Netflix, Inc.: Rebranding and Price Increase Debacle

Abstract

In 2011 Netflix was the world's largest online movie rental service. Its subscribers paid to have DVDs delivered to their homes through the U.S. mail, or to access and watch unlimited TV shows and movies streamed over the Internet to their TVs, mobile devices, or computers. The company was founded by Marc Randolph and Reed Hastings in August, 1997 in Scotts Valley, California, after they had left Pure Software. Hastings was inspired to start Netflix after being charged $40 for an overdue video. Initially, Netflix provided movies at $6 per rental, but moved to a monthly subscription rate in 1999, dropping the single-rental model soon after. From then on, the company built its reputation on the business model of flat fee unlimited rentals per month without any late fees, or shipping and handling fees.

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

2024 Sage Publications, Inc. All Rights Reserved

Resources

Exhibit 1: Netflix Consolidated Statement of Operations

(In thousands, except per share data; year end December 31)

2011

2010

2009

Revenues

$3,204,577

$2,162,625

$1,670,269

Cost of revenues:

Subscription

1,789,596

1,154,109

909,461

Fulfillment expenses

250,305

203,246

169,810

Total cost of revenues

2,039,901

1,357,355

1,079,271

Gross profit

1,164,676

805,270

590,998

Operating expenses:

Marketing

402,638

293,839

237,744

Technology and development

259,033

163,329

114,542

General and administrative

117,937

64,461

46,773

Legal settlement

9,000

-

-

Total operating expenses

788,608

521,629

399,059

Operating income

376,068

283,641

191,939

Other income (expense):

Interest expense

(20,025)

(19,629)

(6,475)

Interest and other income

3,479

3,684

6,728

Income before income taxes

359,522

267,696

192,192

Provision for income taxes

133,396

106,843

76,332

Net income

$226,126

$160,853

$115,860

Net income per share:

Basic

$4.28

$3.06

$2.05

Diluted

$4.16

$2.96

$1.98

Weighted-average common shares outstanding:

Basic

52,847

52,529

56,560

Diluted

54,369

54,304

58,416

Exhibit 2: Netflix Consolidated Balance Sheets

(In thousands, except per share data; year end December 31)

2011

2010

Assets

Current assets:

Cash and cash equivalents

$508,053

$194,499

Short-term investments

289,758

155,888

Current content library, net

919,709

181,006

Prepaid content

56,007

62,217

Other current assets

57,330

43,621

Total current assets

1,830,857

637,231

Non-current content library, net

1,046,934

180,973

Property and equipment, net

136,353

128,570

Other non-current assets

55,052

35,293

Total assets

$3,069,196

$982,067

Liabilities and Stockholders’ Equity

Current liabilities:

Content accounts payable

$924,706

$168,695

Other accounts payable

87,860

54,129

Accrued expenses

63,693

38,572

Deferred revenue

148,796

127,183

Total current liabilities

1,225,055

388,579

Long-term debt

200,000

200,000

Long-term debt due to related party

200,000

-

Non-current content liabilities

739,628

48,179

Other non-current liabilities

61,703

55,145

Total liabilities

2,426,386

691,903

Commitments and contingencies (Note 5)

Stockholders’ equity:

Preferred stock, $0.001 par value; 10,000,000 shares authorized at December 31, 2011 and 2010; no shares issued and outstanding at December 31, 2011 and 2010

-

-

Common stock, $0.001 par value; 160,000,000 shares authorized at December 31, 2011 and 2010; 55,398,615 and 52,781,949 issued and outstanding at December 31, 2011 and 2010, respectively

55

53

Additional paid-in capital

219,119

51,622

Accumulated other comprehensive income

706

750

Retained earnings

422,930

237,739

Total stockholders’ equity

642,810

290,164

Total liabilities and stockholders’ equity

$3,069,196

$982,067

Exhibit 3: Netflix Consolidated Statements of Cash Flows

(In thousands, except per share data; year end December 31)

2011

2010

2009

Cash flows from operating activities:

Net income

$226,126

$160,853

$115,860

Adjustments to reconcile net income to net cash provided by operating activities:

