In this video, we want to take a look at Netflix. And remember, the Netflix motto is, Net flix. It's not DVDs by mail. This is their headquarters, in California, looking like it's right on the railroad tracks. Short history, Reed Hastings is the man behind Netflix. He started the company in 1997 with 3 friends, who were annoyed with the late fees that they were charged for DVD rentals. In 1998 they launched an online version of the video store. Their first fee scheme was $4 a rental, $2 in postage and late fees. Kind of ironic that they didn't like late fees very much that they included them in their business model. As a result, they did not have a great success. So, they chose a different model. Being a little more flexible, and maybe some companies are, and they started a flat rate subscription service. Unlimited rentals and no late fees and no shipping charges. They actually worked with the post office to develop the shipping envelope, to go through the postal machines, because they depend on the post office to get the videos, the DVDs, to and from their customers. They also made a deal, similar to what we saw with Blockbuster, for studios for low upfront price, and then they give them a part of the rental fee, so they can afford to have the copies in stock, the DVDs in stock that people would want to rent. By 2005 they were shipping a million DVDs a day. By 2009, they had 100,000 DVD titles, 10 million subscribers. 2011, 23.6 million US subscribers, digital revenue of $1.5 billion. So what's the technology behind all this? Well pretty elaborate automated distribution centers. The DVD comes in and updates the database and the system then indicates where it's to be mailed to the next viewer preparing the envelope for it. And by 2007, an employee could process over 1,000 DVDs an hour. You have to have fast turnaround for movies for this model to work. we are subscribers to the DVD service, and typically when we put a DVD in the mail, in the Washington DC area, it gets to Netflix in a day, and the replacement comes back to us in another day. You have to have fast turnaround for this to work. There's also something called a recommender the, that they have labeled the Cinematch algorithm, which has 315 million film ratings. And what this system does is to take a look at the movies you've watched, and then try to guess from that, movies that you would like. So, similar to say, Amazon, which comes up and says, people who have bought this book have also bought the following books, the Recommender engine will come up and say, if you like this movie, here we'll pop up another six that are similar to it that you might like. And we'll keep track of all of your movie rentals and try to predict what you would like and, and show that to you, because there are so many movies in our database. In 2007 they mailed their one billionth DVD. They also began a video on demand via the Internet, which is the direction which it would like to move. Remember we said their motto is not DVDs by mail, it's Internet flicks, Internet movies. Well they had a bit of a stumble. In 2011 they decided to create a DVD rental subsidiary called Qwikster and to separate DVDs and streaming with separate pres, subscription prices for each one. Customers did not like this very much, and so Netflix canceled Qwikster. So Qwikster had a very short lifespan. They lost 600,000 customers when they made this split. So, with the payments separated so you were paying separately for DVD and streaming, you had about a 60% increase In your monthly cost. In the old model you paid a flat rate and you had unlimited streaming and unlimited DVDs, one at a time. Now you paid separately for each one. A number of us kept it because it wasn't that large amount of money but you can see they lost subscribers. people who were dissatisfied with this. We'll see how that changed in a little bit. Well, there is competition. Okay. Netflix is not alone, Amazon has its Prime in which you pay a flat rate per year and you get two-day shipping on everything. Okay, for free. And in order to make Prime more attractive, Amazon keeps adding features to it. So, Amazon Prime provides a number of movies on demand for free that Amazon streams to you. Now, a couple of interesting things about this, is what do you suppose the technology is that Netflix uses? Netflix has to send movies to a large number of set tops. There are different ways to do this. There are Internet enabled TVs. We use something called a Roku box, which sets on top of our TV set, and it has a wireless connection to our Internet line coming in, our wireless internet line from Verizon. Where does this movie actually come from? Well it actually streams from Amazon Cloud services. So Amazon is competing with Netflix, and is also providing the hardware and software infrastructure that allows Netflix to distribute its movies. Why would Netflix do this as opposed to building its own? Well think about it, Amazon has a huge infrastructure, and that infrastructure can expand as Netflix needs it, and yet Netflix only has to pay for the amount of the processing power that it is using at any given time. So it's a great opportunity for Netflix to work on its business model and to leave the intricacies of the technology infrastructure to Amazon which has a great deal of experience in providing those kinds of services. There are also many other video sites like Hulu which is owned by the studios. There is Red Box which you may have seen in the United States. It's a kind of vending machine that has a couple of hundred movies. And they're located in shopping malls, in grocery stores, drug stores. you can, reserve a, a movie at a particular kiosk and go pick it up and then return it to that kiosk. The