
$1
$30
500
2000
$1000 (50%)
$1030
$30
$1000

*VHS Revenue Sharing table first appeared in Cachon and Lariviere, 2001
**Annual Rental Volume estimate is based on 3 tapes per month plan, average use of 5 DVDs per month with
a 25 day month and 3 day shipping. Demand for this release is assumed to be high to moderate.

Table 1: The Financial Effects of Revenue Sharing Agreements

Figure 4. The logistics of Netflix. (Business 2.0 How Netflix is Fixing Hollywood)

With their current system, each facility fills approximately 98 percent of customer
orders. Orders that cannot be met by the nearest facility are passed on through time
zones until they can be filled. An estimated 84 percent of its rental library is available
within a few days, making turn-around on titles very quick.11 Logistics are clearly an
important factor in a model such as this. Originally, all returns were checked-in and
shelved before the new demands were met, making the first half of the day returns, the
afternoon fulfillment. However, by changing the procedure to simultaneously check in a
movie and then match it to a new demand the process has streamlined substantially. This
system modification reduces shelf time on inventory has slowed hiring and reduced labor
costs by about 15 percent.9 On average about 300 DVDs are unshipped from each
facility at the end of the day, about 2 percent of the volume that flows through the center
on an average day, and are stored in a small box at the facility. Each week, any
consistently unused inventory is returned to the main distribution center in San Jose for
longer-term storage.4

Operational No. of
Comparisons locations
Blockbuster,
Inc.
Netflix
Walmart.com

No. of
employees

89,000
8000+; 1
distribution
center
381
16
distribution
centers
Not available
6
distribution
center

No. of titles
available
About 1000
per location,
up to 8,000
13,500

No. of DVDs
available
Hundreds Per
Location

12,000

Not available

3.3 Million

Table 2: Operational comparisons for the top three competitive DVD subscription services.

Competition
As with any successful business idea, Netflix has its imitators. While there are
many small online companies with a similar product, the two largest direct competitors
are well known: Wal-Mart and Blockbuster (Table 3).
In October of 2002 Wal-Mart announced a test program through walmart.com in
which customers could rent up to 3 movies for $18.86 per month. Films are delivered via
the postal service and new selections are sent out as prior selections are returned. WalMart currently offers a selection of over 12,000 titles, shipped from its six distribution
centers.
Blockbuster is following suit with its filmcaddy.com site, allowing up to four
DVDs at a time for a $19.95 monthly subscription. Titles are limited and all films ship
from its Arizona distribution center. However, expansion to more distribution centers is
under consideration. In addition, in July of 2002 Blockbuster started a test market for its
DVD Subscription Pass program that would allow for members to rent up to two DVDs
for $19.99/month or 3 for $24.99/month. Members prepay for the service and choose
from DVDs available at their local Blockbuster store. While this service does not
provide any benefits in selection or convenience, it does allow for unlimited viewing of a
DVD. With the enhanced content of DVDs many movie viewers appreciate extra time to
view the bonus features such as deleted scenes, cast interviews, and behind the scenes
footage without the late fees. In addition, while Netflix, Wal-Mart, and FilmCaddy
require at least a day to ship the DVD, Subscription Pass caters to the instant gratification
market in that members can choose their movie the day that they wish to see it and
exchange it for a new selection in one transaction. Blockbuster reports that 90% of its
customers decide on their movie less than 4 hours before making a rental2.

DVD
Subscription
Services

Monthly
Cost

Discs
at a
time

Delivery

Delivery
Time

In Store
selection

Instant

3
4

Customer
picks up/drops
off

8000

Postal

2-4 days

13,500

Postal

1-4 days

3
4

12,000 +
12,000 +

Postal
Postal

2-4 days
1-4 days

13,000+

Postal

2-4 days

19.99

24.99
$19.95

Wal-Mart DVD Rentals

Rent My DVD

19.95 for
basic
18.86
$23.95

www.rentmydvd.com
Number Slate

$19.95

Blockbuster DVD
Subscription Pass aka
DVD Freedom Pass
Blockbusters

Number
of Titles
Available

www.filmcaddy.com
Netflix

www.numberslate.com

Table 3. Comparable subscription packages offered by the main competitors.

