Case Teaching Note 05 - Competition in the Movie Rental Industry in 2008: Netflix & Block¬buster Battle for Market Leadership Teaching Outline and Analysis 1. How strong are the competitive forces in the movie rental marketplace? Do a five-forces analysis to support your answer. Below is a representative five-forces model of competition in the movie rental industry:  Rivalry among companies competing in movie rentals—  Threat of entry  Competition from substitutes—  The bargaining power and leverage of suppliers—  The bargaining power and leverage of people renting DVDs— Conclusions concerning the overall strength of competitive forces: 2. What forces are driving change in the movie rental industry? Are these driving forces likely to have a favorable or unfavorable impact on competitive intensity and future industry profitability? Conclusions: . 3. What does your strategic group map of this industry look like? Is Netflix well-positioned? Why or why not? Figure 1 A Representative Strategic Group Map of the Movie Rental Industry 4. What key factors will determine a company’s success in the movie rental industry in the next 3-5 years? 5. What is Netflix’s strategy? Which of the five generic competitive strategies discussed in Chapter 5 most closely fit the competitive approach that Netflix is taking? What type of competitive advantage is Netflix trying to achieve? Netflix’s Competitive Advantage 6. What does a SWOT analysis of Netflix reveal about the overall attractiveness of its situation? Netflix’s Resource Strengths and Competitive Assets Netflix’s Resource Weaknesses and Competitive Liabilities Netflix’s External Market Opportunities External Threats to Netflix’s Future Profitability Conclusions concerning Netflix’s situation. 7. What is your appraisal of Netflix’s operating and financial performance based on the data in case Exhibits 2, 3, and 4? What positives and negatives do you see in Netflix’s performance? Use the financial ratios in Table 4.1 of Chapter 4 as a guide in doing the calculations needed to arrive at an analysis-based answer to your assessment of Netflix’s recent financial performance.  Netflix’s profit margins have changed as follows: 2000 2002 2004 2005 2006 2007 Gross profit margin (gross profit as a % of revenues) Operating profit margin (operating income as a % of revenues) Net profit margin (net income as a % of revenues) Calculated from information in case Exhibit 3.  The following table shows assorted expense ratios for Netflix: 2000 2002 2004 2005 2006 2007 Subscription costs as a % of subscription revenues Fulfillment costs as a % of total revenues Technology and development costs as a % of total revenues Marketing costs as a % of total revenues General and admin costs as a % of total revenues Calculated from information in case Exhibit 3. Positives (or strengths) in Netflix’s opera ...

1. Case Teaching Note 05 - Competition in the Movie Rental
Industry in 2008: Netflix & Block¬buster Battle for Market
Leadership
Teaching Outline and Analysis
1. How strong are the competitive forces in the movie rental
marketplace? Do a five-forces analysis to support your answer.
Below is a representative five-forces model of competition in
the movie rental industry:
Rivalry among companies competing in movie rentals—
Threat of entry
Competition from substitutes—
The bargaining power and leverage of suppliers—
The bargaining power and leverage of people renting
DVDs—
Conclusions concerning the overall strength of competitive
forces:
2. What forces are driving change in the movie rental
industry? Are these driving forces likely to have a favorable or
unfavorable impact on competitive intensity and future industry
profitability?
Conclusions:
.

2. 3. What does your strategic group map of this industry look
like? Is Netflix well-positioned? Why or why not?
Figure 1 A Representative Strategic Group Map of the Movie
Rental Industry
4. What key factors will determine a company’s success in
the movie rental industry in the next 3-5 years?
5. What is Netflix’s strategy? Which of the five generic
competitive strategies discussed in Chapter 5 most closely fit
the competitive approach that Netflix is taking? What type of
competitive advantage is Netflix trying to achieve?
Netflix’s Competitive Advantage
6. What does a SWOT analysis of Netflix reveal about the
overall attractiveness of its situation?
Netflix’s Resource Strengths and Competitive Assets

3. Netflix’s Resource Weaknesses and Competitive Liabilities
Netflix’s External Market Opportunities
External Threats to Netflix’s Future Profitability
Conclusions concerning Netflix’s situation.
7. What is your appraisal of Netflix’s operating and financial
performance based on the data in case Exhibits 2, 3, and 4?
What positives and negatives do you see in Netflix’s
performance? Use the financial ratios in Table 4.1 of Chapter 4
as a guide in doing the calculations needed to arrive at an
analysis-based answer to your assessment of Netflix’s recent
financial performance.

