NetFlix.com, Inc.

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NetFlix.com, Inc.

Harvard Business School Case Study

Edwin M. Mercado
Montana Tech of The University of Montana
04/05/11
 NetFlix.com, Inc.

Introduction

NetFlix.com, the world’s largest online DVD rental company; the company started its

online DVD rental business by launching Netflix.com, offering pay-per- DVD rental services by

delivering DVDs via mail. As the company prospered during late 1999, Netflix replaced its pay-

per-DVD revenue model with a fixed monthly fee system that allowed customers to rent up to 4

DVDs per month with no due dates or late fees. In February 2000, it launched a new plan, where,

with a monthly fee of $19.95 instead of its previous $15.95, subscribers were able to have up to 4

DVDs in their possession at one time. The website allowed subscribers to make their own lists or

“queues” of movies that they browsed and selected to watch. Then, it shipped movies that were

at the top of the queues of subscribers via mail. It also provided subscribers with individualized

ratings on all movies that customers had previously rated after viewing.

As the company enjoyed tremendous success, it decided to submit its S-1 filing for an

initial public offering. However, soon after it was submitted, the NASDAQ stock market fell

25% to 3,794, making it more difficult for a company’s IPO to succeed with uncertainty in the

financial markets. In July 2000, Reed Hastings, CEO of Netflix, needed to decide whether the

company should proceed with the IPO or withdraw it. Investment banks predicted that the IPO of

Netflix would succeed if it showed positive cash flows within a twelve-month horizon, but the

executives at Netflix were unsure whether they could achieve that goal.

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Problems

 The first strategic issue that Netflix will need to cover is how to gain a

larger consumer base. Without more members they will have a hard time keeping up with

the competition. Many of their competitors have longer operating histories, larger

customer bases, greater brand recognition and significantly greater financial, marketing

and other resources than Netflix currently has to offer. Some of their competitors have

adopted, and may continue to adopt, aggressive pricing policies and devote substantially

more resources to marketing and Web site and systems development than Netflix does.

The rapid growth of their online entertainment subscription business since their

beginning may attract direct competition from larger companies with significantly greater

financial resources and national brand recognition.

 The NASDAQ stock market fell

25% to 3,794, making it more difficult for a company’s IPO to succeed with uncertainty

in the financial markets. In July 2000, Reed Hastings, CEO of Netflix, needed to decide

whether the company should proceed with the IPO or withdraw it. Investment banks

predicted that the IPO of Netflix would succeed if it showed positive cash flows within a

twelve-month horizon, but the executives at Netflix were unsure whether they could

achieve that goal.

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Solutions
 The company needs to raise working capital to allow it to market, purchase inventory,

and continue to offer one-free-month trials. Equity sales would provide it with a large

amount of capital without the added burden of interest payments or any repayment.

Although it has not yet turned a profit, the growth of Internet use and demand for

Netflix.com services, particularly as the American public prefers to spend more time at

home, Internet usage rises, and DVD sales increase, all suggest that profitability for

Netflix.com, just like Amazon.com, is only around the corner.

 Revenue sharing agreements also seem like a good idea for Netflix.com. Its main

attraction to subscribers is not only that they don't have to leave home to get their

movies, but also that the titles they want will be available to them ASAP if not

immediately. Revenue sharing agreements with studios would allow Netflix.com, just

like Blockbuster; to increase its available titles while cutting way down on inventory

costs. Further, the advantage studios would receive from obtaining a percentage of each

subscriber's rental would provide incentive for studios to assist Netflix.com in obtaining

customers. The ability to attract studios to enter such agreements with Netflix.com

would be greatly improved if Netflix.com were able to have an IPO. Again, the IPO

would help the company improve cash flow and its market.

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Conclusion/Recommendations

The timing of Netflix’s IPO is unfavorable for the company. Netflix should delay its IPO

until the financial markets have had a chance to begin recovery. Going forth with the planned

IPO in the midst of the high-tech bubble burst will be unfavorable for Netflix, especially due to

the fact that the company has not yet earned a profit on its operations and the fact that it is an

Internet company. Netflix should proceed with its IPO at a more appropriate time because its net

present value of new subscribers is positive, in addition to the explosive growth in new

subscribers due to the fast adoption rates in DVD players at 50% per annum.

The capital Netflix will be able to raise from its IPO will enable the company to reach

profitability faster than by foregoing it. Thus, in order to reach profitability, expand its customer

base, and ensure a dominant market share already being realized by its early-mover advantage,

Netflix should proceed with its IPO once the technology sector begins to show signs of a

turnaround. Convincing investors that an Internet company will be able to succeed after so many

have failed, even with strong cash flow, a solid business model, and real assets will be no easy

task during the near future.