ESSAY ON NETFLIX

Introduction

The employment of economic theories by a firm’s management through the application of statistical techniques is a vital component in ensuring its’ product’s longevity in the product’s market. These theories play guiding roles in the formulation of operations, risk, pricing, production, and investment strategies. Within economic theories are concepts such as demand functions and demand elasticities, production and cost functions, and profitability indices. Therefore the appropriate application of managerial economics increases the firm’s decision making efficiency, whose outcome is reflected in the firm’s revenue levels. Notably, managerial economics and its comprehension not only provide the management with a foreknowledge of the internal determinants of the firm’s performance but also its external environment. Therefore, the knowledge and correct application of managerial economics significantly contribute to the wholesome performance of a business entity such as has been the case with the globally recognized entertainment giant, Netflix.

Netflix

Netflix Company is one fast-growing firm whose influence is nearly dominating the entire entertainment industry. Established in August 1997 in the Scotts Valley, in California by Reed Hastings and Marc Randolph, Netflix’s presence is visible in over 190 countries (Gabrielli, 2017). Initially, the Company mainly rented digital versatile discs (DVDs), on its website. The establishment of the Company came barely two years after the invention of DVDs, which were developed in early 1995 and introduced into the entertainment market in late 1996 (Sim, 2016). At the time of Netflix’s creation, DVDs were the most convenient modes of data storage, therefore the reason behind the firm’s products’ demand and preference then.

Beginning as a website-based movie rental firm, Netflix is presently known for its products, such as documentaries, Television series, and a variety of films of diverse genres (Jenner, 2016). Netflix boasts of being the leading internet entertainment platform with its following growing each passing day. At the time of its conception, users would place DVD orders, and Netflix would post them to the users’ addresses. Once the consumers were done watching the DVDs’ content, they would post them back to Netflix. Presently, over 190 countries make up the Company’s over 151 million online-based online subscribers who consume the Company’s products (Oliveira & Ribeiro, 2019).

With technological advancements and growing competition from companies such as the once-famous Blockbuster, Netflix revolutionized the entertainment industry when it introduced a streaming model of its products in 2010 (Jenner, 2017). Netflix’s choice of the streaming model, a model that was not common until 2010, signifies a strong presence of proactive marketing strategies, courtesy of the Company’s management’s comprehension, and employment of economic theories.

Netflix’s Problem Statement

Despite its dominance in the entertainment sector, Netflix is not devoid of challenges that have threatened its continuity into the unforeseen future. As of December 2018, the Company’s stock was 40% up amidst precipitous tumble, which had been witnessed in 2018’s third quarter when its new subscription was not met, leading to a negative turn on its stock (Lobato, 2018). The Company had projected a 1.2 million and 4.47 million projection in its United States market and global market, respectively. However, this projection was not met as the Company recorded 670,000 subscribers in the US and 4.47 million subscribers internationally (Burroughs, 2019). In as much as this negative turn of events appears threatening to the company’s continuity, there are core problems of dire negative consequences than its fall in targeted subscribers in 2019.

Netflix is faced with three major challenges whose non-attendance could adversely affect its products in the unforeseen future. First, the Company is faced with the challenge of maintaining its ever-growing subscriber base despite its past failure to meet projected targets (Rahman, 2019). The demand for Netflix’s original series over licensed content in global markets is directly proportional to the Company’s subscribers’ growth. This trend presents Netflix with the task of developing strategies aimed at ensuring that it gets hold of its consumer base in a continuously competitive market landscape whose winners are unknown.

Second, increasing competition is another hurdle that Netflix has to contend with.  Warner Bros. Entertainment Inc., AT&T, and Apple, Fox, and Disney are among some of the company’s whose activities are threatening Netflix’s continuity in the entertainment industry (Rahman, 2019). As of 2019, for example, Disney had announced that it would not be renewing its contract with Netflix in 2020, which they had entered into in 2016. Disney, in partnership with Fox, had entered into a $52.4 billion merger deal on December 14, 2019, awaiting the United States Department of Justice’s approval. Another content contributor to Netflix’s products that had contemplated pulling its content from Netflix to operate a standalone streaming service similar to Netflix was Warner Bros (Rahman, 2019). These companies contributed to nearly 40% to 50% of Netflix’s content before their intentions of terminating their contracts with Netflix, and Warner Bros bought a move that nearly destabilized Netflix as some Netflix’s big shows such as “Friends.”