4. Netflix’s profit margins have changed as follows:
2000
2002
2004
2005
2006
2007
Gross profit margin
(gross profit as a % of revenues)
Operating profit margin
(operating income as a % of revenues)
Net profit margin
(net income as a % of revenues)
Calculated from information in case Exhibit 3.
The following table shows assorted expense ratios for

5. Netflix:
2000
2002
2004
2005
2006
2007
Subscription costs as a
% of subscription revenues
Fulfillment costs as a % of total revenues
Technology and development costs
as a % of total revenues
Marketing costs as a % of total revenues

6. General and admin costs
as a % of total revenues
Calculated from information in case Exhibit 3.
Positives (or strengths) in Netflix’s operating and financial
performance based on the data in case Exhibits 2, 3, and 4:
Negatives (or weaknesses) in Netflix’s operating and financial
performance based on the data in case Exhibits 2, 3, and 4:
8. What does a SWOT analysis of Blockbuster reveal about
the overall attractiveness of its situation?
Blockbuster’s Resource Strengths and Competitive Assets
Blockbuster’s Resource Weaknesses and Competitive Liabilities
Blockbuster’s External Market Opportunities

7. External Threats to Blockbuster’s Future Prospects
9. What is your appraisal of Blockbuster’s performance as
shown in case Exhibit 5? What pluses and minuses do you see?
Use the financial ratios in Table 4.1 of Chapter 4 as a guide in
doing the calculations needed to arrive at an analysis-based
answer to your assessment of Blockbuster’s recent performance.
Conclusions:
10. How does Netflix’s competitive strength compare against
that of Blockbuster? Do a weighted competitive strength
assessment using the methodology presented in Table 4.4 of
Chapter 4 to support your answer. Does Netflix have a
sustainable competitive advantage over Blockbuster in the
movie rental business? Why or why not?
Table 1 Competitive Strength Assessments of Netflix and
Blockbuster
(Rating scale: 1 = very weak; 5 = average; 10 = very strong)
Competitive Strength Measures
Importance
Weight
Netflix
Blockbuster

8. Rating
Score
Rating
Score
Number/variety of titles in library
of content offerings
Ease and convenience of
choosing movies to rent
Ease and convenience of returning rented DVDs
Competitive pricing/variety of subscription plans
Brand image/ability to attract customers

9. Order-filling capabilities
Geographic market coverage
Ability to access movie rental customers
Financial strength
Sum of weights
Total Rating/Score

10. 12. What recommendations would you make to Netflix CEO
Reed Hastings? At a minimum, your recommendations should
cover what to do about each of the top priority issues identified
in question 11.
13. What recommendations would you make to Blockbuster
CEO James Keyes? At a minimum, your recommendations
should cover what to do about each of the top priority issues
identified in question 11.
Epilogue
Netflix reported revenues of $1.36 billion for 2008 (versus $1.2
billion in 2007) and net income of $83 million (equal to $1.32
per diluted share) versus net income of $66.6 million in 2007
and diluted EPS of $0.97. Net cash flows from operating
activities were $284.0 million versus $277.4 million in 2007. At
year-end 2008, Netflix had cash and cash equivalents of $139.9
million (versus $177.4 million at the end of 2007) and short-
term investments of $157.4 million (versus $207.7 million at the