studios are having a problem here. They don't want to lose control of their revenue stream. And yet there are all of these alternatives out there. And people who were trying to get their rights to their products. And distribute them to other people. The content providers are also raising their prices. Netflix ended up dropping Starz, that's Starz, a content provider. when they wanted a huge increase in the licensing fees for the content. But Netflix keeps going. It's expanded its streaming internationally, Canada, Latin America, the Caribbean, three languages, English, Spanish, and Portuguese. It has a 2010 agreement, with Paramount and Lions Gate, and others for back cataloged tv programs. Netflix is, is changing its strategy, I think, to focus more on TV programs, rather than just on movies. Because there are so many TV programs and there are series which means that you'd only not only just see an hour's program or 45 or 50 minute program, but there might be 20 or 30 or 100 of these programs for a TV series that's run for several years. It's worked out agreements with major and many studios, and it has, just for example, an agreement with, with Disney. of, of the latest movies from Disney. And starting in 2011, it's actually offering original programming. So here is a content provider that is now going into the creation of content. In the past it's been a pipe, a distribution system, but now it's actually going to create original programming. And in the fourth quarter of 2012, knock Netflix did really well. It reported that it's DVD by mail service is shrinking. So, I want to ask you, is that good or bad? I believe that Netflix thinks that that is a good idea. Think of how much expense that Netflix could save by not having those automated distribution centers by not having a lot of employees. That's a manpower intensive job. Streaming videos from a video server does not take a lot of people, but handling DVD's, anytime you have a physical process that you have to handle the logistics of that take some amount of labor. Now, as of the 4th quarter of 2012, Netflix reported 33 million streaming customers. 27 million of whom are in the U.S. That means it still has 6 million people outside this country, which is really good. they anticipate adding another 2 million. They're going to release additional TV series called the House of Cards. Now here's an interesting side light that some of the stock analysts are a little concerned about. Netflix owes $5.2 billion in licensing fees over the next five years. What does this mean? Well a huge expense for a content provider is the content, and the way that Netflix pays for that is by licensing the content, the video content that it distributes. And right now it's running a $5.2 billion tab. However, most people regarded all of this as very positive news, and the stock rose such that there was a 42% increase in the market value of Netflix when it announced these fourth quarter 2012 results. Here is what it looks like. Do you remember when we looked at Blockbuster? All of the indicators were going down. Block, Netflix is going up. So why is Netflix a success? Well, big flat panel TVs help. I'm not sure that the attraction of movies would have been so great if you had to watch them on a little screen like this but people are buying huge home theater, LCD and plasma TV's to watch movies on. you've got to have entire bandwidths for video. Video just takes a lot of processing power. Music was easy because you could compress music, and if you compress music the human ear isn't really good enough to pickup much of the compression. So you can squeeze music files down and not have so much to, to distribute, so much bandwidth required. Video, yes you can also compressed video, but you can't do it to the extent that you can with music. So you need high bandwidth Internet in order to really enjoy streaming video. Okay? Their physical distribution, even though they may not think it's the greatest thing in the world to have to maintain it, the physical distribution of DVD's works well. They can execute where Blockbuster could not. Customer satisfaction, well aside from that little glitch when they tried to split up, or they actually did split up the DVD business from the streaming business, they have pretty happy customers. The recommender system is attractive. I feel that it hasn't worked terrifically well for me, but maybe we just have very eclectic taste between my wife and I, and maybe we confuse it. the part that pops up when you choose a particular movie. And then it gives you a window with maybe four or five similar movies. That has been valuable, and I have used that to pick out another movie having chosen one already. The streaming is extremely convenient. I did not relish either stopping at Blockbuster or making a trip to Blockbuster. You could easily spend the amount of time you spent watching the movie Driving to a Blockbuster, looking at all the movies, picking one out, and driving home again. And then of course, you had to go back to Blockbuster and return the movie. I think that a personal criticism of Netflix is it could use more movie content, and more recent movie content, but I think they're going more in the direction of TV series. Okay, certainly Netflix is aware of the technology. In fact it's interesting Netflix actually wondered why Block Buster wasn't doing more to compete with them. And after awhile they just kind of dismissed Block Buster as a threat, maybe because it had such a hard time executing and because its management always seemed to be in a state of turmoil. And so, you could say that Netflix is a firm that uses disruptive technology, and keeps track of this disruptive technology, as it implements it itself.