However, Netflix may be able to defray this direct competition. In June of 2003,
Netflix was granted a patent on their business model for DVD rental. Wal-Mart,
Blockbuster, and any other potential competitors will have to design a model
substantially different from the Netflix model unless Netflix decides to license out the
patent rights. Among over 100 elements of the business model, the patent gives Netflix
intellectual property protection over the way that a customer sets up his or her rental list
and the way the company sends the DVD's.
However, imitators are not the only competition. Pay-per-view, premium cable,
and Video on Demand seek to serve the in-home on-demand movie market. These
services also serve to the stay-in crowd by allowing entertainment selection without
having to leave the house. Pay-per-view and premium cable are available to anyone with
cable, satellite, or digital service; as of 2000 about 75% of households that owned
televisions subscribed to a cable service8. However, cable and pay-per-view are
constrained in their selection to viewers, and the selections are not interactive: they
cannot be paused or replayed and do not offer the bonus features of a DVD. On-line
video rental services, such as Movielink, offer a limited number of films for download to
home computer. Critics of such services say that they are too slow to download and
argue that most people will not want to watch a movie on their computer. Forwardthinking proponents argue that as the line between home entertainment and computers
continues to blur, and as more homes get broadband, the online video rental services will
gain popularity. Video-on-Demand has attracted a lot of attention, offering a wide
selection of films that can be downloaded to a television set via a set-top box. However,
the technology required for this service is costly and not widely available, limiting the
market. As broadband becomes more prevalent and the cost of set-top boxes decreases,
video on demand is expected to gain ground in the on-demand entertainment market.
Netflixs Reed Hastings acknowledges the appeal of going digital, but notes that while
every household has postal service, very few have broadband. Also, delivery costs on
downloadable DVD-quality movies can be more than $30, as compared to the 72-cent
roundtrip cost of the current model. But as the costs of digital delivery drop, Hastings
says, in five to ten years, well have some downloadables as well as DVDs. By having
both, well offer a full service.10

Customer Relationships
Anyone that has used traditional video rental agencies knows that the system has
problems. With a strategy known as managed dissatisfaction, video stores choose to
stock fewer copies of films than projected demand in the first few weeks following
release. Stocking to meet projected demand would result in huge volumes of excess
inventory after the initial rush. Customers unsuccessfully seeking a specific title
generally leave with a second or third choice, with the stores gambling that the customer
will be disappointed but still willing to come back the next weekend. If a customer does
not have a second choice in mind when he comes in, he is left walking the aisles, an often
frustrating and very time consuming part of the evening.

Now consider Netflix. With the online personal profile, movie rental history as
well as the members personal ratings of movies is fed into the CineMatch software,
available free to all subscribing members. A list of recommended movies can be pulled
up and added to the rental queue with a mouse click. When the time comes to send out a
new selection, if a particular movie is out of stock, the next movie in the members rental
queue is substituted. This guarantees that while it may not be the top movie on his list, he
is not settling for just any movie in stock. Netflix claims that they ship more than 90
percent of all titles from the first three spots of members rental queues. However, the
method by which the high demand movies are allocated is under question. A dissatisfied
customer, frustrated because most of the movies on his queue were of long wait status,
investigated the process using several accounts13. He tested the same set of 43 movies
across two types of accounts (3-out and 5-out) and varied the rental rates in the accounts.
Despite the fact that each account had the same movies in queue, those with lower rental
volume and thus a higher per-disc revenue for Netflix, consistently had a lower queue
availability score, meaning more movies were made available to them. In general, he
found that customers with very high rental rates in recent history are given lower priority
on high demand movies. (Figure 5) This means that new customers, trial basis
customers, and those customers who tend to hold onto movies longer and thus rent fewer
per month are given better customer service. Netflix does not reveal how allocations are
made. See the appendix for excerpts of his analysis.

1.

