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Final Project Milestone One: Introduction |
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Netflix Microeconomic Analysis
Southern New Hampshire University
Laveda Mitchell
ECO-201-R3671
2/29/20
Microeconomic Analysis- Netflix Inc.
Introduction
Netflix Inc. is the leading streaming internet television in the world operating in more than one hundred and ninety countries. The organization has more than one hundred and thirty million subscribers who enjoy their products and services. The user enjoys various television shows and movies in a day, including features film, original series, and the documentary on different platforms such as television, tablets, smartphones, laptop, and personal computers. The increase in internet usage has made Netflix Inc. dominate the United States market being able to make substantial revenue (Havens, 2018). The streaming market is growing at a high rate due to advancements in technology, internet of thing, and internet usages, forming a sustainable base for Netflix Inc. expansion and growth.
This paper focuses on the microeconomic analysis of Netflix Inc. with a close examination of how supply and demand, sales, and market trends influences the Netflix business. It also evaluates the price elasticity of Netflix product and service, and how they affect the demand and supply in the firm, how the cost of production with analysis of various cost shape the profitability of Netflix Inc. It also evaluates the market share analysis and overall market trends that influence the present and future of Netflix Inc. Effective analysis of Netflix Inc will help to form a recommendation on how the organization can continue to lead in the industry of streaming television.
History
Netflix Inc. was founded in 1997 by Reed Hastings in California. The company started as online movie rental services with an initial business model of selling DVDs. Subscribers were required to create an account and identify which movies they wish to be delivered to their doorstep with no limitation on the numbers of DVD one can have for the monthly subscriptions.
In 2002, Netflix went public, overcoming its biggest competitor Blockbuster at then with more than six hundred thousand members (Jenner, 2018). The new strategy of allowing users to have as many movies as they could mail back and forth in a month led to superior customer value, gaining a high market share compared to their competitor. In 2007, the company changed its business strategies to begin providing the user with instant access to titles at the comfort users' homes through personal computers without having to wait for DVDs. This was possible due to increased internet usage in the world.
In 2010, Netflix entered the global market, starting in Canada that has seen the users increase internationally. The ability to stream on any devices with internet connection leads to increase market share with many users preferring streaming on their devices other than original DVDs. Users can now watch as many shows and movies as they want with any internet connection screen (Jenner, 2018). The company's strategic plan mostly concentrates on providing original content to drive company growth through quality shows and movies.
Netflix Inc focuses on three business segments that are international streaming, domestic streaming, and domestic DVD. The international sections concentrate on providing its product as service to users outside the United States while the local segment provides service to members of the home country. DVDs segment continues with the traditional business of distributing DVDs to home users in the United States (Jenner, 2018). Recently, the company introduces a download option for its customers that remove the need of the customer to have an internet connection. The new features enable the member to enjoy the service of the company even when they are no internet connection increasing customer values.
Supply and Demand
For the past years, Netflix has experienced steady growth in sales due to the high demand for Netflix services and products, as seen from the graph below. This is due to the increase in internet usage in the world, with many customers demanding the services (Pfeifer & Conroy, 2017). The trend of increased demand has led to a rise in Netflix prices overtime against the law of demand. The law of supply pushes this due to the high cost the company incurs to provide the services available in the market. There is a high cost of obtaining licenses in the global market and the use of material, network from other suppliers that ensure the product is available on the internet, and the cost of providing original content.
Netflix Inc.’s user has experienced continuous prices increase than the competitor in the industry leading to continues to decline in subscribers. Members are trying to find a substitute company offering the same services and products at a lower cost; they would switch to the competitor's services (Pfeifer & Conroy, 2017). This has led to a high reduction of the subscriber in the current years, leading to a decrease in demand for Netflix services. In addition, the introduction of one free month for the New Year and the ability to download the content and enjoy watching later has reduced the demand for Netflix service despite not affecting revenue growth.
Legal framework and government regulation bodies have increased attention to increasing demand for streaming services industry with many countries introducing legal fees and sale tax law for e-books, streaming videos, and games. The implementation of this tax law will affect the Netflix sale volume due to rising prices, changing the demands of the product and service in the market.
Sources: Netflix - quarterly revenue in 2019. (n.d.). Retrieved from https://www.statista.com/statistics/273883/netflixs-quarterly-revenue/
The diagram shows the revenues generated by Netflix from 1st quarter 2011 to 3rd quarter of 2019 (in a million U.S dollars)
Price Elasticity of Demand
The price elasticity for Netflix streaming services is less responsive to changes in price in the industry. It can be considered inelastic seeing there has been a continuing increase in prices of Netflix services over the past year. The total revenues of the company continue to increase (Shattuc, 2019). Despite having other close substitutes such as Amazon Prime, Hulu, and YouTube; Netflix continues to dominate the market even with high prices.
Netflix Inc has diverse types of consumers who subscribe to their services, with the prices not taking a large part of their income compared to their demand. Depending on the past customer responsiveness on changes in Netflix prices, an increase in prices affect the demand (Venkatesan & Shively, 2017). For instance, Netflix experiences a loss of more than eight hundred thousand subscribers due to a rise in prices (Shattuc, 2019). Despite this, years later, the company received more than eleven million subscribers, even with prices. It shows that most of the customers are not sensitive to price changes in the industry or lack close substitutes to switch when prices change. This has led to price elasticity remain inelastic in the market.
The concept of price elasticity of demand shows that changes in price are directly responsive to the change for demand; therefore, changes in quantity demand for Netflix products and service may lead to changes in prices of their services. The elasticity of demand will increase with the rival company gaining more subscribers and increase of close substitutes in streaming services. According to the previous data, even if Netflix raise the price, it may lose some user but continues to dominate the market due to royal customers and quality of services offered (Venkatesan & Shively, 2017). Despite Netflix controlling the market, recently, competition has increased, and many subscribers may choose to switch to other services.