11. end of 2007).
Netflix ended 2008 with approximately 9,390,000 total
subscribers, representing 26% year-over-year growth from
7,479,000 total subscribers at the end of 2007 and 8%
sequential growth from 8,672,000 subscribers at the end of the
third quarter of 2008. Subscriber acquisition cost for 2008 was
$29.12 per gross subscriber addition compared to $40.86 for
2007.
In January 2009, Netflix announced partnerships with LG
Electronics and Vizio, both makers of big-screen high-
definition TVs, that would enable Netflix subscribers to watch
movies streamed from Netflix directly to new Internet-
connected LG and Vizio TV models that would be equipped
with manufacturer-installed devices enabling such streaming.
Netflix subscribers with such TVs would no longer need an
external device to enable Netflix to stream movies directly to
their TVs. Earlier, in November 2008, Netflix announced that
its subscribers could have movies and TV episodes instantly
streamed to their TVs via the Xbox 360 video game and
entertainment system utilizing the New Xbox Experience that
premiered nationwide on November 19. The Xbox 360 was the
only game and entertainment console that let users instantly
watch movies and TV episodes streamed from Netflix to the TV.
There was no additional monthly fee for Netflix members who
were also Xbox LIVE Gold members.
Netflix management projected that full-year 2009 results would
be as follows:
Ending subscribers of 10.6 million to 11.3 million
Revenue of $1.58 billion to $1.635 billion
Net income of $88 million to $98 million
EPS of $1.43 to $1.59 per diluted share
For the first three quarters of 2008, Blockbuster reported total
revenues of $3.90 billion versus total revenues of $3.975 billion
for the first nine months of 2007. Both rental revenues and
merchandise sales were down slightly from 2007 levels. The
company reported a net loss of $22.7 million for the first nine

12. months of 2008, significantly better than the loss of $123.2
million for the first nine months of 2007. Net cash flows from
operations for the first nine months of 2008 were a negative
$101.1 million. To contain its operating losses, Blockbuster
management cut advertising expenditures to $94.8 million
during the first nine months of 2008 (versus $158.9 million for
the first three quarters of 2007). Long-term debt was $614.8
million, down from $665.6 million at the end of 2007.
At the end of the third quarter of 2008, Blockbuster had 5,843
company-owned stores, of which 3,909 were domestic and 1,934
were foreign. Counting franchised stores, Blockbuster had 7,525
stores as of October 5, 2008, down 305 stores since January 1,
2008. Domestic same-store revenues increased 5.1% in the third
quarter of 2008 as compared to the third quarter of 2007, due to
a 0.8% growth in same-store rental revenues and a 30.7%
increase in same-store merchandise sales, largely driven by a
significant increase in sales of games software and hardware.
International same-store revenues decreased 3.4% as compared
to the same period last year, reflecting a 2.2% decline in same-
store rental revenues and a 5.0% decline in same-store
merchandise sales. Worldwide same-store revenues grew 1.9%
from the same period last year.
On March 3, 2009, Blockbuster announced that it had hired a
prominent law firm that specialized in financially-troubled
enterprises to advise the company on financing and capital-
raising efforts; the company’s stock price plunged from about
$1 per share to $0.22 on the announcement. On March 4,
Standard & Poors placed Blockbuster on its credit watch list,
including its speculative ‘B-’ corporate credit rating, in light of
pending maturities of a revolving credit line and term loan A
debt in August 2009. There were doubts that Blockbuster would
be able to refinance the debt that was maturing in August. On
March 5, Blockbuster announced that same-store sales rose
4.4% in the fourth quarter of 2008 and that domestic same-store
sales were up 6.4% for full-year 2008. The increase in 4th

13. quarter 2008 same-store sales was comprised of a 2.6% decrease
in domestic same-store rental comparables and a 36.5% increase
in domestic same-store retail comparables, which was largely
driven by increased sales of games, game merchandise and
consumer electronics. These sales increases prompted
Blockbuster’s stock price to rise to the $0.50-$0.65 range as of
March 6, 2009.
Please check the investor relations sections and the press
releases at www.netflix.com and www.blockbuster.com for the
latest developments on how these two movie rental competitors
are faring.
CTN 5-10