Figure 5. Account A paid $30 per month for a 5-out plan, Account B paid $20 per month for a 3-out plan. Lower scores indicate less
waiting time. For account A in the first shown billing period, the price-per-disc the previous month was about $2, resulting in an average
availability score of 42 (most movies had at least a short wait). In the second billing cycle, the price per disc history had increased to $5
per disc and the score improved to 25, meaning about half of the movies had status available now. Notice that when account Bs
average price-per-disc changed from $4 to less than $2 on 4/14 the availability score drastically jumped from an average of 13 to an
average of 40. Source: http://dvd-rent-test.dreamhost.com

The CineMatch software also aids in inventory control. Traditional video stores
rarely take the time and money to market smaller films, instead deriving about 80 percent
of rental activity from 200 titles10. Using CineMatch, Netflix can recommend titles based
on a members rental history and ratings, regardless of how the film did at the box office.
As a result, 80 percent of rental activity is generated by 2,000 titles, and 97 percent of
Netflixs titles are rented in a month12. With the decrease in demand on popular new
releases, Netflix can better meet customer demand and saves on payouts for revenue
sharing agreements. The whole experience is catered to a members personal tastes and
preferences, making an online transaction seem more personalized than an actual trip to a
video store.
One customer service drawback to the Netflix arrangement that similar models
will also face is the involvement of a third party, namely the US Postal Service (USPS).
Discs lost en route to the member or back to the distribution center reflect poorly on both
the customer and the service, with both parties likely to blame the USPS for the loss.
Customers with chronic problems have their accounts put on hold, which is frustrating to
a customer that has done everything correctly. Members must file a complaint with the
postal service in order to have their accounts reinstated, a time consuming process during
which they are paying for services that are not active.

Conclusion
The advent of digital entertainment has changed the face of video rental, and as
technology improves the industry will continue to utilize new developments to better
serve customers seeking convenience, ease of use, and variety all at a low cost. In the
meantime, current models seek a competitive advantage among similar services and
attempt to streamline current operations to make the systems profitable.

Discussion Questions
1. At what rate should a Netflix customer rent in order to enjoy the value of the
subscription rather than renting from Blockbuster? How are you going to account
for the late rental return behavior of the customer in your estimate? How
should the rate be different for different types of movies, new releases, old
movies, kids movies?
2. Based on your answer to the above question, how would you estimate the variable
costs incurred by a customer who enjoys the value of the subscription? Can you
describe two or three customer segments that affect Netflix's margin differently?
3. In a recent article about the Netflix business model, the following statement was
made: Boutique movie studios like IFC films, which released last years critical
hit Y Tu Mama Tambien love Netflix because it provides a huge market for
movies that cant muster a widespread theatrical release, as well as for those that
last only a few weeks on the big screen. Why do you think it is so? Is after all
Netflix just a niche market player? Should it become one? Justify your answer.
4. It looks like success could breed failure. According to a recent story: But the
[Netflixs] spectacular growth is creating unforeseen problems Customers are
renting an average of 5.5 movies per month, compared with 4.5 two years ago.
Why is this a problem for Netflix? In what ways could Netflix handle the
operational and revenue sides of this observed trend?
5. Netflix uses multiple regional DCs while Wal-Mart until recently used one central
DC for its DVD rental program. Compare the pros and cons of these two
distribution strategies. What inventory allocation strategy should Netflix employ
to achieve better usage of inventory? What are the logistics challenges Netflix
faces at each one of its distribution centers? How should the information on
inventory be exploited to manage the material flow in Netflix's distribution
system? What shipping priority to customer rules should Netflix use for limited
availability movies?
6. How should Netflix and Blockbuster estimate the life-time value of customers?
Compare the strategies that Netflix and Blockbuster should use to attract
customers. How do strategies affect decisions on metrics for customer service
levels?
7. What are the pros and cons of the revenue-sharing contract used by Blockbuster
on VHS tapes versus its earlier practice? How comfortable do you feel with the
assumptions in Table 1 in attempting to extrapolate revenue sharing benefits of
VHS rentals to DVDs and subsequently compare Blockbusters and Netflixs