Cost of Production
Over the years, Netflix has experienced an increase in the cost of production, forcing the company to raise the cost of service offered to the customer to compensate for the high price. Since 2013, Netflix has experience increase cost of variable costs such as licensing agreement, operation cost, customer service, employee salaries, and marketing (Pfeifer & Conroy, 2017). An increase in popularity and demand has led to a change in the company structure, leading to an increase in the cost of licensing agreement and marketing, wherein 2018, it spends around $ 7.5 billion to get licenses. Some of the fixed costs include warehouse fees, office space, annual employee salaries, streaming delivery cost, and content amortization. Despite all this cost, the profitability of the company continues to grow current revenue being 5.2 billion U.S dollars. It showed an increase in profitability compared to 4 billion U.S dollars in 2018.
The fixed and variable cost nature of Netflix adversely affects the cash flow and liquidity of the company. For instance, continues change of obtaining content licenses for the company upward surpasses the expenses of producing their original content affecting the pricing of the output product and service (Jones, Bechtold, & Hayman, (2017). Original content has been the secret to sustaining their customer and gaining competitiveness leading to the company investing heavily in research and development that affect the price of the product and service sold in the market.
Overall Market
Netflix occupies around 51.8 % of the market share, with its significant threat being Amazon prime that occupies around 24.8 % of the streaming market. As shown in the diagram below, Netflix Inc. has dominated the market, with more than half of the consumer being their royal user while all the other competitors fight for less than half of the market share (Pfeifer & Conroy, 2017). Currently, Amazon prime seems to bring up the challenges on Netflix, with many users switching to Amazon for streaming service. Other competitors include Hulu, YouTube red, HBO Now, and CBS all access.
Source: (Bouma, 2016)
The high initial cost of running an online-based streaming company such as the cost of research and development, licenses, and other starts up capital has increased the barrier for the new entrance to the industry (Aliloupour, 2016). Netflix Inc has set the bar too high on the prices, making it more competitive for other businesses to enter the industry and survive. The likelihood of new entrants is very low to high competition in the market, and economies of scale hence have little impact on the future profitability of Netflix Inc.
Netflix Inc operates under an oligopolistic market structure due to limited competition and high barriers new to enter the market (Aliloupour, 2016). The few rival companies compete to control the market; thus, Netflix can influence the market future easily due to having a large market share and low competition from existing companies (Bouma, 2016). It has unique services such as an original element that other competitors do not have hence, which can shape the future of the streaming service industry. This has enabled the company to stay ahead of others due to the ability to innovate original content.
Add Barriers to Entry here:
Recommendations
For amazon to continue being the leader in the market, it needs to monitor its market share by ensure continues customer retention (Tryon, 2015). The increase of customer values will lead to customer satisfaction leading to customer loyalty hence able to control the market. This will reduce the possibility of Amazon prime take the opportunities to gain more subscribers in the future. Another is retaining their secret of providing original content to increase profitability. This is something other competitors are unable to do, that can help the company to implement its future goals
Netflix needs to watch its pricing strategies to avoid random changes in price upward in the future to continue dominating the market. Most of the Netflix user is loyal to the company despite the various incident of price rise (Jones, Bechtold, & Hayman, (2017). This can change in the future, if the user finds a better substitute with the same quality, such as Hulu and HBO now that are coming up strongly.
References
Aliloupour, N. P. (2016). The Impact of Technology on the Entertainment Distribution Market: The Effects of Netflix and Hulu on Cable Revenue. Retrieved from: https://scholarship.claremont.edu/cgi/viewcontent.cgi?referer=&httpsredir=1&article=1811&context=scripps_theses
Jones, E. H., Bechtold, A., & Hayman, K. (2017). HBO NOW: Watch Out, Netflix!. Journal of Case Studies, 35(2), 37-43. Retrieved from: http://www.sfcrjcs.org/index.php/sfcrjcs/article/viewFile/430/294
Havens, T. (2018). Netflix. From Networks to Netflix, 321-331. doi:10.4324/9781315658643-30
Jenner, M. (2018). Introduction: Binge-Watching Netflix. Netflix and the Re-invention of Television, 109-118. doi:10.1007/978-3-319-94316-9_6
Jenner, M. (2018). Introduction: Netflix as Transnational Broadcaster. Netflix and the Re-invention of Television, 185-197. doi: 10.1007/978-3-319-94316-9_10
Netflix - quarterly revenue 2019. (n.d.). Retrieved from https://www.statista.com/statistics/273883/netflixs-quarterly-revenue/
Pfeifer, P. E., & Conroy, R. M. (2017). Netflix, Inc., 2007. Darden Business Publishing Cases, 1(1), 1-15. doi:10.1108/case.darden.2016.000212
Pfeifer, P. E., & Conroy, R. M. (2017). Valuation of Netflix, Inc. Darden Business Publishing Cases, 1(1), 1-13. doi:10.1108/case.darden.2016.000339
Shattuc, J. (2019). Netflix, Inc. and Online Television. A Companion to Television, 145-164. doi:10.1002/9781119269465.ch7
Venkatesan, R., & Shively, D. (2017). Netflix, Inc.: The Customer Strikes Back. Darden Business Publishing Cases, 1(1), 1-7. doi:10.1108/case.darden.2016.000213
Overall Market Share
Market Share Netflix Amazon Prime Hulu HBO Now YouTube Red CBS All Access Sling TV PlayStation VUE 51.8 24.8 9.9 5.2 3.1 2.1 1.7 1.6