Additions to streaming content library

(2,320,732)

(406,210)

(64,217)

Change in streaming content liabilities

1,460,400

167,836

(4,014)

Amortization of streaming content library

699,128

158,100

48,192

Amortization of DVD content library

96,744

142,496

171,298

Depreciation and amortization of property, equipment and intangibles

43,747

38,099

38,044

Stock-based compensation expense

61,582

27,996

12,618

Excess tax benefits from stock-based compensation

(45,784)

(62,214)

(12,683)

Other non-cash items

(4,050)

(9,128)

(7,161)

Deferred taxes

(18,597)

(962)

6,328

Gain on sale of business

-

-

(1,783)

Changes in operating assets and liabilities:

Prepaid content

6,211

(35,476)

(5,643)

Other current assets

(4,775)

(18,027)

(5,358)

Other accounts payable

24,314

18,098

1,537

Accrued expenses

68,902

67,209

13,169

Deferred revenue

21,613

27,086

16,970

Other non- current assets and liabilities

2,883

645

1,906

Net cash provided by operating activities

317,712

276,401

325,063

Cash flows from investing activities:

Acquisition of DVD content library

(85,154)

(123,901)

(193,044)

Purchases of short-term investments

(223,750)

(107,362)

(228,000)

Proceeds from sale of short-term investments

50,993

120,857

166,706

Proceeds from maturities of short-term investments

38,105

15,818

35,673

Purchases of property and equipment

(49,682)

(33,837)

(45,932)

Proceeds from sale of business

-

-

7,483

Other assets

3,674

12,344

11,035

Net cash used in investing activities

(265,814)

(116,081)

(246,079)

Cash flows from financing activities:

Principal payments of lease financing obligations

(2,083)

(1,776)

(1,158)

Proceeds from issuance of common stock upon exercise of options

19,614

49,776

35,274

Proceeds from public offering of common stock, net of issuance costs

199,947

-

-

Excess tax benefits from stock-based compensation

45,784

62,214

12,683

Borrowings on line of credit, net of issuance costs

-

-

18,978

Payments on line of credit

-

-

(20,000)

Proceeds from issuance of debt, net of issuance costs

198,060

-

193,917

Repurchases of common stock

(199,666)

(210,259)

(324,335)

Net cash provided by (used in) financing activities

261,656

(100,045)

(84,641)

Net increase (decrease) in cash and cash equivalents

313,554

60,275

(5,657)

Cash and cash equivalents, beginning of year

194,499

134,224

139,881

Cash and cash equivalents, end of year

$508,053

$194,499

$134,224

Supplemental disclosure:

Income taxes paid

$79,069

$56,218

$58,770

Interest paid

19,395

20,101

3,878

Exhibit 4

Netflix Management Team
Reed Hastings, Founder and CEO

Reed Hastings has served as the Chief Executive Officer since September 1998 and the Chairman of the Board since inception. Mr. Hastings served as Chief Executive Officer of Pure Atria Software, a maker of software development tools, from its inception in October 1991 until it was acquired by Rational Software Corporation, in August 1997. Mr. Hastings currently serves as a member of the board of directors of Microsoft. Mr. Hastings holds an M.S.C.S. degree from Stanford University and a B.A. from Bowdoin College.

Kelly Bennett, Chief Marketing Officer

Kelly Bennett became Netflix Chief Marketing Officer in July 2012 after nearly a decade at Warner Bros. where he was most recently Vice President Interactive, World Wide Marketing with the pictures group, leading international online campaigns for Warner Bros. movies. Before that Kelly ran digital marketing for Warner Bros. Pictures in Europe, the Middle East and Africa and worked in promotion and business development at the company. He previously held executive positions at Dow Jones International and Ignition Media as well as being a partner in online marketing agency Cimex Media. The Canada-born Bennett is a graduate of Simon Fraser University.