benefits? Which assumptions would you challenge? From the Netflix

perspective, how should the revenue-sharing agreement be structured? Does it
make sense for Netflix to use revenue sharing arrangements for DVDs in the first
place? Explain.
8. In a recent article the following information was repeated: Netflix acquired 500
copies of the Nice Guys Sleep Alone film. They paid only $1 per copy and
offered a cut of each rental for the first year. The 10,000 rentals of the movie in
the year allowed the producer to collect $12,000 in rental income. Using this
information, what changes would you make to your revenue sharing calculations
for DVDs in Table 1? Explain.
9. Netflix's system collects a lot of information from customers. When ordering
DVDs for a new release, how can Netflix take advantages of the information in
making the ordering decision? Is that information valuable to the film studios? In
what way? What would you suggest to Netflix on using information to manage
its customer relationship, as well as studio relationship?
10. How do you anticipate the Netflix-Wal-Mart competition to evolve? What is your
advice to Netflix on what to do with its new patent on DVD subscription services?
Should they enter licensing agreements with its major competitors? How likely
do you consider for the implied event in the recent journal article entitled
Netflix, a Division of Wal-Mart? to happen?
11. What aspects and observations of the insightful Michael Porter HBR article
Strategy and the Internet do you see applicable in the video rental setting as of
today. Mostly Comment on Netflix, Blockbuster, and Wal-Mart supply chain
models. Is the Netflix business model disruptive? What should be the future
business model for video rental?
12. Blockbuster offers video game rentals. Based on the above analysis, should
Netflix expand its product offering to game rental? Are there any other product
categories you might consider appropriate for a Netflix-like model? What are
the product and currently used supply chain features that make them amenable to
this business model?

Citations
1. Cachon, Gerard P. and Martin A. Lariviere Turning the Supply Chain into a
Revenue Chain Harvard Business Review March 2001
2. Cohen, Alan The Great Race www.fortune.com 1 December, 2002
3. Hyman, Gretchen Netflix Flicks Switch on DVD Rental Centers
www.internetnews.com 20 June 2002
4. Mason, Sarah Movies on Demand IIE Solutions, October 2002, p.25-31
5. Narayanan, V. G. and Lisa Brem. Thats a Wrap: The Dynamics of the Video
Rental Industry Harvard Business School
6. Netflix Opens New Shipping Center www.etrade.com 26 February 2003
7. Netflix Opens Tempe Distribution Center The Business Journal of Phoenix 24
February 2003
8. Networks, Party Chairs Differ Sharply on Obligation of TV Networks to Cover
Conventions www.vanishingvoter.org 31 July 2000
9. Null, Christopher How Netflix is Fixing Hollywood www.business2.0.com July
2003
10. OBrian, Jeffrey M. The Netflix Effect www.wired.com December 2002
11. Ostrom, Mary A With Newer Releases, Netflix Users Can Anticipate a Very
Long Wait The Mercury News 7 July, 2002
12. www.netflix.com (SEC: Netflix, Inc. Form S-1, March 6, 2002, page 36)
13. http://dvd-rent-test.dreamhost.com
14. Blockbuster Annual Report 2000

Exhibit 1: Comparison Of Financial Statements Fiscal Year 2002

Blockbuster

Netflix

Industry

S&P 500

Sales Growth (Qtr vs Year ago Qtr) %

7.9

101.30

7.10

-2.80

Income (Qtr Vs Year ago Qtr) %

NA

NA

NA

6.00

Gross Profit Margin %

76.0

66.2

70.8

47.5

Pre-Tax Margin %

5.3

-14.3

5.3

7.3

Net Profit Margin %

3.4

-14.3

4.9

3.7

5 Yr Gross Margin (5-Yr Average) %

74.7

NA

67.8

47.5

5 Yr Pre-Tax Margin (5-Yr Average) %

-1.8

NA

-1.4

9.0

5 Yr Net Profit Margin (5-Yr Average) %

-2.2

NA

-1.8

5.5

Return on Equity %

4.5

NA

8.6

7.7

Return on Assets %

3.0

-16.8

5.1

7.2

Return on Capital %

4.1

NA

7.5

3.6

Income/Employee $

4,000

-57,000

6,000

11,000

117,000

401,000

114,000

287,000

33.2

NA

43.2

5.7

Inventory Turnover %

4.1

NA

3.2

7.9

Asset Turnover %

0.8

1.8

1.0

0.3

Revenue/Employee $
Receivable Turnover %

Exhibit 2: Balance Sheet Comparisons: FY 2002 (in millions)

