HBR Netflix Case

9-201-037REV:OCTOBER17,2006________________________________________________________________________________________________________________ProfessorE.ScottMayfieldpreparedthiscase.HBScasesaredevelopedsolelyasthebasisforclassdiscussion.Casesarenotintendedtoserveasendorsements,sourcesofprimarydata,orillustrationsofeffectiveorineffectivemanagement.Copyright©2000PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchool.E.SCOTTMAYFIELDNetFlix.com,Inc.InJuly2000,ReedHastings,chairmanandCEOofNetFlix.com,Inc.,facedacriticaldecision.Threemonthsearlier,followingoneoftheworstepisodesonrecordfortheNASDAQmarket,NetFlixhadsubmitteditsS-1filingforitsinitialpublicoffering(IPO).1Asaresultofthemarketdownturn,manyInternetcompanieshadbeenforcedtowithdrawtheirIPOs.InvestmentbankersindicatedtoHastingsthatNetFlixwouldneedtoshowpositivecashflowswithinatwelve-monthhorizoninordertohaveasuccessfuloffering.HastingsknewthatNetFlixwasatacrucialstage.Withrevenuesdoublingeverysixmonths,NetFlixwasenjoyingtremendoussuccess.Butcontinuedsuccessdependedonthecompany’sabilitytosustaintriple-digitgrowthfortheforeseeablefuture.Soon,Hastingswouldhavetodecidewhetherornottoproceedwiththecompany’santicipatedIPO.HastingsaskedBarryMcCarthy,thechieffinancialofficer,tore-evaluatethecashflowrequirementsofthecompany’scurrentbusinessplan,tosuggestmodificationsthatwouldimprovethecompany’sprojectedcashflows,andtomakearecommendationonwhetherthecompanyshouldgoforwardwithitsplannedoffering.AsMcCarthyreviewedtheexistingNetFlixbusinessmodel,heconsideredpossiblechangesthatmightallowthecompanytoproceedwithitsplannedIPOandyetsustainthetypeoffuturegrowththatwouldbenecessaryforthecompanytoachieveitslong-runobjectives.McCarthywasacutelyawareofthecompany’scurrentfinancingneed,butheworriedabouttheeffectthatchangestothebusinessplanmighthaveonthecompany’scurrentoperations.TheCompanyNetFlix.com,Inc.wasfoundedin1997byReedHastingsandMarcRandolph.NetFlixoperatedanInternet-basedunlimitedrentalsubscriptionservicefordigitalvideodisc(DVD)formattedmovies.TheDVDprovidedanewtechnologyforstoringandplayingmovieswithimageandsoundqualityexceedingthatoftraditionalvideocassettes.ADVDwassimilarinsizetoanaudiocompactdiscandwascapableofholdinganentirefeature-lengthfilm,aswellasadditionalinformationsuchassubtitlesindifferentlanguages,additionalshortervideosaboutthemakingofthefilmorotherrelatedsubjectmatter,andinformationabouttheactors,director,andproducers.Withitshighqualityandadditionalfeatures,thenewDVDtechnologyprovidedanattractivealternativetotraditionalvideocassettesforthehomevideomarket.BycombiningthesuperiorityofthenewDVD1Afterreachingahistoricalhighof5,048onMarch10,2000,theNASDAQCompositeIndexhadfallen25%to3,794byApril18,2000,thedayoftheNetFlixS-1filing.201-037NetFlix.com,Inc.2technologywiththeconvenienceoftheInternet,NetFlixprovidedanewwaytoselectandtorenthomemovies.RandolphmanagedproductionoftheNetFlixwebsite,includingthefeatures,functionality,andcontentonthesite.Randolphbelievedthatconsumerswereoftenfrustratedintheireffortstoselectandviewmoviesattraditionalvideostoresbecauseoflimitedselectionsandafocusonnewreleasemovies.Withitsunlimited“virtual”shelfspaceforstockingvideos,theNetFlixwebsitefocusedonimprovingtheexperienceofselectingamovietowatchbyprovidinganintelligentinterfaceforbrowsing,searching,andevaluatingpotentialmovies.TheNetFlixwebsitealsointegratedmoviescurrentlyshowingintheatersbyprovidingtheabilitytochecklocallistingsandshowtimes,aswellastheabilitytoviewmovietrailersonitswebsite.Inaddition,theNetFlixwebsitekepttrackofeachsubscriber’spreferenceforvarioustypesofmoviesandprovidedanindividualizedpredictedratingforallofthemoviesonthewebsite.SincelaunchingitswebsiteinApril1998,NetFlixhadexperiencedrapidgrowth.Revenueshadgrownfrom$1.4millionin1998to$5.0millionin1999.Thenumberoffull-timeemployeesincreasedfrom46inDecember1998to270inDecember1999.ByMarch31,2000,NetFlixhadover120,000payingsubscribers.TypicalofmostInternetstartups,however,NetFlixhadnotyetearnedaprofit,reportingnetlossesof$11.1and$29.8millionin1998and1999,respectively.Exhibit1andExhibit2provideannualfinancialstatementsfor1998and1999.Exhibit3providesquarterlyoperatingresultsfor1999.TheNetFlixbusinessmodelfocusedexclusivelyonthenewDVDformattechnology.Managementhadfourmainreasonsforfocusingonthisspecificsegmentofthehomevideomarket.•DVDplayerswerethefastestgrowingsegmentofthevideoplayermarket.BecauseoftherapidadoptionofthenewDVDtechnology,saleswereforecasttogrowata49%compoundannualrateoverthenextfiveyears.2Exhibit4providesacomparisonofDVDplayerandvideocassetterecordersalesduringthefirstfiveyearsaftertheirrespectiveintroductions.•Becauseoftheirsmallsize,lightweight,anddurability