1. First-mover advantage â Netflix pioneered the online DVD rental model in September 1999 and faced no serious competition until August 2004, when Blockbuster launched its online DVD rental program. That gave Netflix a five-year lead in establishing its brand and creating a first-class consumer experience. Netflix has been rated the #1 website for customer satisfaction in the past four semi-annual surveys by ForeSee Results and FGI Research. By way of contrast, anecdotal evidence suggests that Blockbuster Onlineâs website is clumsier and less intuitive. Netflixâs early start also has provided an edge in collecting the largest number of subscriber-generated movie reviews and ratings (over 1.7 billion), which contributes to making Netflix the most user-friendly service for finding content.
2. Barriers to entry â Online DVD rental has become a two-pony race between Netflix and Blockbuster. As of year-end 2006, Blockbuster had 2.2 million online subscribers versus Netflixâs 6.3 million. That puts the current online market share at 74% Netflix, 26% Blockbuster. As recently as two years ago Wal-Mart was a competitor, and Amazon was making rumblings about entering the online DVD rental market as well. But in May 2005, Wal-Mart discontinued its DVD rental service and handed over its subscribers to Netflix in exchange for Netflixâs agreement to promote Wal-Martâs DVD sales. Similarly, Amazon never entered the market, probably in part because it saw how Blockbuster had to spend roughly $300 million during 2004 and 2005 just to scrape together a distant second place to Netflix. The fact that Netflix successfully warded off both Wal-Mart and Amazon speaks to the significant barriers to entry that now exist in the online DVD rental business. I estimate that today the minimum cost of entry for a new competitor would likely be north of $500 million in order to build a network of nationwide shipping centers, run a huge advertising campaign, and endure deep losses while scaling up to a level of critical mass.
3. Low-cost provider â This one is a bit more difficult to prove objectively because Blockbusterâs financials reflect a hybrid of online and offline operations, making it impossible to compare BBI and NFLXâs cost structures on an apples-to-apples basis. Nevertheless, the simple fact that Blockbuster must support a costly base of physical stores, while Netflix does not, supports the rationale for believing that Netflixâs costs are structurally lower than that of Blockbuster. Netflixâs CEO Reed Hastings has asserted, âOur scale and technology allow us to make money at price points no competitor can sustainably matchâ (Q3 â05 earnings call).
4. Long-tail economics â Iâm using this label to describe the unique nature of Netflixâs emphasis on lesser-known titles and independent films, which collectively are referred to as âlong-tailâ content. This term comes from a November 2005 article in Wired Magazine describing the long-tail phenomenon which is relevant to numerous internet business models. The long tail represents the thousands of niche interests and pockets of consumer demand â each one tiny on its own and therefore too small to be a target of traditional mass-market merchandising â but the collective whole of these niches represents a large market. For Netflix, the long-tail phenomenon is visible in its usersâ viewing habits in that only about one-third of Netflixâs rentals are new releases, while the other two-thirds are older films, foreign titles, or independent content. This is exactly the opposite of traditional video stores which are primarily reliant on the new release slate. (Envision your typical video store where people are roaming the perimeter for new releases, while practically nobody ventures into the middle of the store.)
Netflixâs system of personalized recommendations plays a key role in driving demand across the full breadth of its DVD library. In fact, every three months, Netflix members rent more than 95% of the 70,000 titles in the Netflix library. This ability to connect subscribers to long-tail content is, most significantly, a vital source of competitive differentiation. There are many alternative channels for new release and pop hit content â including traditional video stores, video on demand, mass market retailers, and DVD self-rental kiosks â but long-tail content is nearly impossible to access economically except by online DVD rental. Netflixâs ability to tap into long-tail economics is a vital source of competitive differentiation that the market is clearly underrating.