BBI
NFLX
FY2002 FY2002
Assets
Cash and equivalent 152.5

Total Current Assets

958.9

59.8
0.0
0.0
47.3
107.1

Total Non-Current Assets

5284.9

23.4

Total Assets

6243.8

130.5

Receivables 184.8
Inventories 452.1
Other current assets 169.5

Liabilities
Accounts Payable 757.0

Total Equity

1477.6
2076.8
4167.0

20.4
1.2
18.8
40.4
41.2
89.4

Total Liabilities and Equity

6243.8

130.6

From Operating Activities 1451.2

40.1
70.9
-67.3
13.2

Short-Term Debt 132.8

Other Current Liabilities 587.8
Total Current Liabilities
Total Liabilities

Cash Flow
From Financing Activities -199.2
From Investing Activities -1303.5
Free Cash Flow

129.4

Excerpts from An Analysis of Netflix's DVD Allocation System

For the original full version see: http://dvd-rent-test.dreamhost.com/

Introduction
Around January 2003 I started seeing "wait times" on numerous movies in my queue
skyrocket. In particular some movies which were recent, mainstream, and well advertised
releases were impossible to get. About a Boy was one such example. Thus I began a quest
to determine what was going on. It just did not make sense that some of the popular
movies in my queue were so hard to get. I searched USENET but came up empty.
Test Overview
I created a list of 45 movies in my queue that did not have an availability of "Now."
Initially I only added these movies to account "B." I later added these same 45 movies to
three other pre-existing friend and family accounts, which will be referred to as accounts
"C", "D", and "E". Three of these movies eventually shipped to account "A" or "B"
during the period I was collecting data, so in the end there were only 43 movies that were
in common to all five accounts during the entire test period.
Keep in mind that most movies in my queue had a "Now" availability. The following
table summarizes the state of my queue before testing. Future releases have been
excluded.
Availability

Number of
Movies

Percentage
of Total

Now
Short Wait
Long Wait
Very Long Wait

214
48
19
12

73%
16%
6%
4%

293
This report does not attempt to determine what percentage or class of movies Netflix has
availability problems for. It focuses solely on how movies are allocated when there are
availability problems.
The five test accounts used three different Netflix service centers. A service center is the
place where you are most likely to receive a DVD from and where you return your DVDs
to. Two of the accounts were in the 5 movie out plan ("A" and "C") while the rest were in
the 3 movie out plan ("B", "D", and "E").
An overview of the test accounts:

The Results
To aid in comparing the availability of movies in one queue to another, I created an
"availability score" for each queue. I assigned a weighting to the different levels of
availability
Availability Weighting
Now

Short Wait

Long Wait

Very Long
Wait

A queue was then assigned an overall "availability score" by adding up the weighting of
each movie. So lower availability scores mean more movies are available, higher
scores mean more movies are unavailable. To put it another way: low score good, high
score bad!
The following table summarizes the availability stats for each test account:

The number of rentals in the previous billing period is charted against average
availability score for the current billing period below. Accounts in the 3 movie plan are
shown in orange while those in the 5 movie plan are shown in blue.

In version 1.0 of this report I indicated that I thought the rental plan you are in is not
affecting the availability score. I.e. if customer A who is on a 5 disc plan and customer B
who is on a 3 disc plan had the same rental habits over a period of time, they would have
the same availability rating.
A slashdot poster suggested average rental price was in fact what is affecting availability,
and this it would take into account the various rental plans. Or at least in the unlimited
plans. The following chart shows per-disc rental cost charted against availability score. I
have charted two data sets: the previous billing period average disc cost and the average
disc cost over the last two billing periods.

The points stuck on the X axis are for "B" during the trial and 1st month. The clustering
of both 3 and 5 disc plan samples in the same area does indicate that your rental plan is
part of the equation! This is great news.
Given the very small data set, it is difficult to tell whether Netflix simply places renters
into different priority "buckets" or fine tunes the algorithm on a per-customer basis. Note
that as of the 1st quarter of 2003, on average each customer rents 5.5 discs per month. I
do not know whether this is an average across all plans or only the $19.95 plan.
Assuming a $19.95 plan, this translates to $3.63 per disc. This would put the average
customer in the second cluster from the top above.