Case Exercises

Netflix and Redbox Compete for Movie Rentals

Charging $17.99 a month for an unlimited number of movie rentals (three at one time), Netflix revolutionized the movie rental business with a one-day mailing service for DVDs and acquired 12 million subscribers and $1.5 billion in revenue. However, Blockbuster, the video rental giant from the earlier $5.5 billion bricks-and-mortar movie rental business, decided to enter the mail-in delivery and online-DVD rental businesses. Blockbuster (now a division of Dish Network) drove prices down to $14.99, attracting 2 million subscribers. Netflix responded with a cut-rate service of one movie at a time for $9.99 per month, which drove the net profit right out of the business.

Movie studios like Viacom and Time Warner also entered the market with direct-to-the-customer video on demand delivered over the broadband web. Following two months of theatre-only releases, the studios asked $20 to $25 per showing. This fee is five times what it costs to rent a second-run or classic movie from the cable companies and 10 times Netflix’s or Redbox’s SI.99 or SI fees for overnight rentals. At such exorbitant prices, the studios earn a 70 percent margin, but the –16.0 price elasticity of home entertainment suggests an eight-fold increase in volume for half-price promotions. On-demand broadband movies and Blu-ray are the only two growing segments of consumer demand for video (see 

Figure 10.12

).

Figure 10.12Consumer Spending on Video

Source: IHS Screen Digest, Wall Street Journal (February 9, 2011, p. B14).

Use Porter’s Five Forces model to answer the following questions:

Questions

1. What disruptive technology has threatened the bricks-and-mortar and mail-in movie rental business?

2. Does easy access to distribution channels at grocery stores for Redbox’s 22,000 vending machines indicate a high- or low-entry threat in the movie rental business? Why? Why might McDonald’s be an even better distribution channel than grocery stores?

3. Are there any economies of scale in the on-demand video rental business to serve as a barrier to the entry of Amazon?

4. Who are Netflix’s and Redbox’s suppliers? Are they in a position to appropriate much of the value in the value chain? Why or why not?

5. What factors determine the intensity of rivalry in any industry? Is the intensity of rivalry in the video rental industry high or low? Why?