Ron Golan Andy Shin Kevin You
March 25, 2008
BMGT 440 – Professor David Kass
Company Background & The Issue At Hand
NetFlix.com, the world’s largest online DVD rental company, was founded by Reed Hastings and Marc Randolph in 1997, and is headquartered in Los Gatos, California. The company started its online DVD rental business by launching Netflix.com, offering pay-perDVD rental services by delivering DVDs via mail. As the company prospered during late 1999, NetFlix replaced its pay-per-DVD revenue model with a fixed monthly fee system that allowed customers to rent up to 4 DVDs per month with no due dates or late fees. In February 2000, it launched a new plan, where, with a monthly fee of $19.95 instead of its previous $15.95, subscribers were able to have up to 4 DVDs in their possession at one time. The website allowed subscribers to make their own lists or “queues” of movies that they browsed and selected to watch. Then, it shipped movies that were at the top of the queues of subscribers via mail. It also provided subscribers with individualized ratings on all movies that customers had previously rated after viewing. As the company enjoyed tremendous success, it decided to submit its S-1 filing for an initial public offering. However, soon after it was submitted, the NASDAQ stock market fell 25% to 3,794, making it more difficult for a company’s IPO to succeed with uncertainty in the financial markets. In July 2000, Reed Hastings, CEO of NetFlix, needed to decide whether the compnay should proceed with the IPO or withdraw it. Investment banks predicted that the IPO of NetFlix would succeed if it showed positive cash flows within a twelve-month horizon, but the executives at NetFlix were unsure whether they could achieve that goal.
Long-Run Objectives & Performance To Date
NetFlix’s long-run objectives are to convert as many free trial users to paid users as possible and to retain paid users over the long run. NetFlix plans to achieve its long-run objectives by building and enhancing customers’ brand loyalty in NetFlix. It provides subscribers various features to encourage them to stay with the company. For example, it offers one month free trials to potential subscribers with unlimited number of DVD rentals. As new customers experience free trials, NetFlix keeps track of movies they rented and provides individualized ratings on all movies in its inventory using its marquee queue system. New subscribers benefit from this feature by easily choosing movies that match with their preferences. It also automatically sends out movies that are on the top of subscribers’ queues as soon as they return the DVDs in their possession to NetFlix. Along with NetFlix’s individualized services, its extensive DVD library, fast shipping, no return dates, and no late fees build and enhance customers’ brand loyalty. Its performance to date can be assessed by looking at the conversion rate of free-trial users to paid users and the retention rate of paid users after 6 months. If these rates are high, it implies that more free-trial users have converted to paid users, and more subscribers have
continued to subscribe with the company. Therefore, high conversion and retention rates ultimately meet the company’s long-run objectives. Its performance can also be measured by assessing the net present value of a new NetFlix subscriber and the total enterprise value. Net present value (NPV) shows whether the company’s cash inflows per new subscriber exceed its cash outflows per new subscriber. A positive NPV means that cash inflows exceed cash outflows, and it results in NetFlix making profit from each new subscriber. However, if it is negative, cash outflows exceed cash inflows, and thus results in NetFlix losing money for each new subscriber. The total enterprise value indicates the net present value of the company as a whole by subtracting the present value of corporate costs from the present value...
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