Third, the continuous upsurge in content costs is another major problem that is likely to affect Netflix’s products’ existence in the future. Towards the end of 2019, Netflix paid an alarming $100 million as license renewal fee for its content “Friends,” a $70 million increment from the amount it had previously paid for the same material (Rahman, 2019). With Netflix’s intended international expansion in 2020, this skyrocketed figure raised concerns among investors, creating uneasiness on their stake at the Company. An increment in content costs would ultimately lead to increased marketing and launching costs, which may turn out sustainable unless appropriate countermeasures are taken.

Demand Analysis

The responsiveness of the quantity demanded of a product upon a change in the product’s price could greatly determine the product’s continuity. This kind of response, commonly known as Price Elasticity of Demand (PED or E_d), could either be elastic or inelastic. In price elasticity, no other variable is altered to expect the product’s price. The former type of demand implies that an increase or decrease in a product’s price would lead to a significant change in the quantity demanded of that product. The latter means that a reduction or increase in a product’s price will only lead to a small change in the product’s quantity demanded.

In the determination of whether a product is elastic or inelastic, the ratio of the percentage change of demand is compared to the percentage change in the product’s price. This is done by dividing the former with the latter. If the division gives a value that is greater than one, then the product’s demand is regarded as elastic. However, if the value comes out less than one, then the demand is considered inelastic. Therefore, to express this information graphically, a demand function is necessary. This function requires a minimum of two data sets showing the quantity of goods consumed or bought at a given price. Simply put, the demand function is a straight line.

In the case of Netflix, the Company increased the price of its standard subscription from an initial rate of $7.99 to $8.99 in May 2014 (Raymond, 2017). However, this price only applied to new subscribers, a move that was considered strategic as it increased the Company’s revenue and profits as well. In October 2015, the price increased further to $9.99 for its new subscribers from $8.99 (Rahman, 2019). According to Figure1.0, the progressive increases in Netflix’s subscription did not negatively affect the firm’s overall demand as it witnessed a continuous rise in subscribers over the years.

Figure1.0. Graphical presentation of Netflix’s Pricing Strategy.

Short-run Production and Cost Analysis

Notably, Netflix lacks production costs, as well as inventory, as a majority of its tangible titles are basically either rented or purchased in mass quantities, which attract significant discounts (Jones, Bechtold, & Hayman, 2017). With the significant discounts accorded to Netflix’s products, the Company’s profit margins are tremendously healthy as this cut down on production costs enables the firm to maximize profits as they minimize costs. The Company’s initial costs, therefore, mainly reflected in the maintenance of their servers, which play the role of monitoring Netflix’s new subscriptions. Additionally, these costs also lie in the Company’s shipping titles, which collectively contributed to the Company’s rapid growth during its early years of establishment.

As a result of the lack of inventory and production costs, the firm has hugely invested its financial resources in research and development. Out of the costs incurred by Netflix in the dissemination of its products, research, and development takes the largest share (Jones, Bechtold, & Hayman, 2017). Before opting to invest hugely in an advertisement, Netflix’s research studies reported that a significant amount of resources in the United States were being invested in network televisions, spot televisions, syndication, and cable televisions. As a result of this discovery, Netflix has continuously availed its products on these platforms whose consumption has progressively escalated.

Past financial statements such as in 2012 and 2013and successive years have indicated the Company’s continuous upsurge in its research and development costs, which have had a resultant positive effect on its revenue at the end of each fiscal year. In 2013, for example, the firm recorded $378,769 on its research and development costs (Jones, Bechtold, & Hayman, 2017). This figure was a 15.1% increment from the 2012 value. The 2018 and 2019 financial statements, too, recorded a continued increase in the Company’s costs on marketing as the firm’s expansive undertakings in the global entertainment sphere advanced (Oliveira, & Ribeiro, 2019). Netflix’s aggressive marketing strategies have seen the Company’s revenue to continuously increase to its current value as more subscribers are added to its already huge subscribers’ base. However, caution ought to be taken lest the law of diminishing returns takes a toll on Netflix.

Diminishing Returns Concept

This economic concept states that as one production input is increased. In contrast, all other production inputs are held constant; there is the likelihood that a time shall come when progressive additions of such input will yield insignificant output. Therefore, a continuous diminishing output or returns will be witnessed. This case applies to Netflix’s activities, which have, for a long time, only dwelt on subscription video on demand (SVOD), (Oliveira, & Ribeiro, 2019). The 2019s missed subscription targets in the second quarter dealt a significant blow in the Company’s image whose consequences were felt in the Stock Markets. Despite the sobering realities, Netflix has, for a while, been holding on to SVOD and has ignored the use of ads to ensure its continuity.

