For the final exam in our Business, Government and Society class at IE Business School, we were required to write an "integrated strategy brief" for Netflix on the issue of net neutrality.
I share with you the paper I wrote. Please note that this paper was written under time pressure as we were given a fixed amount of time to read the case and complete our output.
Thesis
Statement
There is a popular
saying in my line of work that content is king but distribution is queen [i]. I believe that this, in a
nutshell, helps to explain what lies at the heart of net neutrality issue.
Content producers and distributors now lie on the same side of the fence pitted
against ISP’s who are positioned to become the “gatekeepers” to consumers.
ISP’s, who shoulder the majority of the infrastructure costs to bring the
Internet into consumers homes, now want a piece of the pie and are threatening
to disrupt distribution.
The objective of this
strategy brief is to give an integrated view on the issue of net neutrality by
examining the market and non-market factors at work that will help lead to a
possible course of action or a roadmap to help Netflix survive and thrive in
the years to come. I will begin with a simple analysis of market and non-market
factors using two popular frameworks: Porter’s Five Forces and IA3 and wrap up
with some concrete action steps to take in the short, medium and long-term
including my best forecast of the desired outcomes and risks associated with
each action.
Market
Factors
The market for Internet
content can be divided into content creators, content aggregators and content
distributors. The threat of new entrants for content creators and aggregators is
quite high but the threat of new entrants in content distribution (where
Netflix mainly operates) is quite low, as it requires a lot of resources to
build scale and a large consumer base.
The threat of substitute
products is medium; such is the power of content. There is no easy substitute
for an award-winning film but people can switch to doing another activity. This
gives people who control content power. But at the same time, the very
popularity of things can change over night depending on quickly changing
consumer behavior.
Consumers are normally
price takers when consuming content. However, the popularity of torrents is a
big threat as piracy continues to be a major problem for content creators and
content distributors. Why pay for something that is readily available for free?
Bargaining power of
suppliers is high. Netflix is at the mercy of 3rd party content
creators such as Disney as they need to allow distribution of their content on
Netflix’s platform [ii].
This is why Netflix has now ventured into content creation also. At the same
time, the growing strain on bandwidth has made ISP’s, such as Comcast, exert
pressure on content distributors who they want to help shoulder part of the
cost.
Competitive rivalry for
Netflix is medium to low, as there appears to be little competition for the
platform they provide. They control majority of TV streaming in the U.S. (63%)
and are expanding to other parts of the world. Some direct competitors do exist,
like Amazon and Apple, but they have not yet achieved the same level of
popularity as Netflix.
The market that Netflix
operates in is quite complex and the position they find themselves in now is
tough. The obvious threats are that consumers shift to another form of
entertainment (highly unlikely in the short-term) or that margins become so
narrow (because of increasing costs to secure content and increasing costs to
get the content through ISPs) that it becomes unprofitable to operate purely as
a content distributor. Other competitors like Amazon and Apple have other
businesses that can help subsidize any losses in content distribution.
There are some notable
opportunities though. The market of Netflix is still very much U.S. centric.
The potential to grow in other markets is very real. Another opportunity is the
shift into content production. Although expensive, it looks quite promising
given the success of House of Cards.
Non-Market Factors
The issue on net
neutrality is a big concern for many parties. I have outlined a simple IA3
framework in Appendix 1 and will discuss the main points briefly below.
Content creators,
distributors and everyday consumers are openly opposing regulations that
threaten net neutrality while telecoms and ISP’s find themselves on the other
side of the issue. The U.S. government is split.
From the point of view
of content creators and distributors, they want to keep net neutrality, because
they stand to benefit the most from equal internet speeds for all types of
content without having to shoulder any of the burden. Looking at Figure 2 there
are a few content distributors (Top 10 have 82.89%) that dominate majority of
traffic.
From the point of view
of ISP’s, they are burdened with having to provide greater bandwidth to
consumers at faster speeds (to cope with greater consumer appetite for
streaming) but are unable to capture any of the additional value they are
providing. Some ISP’s, such as Comcast, have ventured into content (through the
acquisition of NBC Universal) as a means to capture some of this value.
For consumers, mergers
have left them with little choice and the likely scenario of having to pay more
for a service than is likely to deteriorate with time.
The issue is currently being
played out in the US court system, Congress, and in the media. Many of those
threatened are large media companies that have gone on the offensive to try and
swing public sentiment to their side. The courts, however, have already awarded
the first major win to the ISP’s.
Both parties have
provided information and assets that look to swing the decision to their side.
Road Map
Given the above, below
are a few recommendations that I think may work to help ensure that Netflix
survives and thrives in the marketplace.
In the U.S., I propose
the following action plan:
In the short-term, I
would lock into place pricing schemes with ISP’s that would ensure that Netflix
subscribers continue to receive the same level of service as they have in the
past. In reality, Netflix should have anticipated this and done this a long
time ago. Had it locked preferential pricing early on when its traffic was not
yet substantial, it could have enjoyed much lower rates. Shortsightedness has
cost Netflix an opportunity to act before the situation became dire.
Admittedly, by doing
this, Netflix concedes that net neutrality in its current form is dead. This is
a short-term loss on the part of Netflix. However, it ensures that the service
is not disrupted which is needed to safeguard the core business. On the upside, it hands the burden of
providing fast Internet speeds back to ISP’s and can put the blame (and any
negative consumer backlash) on them for any future disruption in the service.
In the medium-term, I will
continue to align with fellow Internet giants and small startups and form a
coalition that will look to alter the way ISP’s are regulated and push to open
competition. An organized and homogenous coalition can paint the picture of
ISP’s being greedy while playing gatekeeper to consumers. The coalition would
look to push for Internet to become a utility to bring it under the regulations
of the FCC. The European (and possibly even Asian) case study should be used as
a benchmark for what can be accomplished with ISP’s opened to competition. The
risk to this is that it will cost a lot of time, money effort to push for this
type of regulation. And in the end, it may not even work as it is highly
dependent on who controls Congress.
In the long-term, I will
look to work with ISP’s to improve infrastructure. This can be done through a
partnership or quite possibly even via acquisition. If ISP’s are successfully
opened to competition, the ability to start our own ISP is very real and with
it the ability to improve infrastructure. An alternative to this is to partner
with Google and become an active stakeholder in their push to increase coverage
of Google Fiber. The risk to this is that both options will require massive
investments in CAPEX. However, it will give Netflix more control of the value
chain, a logical step to take after already venturing into content creation.
In Europe, where net
neutrality looks like it will be kept, I will fast track the expansion plan for
Netflix. There is a need to diversify outside of the U.S. and the environment
in Europe looks like it is suitable. Penetrating Europe will not be as easy
though, given that consumer tastes are quite different. As such, there is going
to be a need to form strong partnerships with local content creators and quite
possibly even a push towards content created by Netflix specific for European
markets.
By diversifying further
into content creation, Netflix moves into a part of the value chain where it
can capture more value as opposed to the low margins that exist simply as a
distributor. Main risk to this is that Netflix may not have the necessary expertise
in European tastes and securing this expertise is bound to cost a lot of money.
Appendix
1: IA3 Framework
References:
[i]
http://www.forbes.com/sites/peterhimler/2013/07/09/content-is-king-distribution-is-queen/
[ii]
http://money.cnn.com/2012/12/04/technology/netflix-disney/