Jonathan Friedland, Chief Communications Officer

Mr. Friedland joined Netflix in February 2011 from The Walt Disney Company, where he was SVP, Corporate Communications. Before that, he spent over 20 years as a foreign correspondent and editor, mainly with The Wall Street Journal, in the U.S., Asia and Latin America and co-founded the Diarios Rumbo chain of Spanish-language newspapers in Texas. Mr. Friedland, who has a MSc. Economics from the London School of Economics and a BA from Hampshire College, was a member of the WSJ team that won the Pulitzer Prize for its coverage of the 9/11 attacks.

Bill Holmes, Chief Business Development Officer

Bill Holmes joined Netflix in 2008 and has most recently served as Vice President, Business Development, in charge of the company’s global partnerships across the consumer electronics, gaming, operator, service provider and retail markets. Prior to joining Netflix, Mr. Holmes served as Vice President Business Development & Strategy at DivX, Inc. where he oversaw the launch and global adoption of the DivX Certified program into hundreds of millions of consumer electronics devices. Mr. Holmes holds a B.A. degree from Trinity University.

Neil Hunt, Chief Product Officer

Neil Hunt has served as the Company’s Chief Product Officer since 2002 and as its Vice President of Internet Engineering from 1999 to 2002. From 1997 to 1999, Mr. Hunt was Director of Engineering for Rational Software. Mr. Hunt holds a doctorate in computer science from the University of Aberdeen, U.K. and a bachelor’s degree from the University of Durham, U.K.

David Hyman, General Counsel

David Hyman has served as the Company’s General Counsel since 2002. Mr. Hyman also serves as the Company’s secretary. Prior to joining Netflix, Mr. Hyman served as General Counsel of Webvan, Inc., an Internet-based grocery delivery service. Mr. Hyman holds a J.D. and a B.A. degree from the University of Virginia.

Patty McCord, Chief Talent Officer

Patty McCord has served as the Company’s Chief Talent Officer since 1998. Prior to joining Netflix, from 1994 to 1997, Ms. McCord served as Director of Human Resources at Pure Atria, which was acquired by Rational Software, where she managed all human resources functions and directed all management development programs.

Ted Sarandos, Chief Content Officer

Ted Sarandos has served as the Company’s Chief Content Officer and Vice President of Content since 2000. Prior to joining Netflix, Mr. Sarandos was Vice President of Product and Merchandising for Video City.

David Wells, Chief Financial Officer

David Wells has served as the Company’s Chief Financial Officer since December 2010 and its Vice President of Financial Planning & Analysis from August 2008 to December 2010. He held the position of Director of Operations Planning & Analysis from March 2004 to August 2008. Prior to joining Netflix, Mr. Wells served in progressive roles at Deloitte Consulting from August 1998 to August 2004. Mr. Wells holds an M.B.A and M.P.P. from The University of Chicago and an undergraduate degree in both Accounting and English from the University of Virginia.

Netflix Board of Directors
Richard Barton, Chief Executive Officer and Chairman of the Board, Zillow, Inc.

Richard Barton has served as one of the Company’s directors since May 2002. In late 2004, Mr. Barton co-founded Zillow, Inc. where he is now Executive Chairman of the Board. Additionally, Mr. Barton is a Venture Partner with Benchmark Capital. Previously, Mr. Barton founded Expedia, Inc. in 1994 and was its President, Chief Executive Officer and director from November 1999 to March 2003. Mr. Barton was a director of InterActiveCorp from February 2003 until January 2005. Mr. Barton also serves as a director for Avvo, Inc. and Glassdoor.com. Mr. Barton holds a B.S. in industrial engineering from Stanford University.

A. George (Skip) Battle, Investor

A. George (Skip) Battle has served as one of the Company’s directors since June 2005. Mr. Battle was previously Executive Chairman of the Board of Ask Jeeves, Inc. which was acquired by IAC/InterActiveCorp in July 2005. He was Chief Executive Officer of Ask Jeeves from 2000 to 2003. From 1968 until his retirement in 1995, Mr. Battle served in management roles at Arthur Andersen LLP and then Andersen Consulting LLP (now Accenture), where he became worldwide managing partner of market development and a member of the firm’s executive committee. Educated at Dartmouth College and the Stanford Graduate School of Business, Mr. Battle currently serves as Chairman of the Board of Fair Isaac Corporation, a director of Advent Software, Inc. OpenTable, Inc. and Expedia, Inc., and a member of the board of the Masters Select family of mutual funds. He was previously a director of PeopleSoft, Inc.