Such a myopic model could cost the business as competition becomes stiffer in 2020 with companies such as Disney, Fox, and Warner Bros enter the entertainment industry as standalone streaming companies. Since these firms have, in the past, been the most significant contributors in Netflix’s contents, a shift in demand is probably likely to be witnessed in Netflix’s contents. This reality poses a considerable threat to Netflix’s performance in 2020 and successive years. In a world of dynamic content development as well as unpredictable consumer tastes and preferences, Netflix’s products may, with time, experience a decline in consumer demand, which will imply a reduction in its revenue amounts.

Netflix’s Cost Function

To ensure continuity into the unforeseen future, Netflix’s cost function ought to be regularly checked and appropriate adjustments made. A cost function is an expression of the costs of production in terms of output amounts. This function enables the calculation and determination of the cost incurred in production, given the respective prices of the inputs used. The equation relating to cost function is written as C(x) = FC + V(x), in which C represents the total cost of production, FC being the total fixed costs, while V represents the total variable costs, and x represents the unit quantity. Therefore, Netflix’s management is presented with the responsibility of continuously checking and adjusting its cost function lest its operations become unsustainable. As the Company’s revenue levels have been increasing over the years since its inception, this witnessed growth has also been associated with substantive escalations in Netflix’s streaming costs (Gabrielli, 2017).

In 2016, for example, the Company recorded a record increase of revenue from 2013’s $3.46 billion to a whopping $8.29 billion, marking a 34% compound annual growth rate (Gabrielli, 2017). In 2017, the revenue even swelled more, with the first three quarters surpassing the annual $8.29 billion recorded in 2016. On the other hand, this progressive revenue growth witnessed has been associated with substantial streaming costs, such as $2.6 billion in 2013, $5.8 billion in 2016, and a projected $13.3biilion in streaming costs in 2020. As Netflix increases its library content in 2020, more so in the international entertainment markets, these costs are expected to increase further in the successive years. These costly streaming costs may turn out uneconomical to subscribers as Netflix will continuously raise its subscription prices for new subscribers who are likely to shy off and seek alternatively economically friendly options from Netflix’s rivals.

Market Structure

There exist a total of four economically recognized market structures, namely: monopolistic competition, monopoly, perfect competition, and oligopoly. Out of these known structures, Netflix’s market could be described as being in an oligopoly market structure. This type of market structure is one that is comprised of a few dominant firms, none of which has the power to deter competing firms from influencing market activities. The unique characteristic of this type of market is interdependence. Since the market is comprised of a few large business entities, the actions by any of the firms could significantly alter market conditions.

Netflix fits in this type of market as it operates an SVOD business where its products are paid online, and there are only countable firms such as YouTube and Amazon, that provide such services. Amazon and YouTube offer identical services to Netflix, which requires its consumers to subscribe to their services for them to have access to a variety of their contents (Oliveira, & Ribeiro, 2019). Unlike Netflix, which requires a prepaid subscription for their users to enjoy their products, YouTube movies and shows do not charge any amounts to permit access and downloading of their contents. This activity by YouTube could be a threat to Netflix in the unforeseen future as YouTube subscribers increase daily.

The oligopoly market in which Netflix operates is also characterized by several limitations that act as barriers that prevent new entrants into the market. A considerable amount of capital, as well as significant investment in information technology for the purpose database monitoring, is barely affordable by prospective market entrants, therefore, leaving the market for a few capital-abled firms such as Netflix. Nonetheless with the recent activities by Disney, Warner Bros, and Fox to enter the market as standalone entities are about to reshape this market structure leading to increased competition, and they strive to dominate and outdo each other. These new entrants are therefore faced with the challenges of economies of scale, which have enabled huge firms such as Netflix to offer their products at relatively lower costs as could be incurred by new entrants such as Disney and the rest.

Macroeconomic Environment

A critical analysis and understanding of Netflix’s external environment by the firm’s management is essential in ensuring the firm’s continuous dominance amidst market shakeups and increasing streaming costs. It is in the macroeconomic environment that Netflix’s weaknesses and opportunities concerning its products are revealed, and corrective measures are taken where possible. Continuously increasing operational costs is a fact that is likely to force Netflix out of the market in the unforeseen future unless it devises alternative cost-effective options. Netflix produces and provides original content to its subscribers, which gives the firm a competitive advantage over its Amazon, YouTube, and expected new entrants. However, the cost of maintaining this coveted original content is continuously growing. In June 2018, for example, the projected expenditure stood at $12 billion to $13 billion. This figure has always risen and is also expected to rise in 2020 (Oliveira, & Ribeiro, 2019).

