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Reed Hastings often told the story of his inspiration for Netflix: a $40 late fee from Blockbuster. He said, “It was all my fault. I didn’t want to tell my wife about it. And I said to myself, ‘I’m going to compromise the integrity of my marriage over a late fee?’” Still chagrinned over the late fee, Hastings, a dot-com multimillionaire, formed Netflix, a company that would rent DVDs through the mail for a monthly subscription price, with no postage charges or late fees. Hastings’s model for Netflix seemed simple enough. Netflix subscribers would create a wish list of DVDs on the company’s website, and Netflix would send a new title from the list when the previous rental was returned.

Behind the simple model however, Netflix’s success had been built on attending to every detail of its operations and adapting to the company’s various constituencies. For subscribers, Netflix designed a recommendations engine that customers liked and that allowed Netflix to shift subscriber interest from new releases. By attending to United States Postal Service (USPS) processes, Netflix had located its 41 warehouses, created processing procedures, and even designed its envelope in such a way as to minimize both operating costs and turnaround times. By working with the film studios, Netflix had reached agreements through which it reduced its risk in holding large numbers of DVDs from new releases.

The attention to detail paid off. Nine years after its April 1998 launch in the San Francisco Bay Area, Netflix generated net income of $49 million on revenues of $996.7 million. The firm boasted 6.3 million subscribers and carried an inventory of 70,000 titles on 42 million discs. Netflix’s website, in 2006, was rated the best website for retail satisfaction for the third year in a row.(See Exhibit 1 for Netflix financial data and stock prices.)

In spite of the company’s operational success, Netflix faced two big challenges in 2007. First, in 2006 Blockbuster had made a major move into online rental. In Blockbuster’s new service, subscribers could bring mailers directly to a Blockbuster store and immediately rent a DVD, getting the instant gratification denied to Netflix subscribers. By January 2007, Blockbuster had grown its online business to two million customers.

Second, a number of firms were beginning to offer video on demand (VoD). Netflix announced its own internet service in January 2007. The service complemented the existing subscriber service, generating no new fees. Netflix had budgeted $40 million to develop the system, but some analysts questioned whether that was sufficient to cover server data centers and licensing fees. Others argued that VoD would kill off the DVD rental business in general and that, for all its operational savvy, Netflix’s time had passed.

Published Date: 20/02/2007

Suggested Citation: Jean W. Rosenthal, "Netflix," Yale SOM Case 07-014, February 20, 2007

Keywords: Process optimization, customer management, United States, Entertainment