Timothy Haley, Managing Director, Redpoint Ventures

Timothy M. Haley has served as one of the Company’s directors since June 1998. Mr. Haley is a co-founder of Redpoint Ventures, a venture capital firm, and has been a Managing Director of the firm since October 1999. Mr. Haley has been a Managing Director of Institutional Venture Partners, a venture capital firm, since February 1998. From June 1986 to February 1998, Mr. Haley was the President of Haley Associates, an executive recruiting firm in the high technology industry. Mr. Haley currently serves on the board of directors of several private companies. Mr. Haley holds a B.A. from Santa Clara University.

Reed Hastings, Chief Executive Officer, President, Chairman of the Board

Reed Hastings has served as the Chief Executive Officer since September 1998 and the Chairman of the Board since inception. Mr. Hastings served as Chief Executive Officer of Pure Atria Software, a maker of software development tools, from its inception in October 1991 until it was acquired by Rational Software Corporation, in August 1997. Mr. Hastings currently serves as a member of the board of directors of Microsoft. Mr. Hastings holds an M.S.C.S. degree from Stanford University and a B.A. from Bowdoin College.

Jay Hoag, General Partner, Technology Crossover Ventures

Jay Hoag has served as one of the Company’s directors since June 1999. Since June 1995, Mr. Hoag has served as a founding General Partner at Technology Crossover Ventures, a private equity and venture capital firm. Mr. Hoag serves on the board of directors of Tech Target and several private companies. Previously Mr. Hoag served on the boards of directors of TheStreet.com, Altiris, Inc. and eLoyalty Corporation. Mr. Hoag holds an M.B.A. from the University of Michigan and a B.A. from Northwestern University.

Leslie Kilgore

Leslie Kilgore served as the Company’s Chief Marketing Officer from 2000 till 2012. From February 1999 to March 2000, Ms. Kilgore served as Director of Marketing for Amazon.com, Inc., an Internet retailer. Ms. Kilgore served as a brand manager for The Procter & Gamble Company, a manufacturer and marketer of consumer products, from August 1992 to February 1999. Ms. Kilgore holds an M.B.A. from the Stanford University Graduate School of Business and a B.S. from The Wharton School of Business at the University of Pennsylvania.

Ann Mather

Ann Mather has served as a member of the board of directors since July 2010. Since September 2005, Ms. Mather has been a director of Glu Mobile Inc., a publisher of mobile games. Since November 2005, Ms. Mather has been a director of Google, Inc. and serves as chair of its audit committee. Since May 2010, Ms. Mather has been a director of MoneyGram International, a global payment services company, and serves as chair of its audit committee. Ms. Mather is also a director of Ariat International, Inc, a privately held manufacturer of footwear for equestrian athletes. Ms. Mather was previously a director of Central European Media Enterprises Group, a developer and operator of national commercial television channels and stations in Central and Eastern Europe, Zappos.com, Inc., a privately held, online retailer, until it was acquired by Amazon.com, Inc. in 2009, and Shopping.com, Inc., a price comparison web site, until it was acquired by eBay Inc. in 2005. Ms. Mather was chair of Shopping.com’s audit committee, and a member of its corporate governance and nominating committee. From 1999 to 2004, Ms. Mather was Executive Vice President and Chief Financial Officer of Pixar, a computer animation studio. Prior to her service at Pixar, Ms. Mather was Executive Vice President and Chief Financial Officer at Village Roadshow Pictures, the film production division of Village Roadshow Limited. From 1993 to 1999, she held various executive positions at The Walt Disney Company, including Senior Vice President of Finance and Administration for its Buena Vista International Theatrical Division. Ms. Mather holds a Master of Arts degree from Cambridge University.

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

2024 Sage Publications, Inc. All Rights Reserved

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