The second threat to Netflix’s macroeconomic environment is limited to copyrights (Rahman, 2019). The Company barely owns a majority of its original programming. For continuity in its operations, Netflix has to periodically renew its license as well as contracts with original programming owners. This has negatively affected the Company, as the rates continuously rise at the beginning of each period. Third, Netflix’s ballooning debt is likely to overwhelm the firm in the long run that may force it out of the market due to bankruptcy if it does not settle the amount in due time, as was the case with formerly famous Thomas Cook plc. Netflix serves a diversified market in over 190 nations globally, which requires it to put up with substantial financial burdens. To keep up with the competition, Netflix has annually improved its content to lure more subscribers into its products. This need for diversification and consumer satisfaction has forced the firm into more and more debts, adding to its already swollen debt basket (Raymond, 2017). As of the end of September 2018, Netflix’s accumulated long-term debt stood at a worrying $34 billion. This annual debt increase without significant attempts to settle the liability is an indication of the firm’s unlikely existence in the entertainment sector in the long-run.

Finally, Netflix remains to be one of the few multibillion companies that are yet to embrace green energy technology (Said, 2016). Netflix is yet to use renewable energy as well as yet to create a business model aimed at promoting environmental sustainability compared to Apple, Google, Facebook, and Amazon that have already implemented the use of green technology in their goods and services. These four technology giants have separately committed themselves to 100% compliance with green technology requirements in their production activities. The lack of compliance with green technology recommendations could taint Netflix’s brand image in the macro-economic environment at a time when the globe is green technology cautious.

Since Netflix’s economic contributions concerning taxes charged on the Company significantly affect the US’ GDP among other nations, non-attendance to such weaknesses could prove detrimental to the firm’s continuity.  Non-adherence to environmental policies such as on green technology could cost the Company of its operations if its compliance is to be implemented. The increasing debt by Netflix could also lead to the fall of the entertainment giant as its liabilities swell up to outweigh its financial assets. These challenges, therefore, require strategic planning to ensure proactivity and continuity in the unforeseen future. Additionally, the opportunities, as well as advantages enjoyed by the firm such as economies of scale, high subscribers’ base, and receptive and accommodative markets, are some aspects that the Company could maximize on therefore cushioning it from possibly unforeseen macroeconomic situations.

Strategic Recommendation

To ensure continuity, Netflix is mandated to review its managerial economics models that could help the firm to not only avoid the adverse consequences of its weaknesses but also enable its penetration into the unconquered international market spheres. First, Netflix must cut down on its unnecessary expenditure in the already conquered market spheres and concentrate on reducing its ballooning debt, which will ultimately devour the firm of its resources in the event of insolvency. The growing debt to finance its content development undertakings could be reduced in product segments whose outputs are insignificant compared to the input costs. Therefore, a readjustment of the Company’s cost function is inevitable to ensure that there is value for every $1 worth of investment. This review will also ensure that the Company only invests in contents whose returns are capable of repaying any loans accrued in their development within the shortest time possible.

In the wake of ads, Netflix could reconsider investing in ads too, which could generate revenue as well as improve its ratings and consumer preference over time. Netflix’s idea of cloaking on to SVOD could work to its detriment as the consumer market diversifies, and market winners become even more unpredictable. Since ads are cost-effective in comparison to the marketing strategies employed by Netflix, reconsidering it could minimize the Company’s operational costs, thus diverting such excess into other equally meaningful undertakings such as the repaying of loans.

Finally, Netflix could also consider the possibility of mergers and alliances with equally competitive telecommunication firms. Since most of these telecom firms are locally based, it will enable the Company to penetrate more markets at sizeable economic costs rather than solely undertaking its expansive activities alone. Additionally, having made alliances, the Company could also consider refreshing its library’s content to fit the new markets as well as replace the lost contents due to the exit of partners such as Disney, Fox, and Warner Bros.

References

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Gabrielli, G. (2017). Netflix inc. valuation (Doctoral dissertation).

Jenner, M. (2016). Is this TVIV? On Netflix, TVIII and binge-watching. New media & society, 18(2), 257-273.

Jenner, M. (2018). Introduction: Binge-Watching Netflix. In Netflix and the Re-invention of Television (pp. 109-118). Palgrave Macmillan, Cham.

Jones, E. H., Bechtold, A., & Hayman, K. (2017). HBO NOW: Watch Out, Netflix!. Journal of Case Studies, 35(2), 37-43.

Lobato, R. (2018). Rethinking international TV flows research in the age of Netflix. Television & New Media, 19(3), 241-256.

Oliveira, C., & Ribeiro, M. I. (2019). Netflix-enterteinment services (Doctoral dissertation).

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Raymond, L. (2017). Netflix Case Study Louisiana State University Shreveport MKT 701 Dr. James February 5, 2017.

Said, A. (2016). A short history of the recsys challenge. AI Magazine, 37(4), 102-104.

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