MBAF-504-TEAM-PROJECT

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MBAF 504-F29: BUSINESS ECONOMICS University Canada West Professor, Mukhtar Tabari 12 th November 2022 TEAM PROJECT 1: Analysis of Netflix Business Model using Microeconomics Principles Team C Christiana Ilechukwu A (2219747) Kapil Thukral (2211430) Mahagammulle Gamage Piyumi Nisansala Wickramasinghe (2200845) Juan Gutierrez (2205749) Chiazoka Chidubem(2218529) Chiamaka Angel Aja-Eze (2200403) Dimpy Dhamija (2210564)

Analysis of Netflix Business Model using Microeconomics Principles ------------------------------------------------------------------------------------------------------------------------------ Abstract The purpose of this paper is to research and identify how Netflix utilizes components of microeconomics like supply and demand, to help achieve their business goals by increasing subscribers and generating revenue for the company. At the same time, the research paper demonstrates the behaviors of long- and short-run cost curves and their impact on subscriptions by examining recent events that has caused the company’s subscription rise and analyzing how the competing firms have been performing to surpass the market dominance Netflix has acquired over the years. Introduction Netflix, which was once a DVD distributor, has now become the world’s leading streaming entertainment service with about 223 million paid subscribers in more than 190 countries around the globe. The marketing techniques and the user interface of Netflix have revolutionized how people watch TV. Although, their unique advertising strategies like ‘Netflix and Chill’ has brought a great deal of attention to this video streaming platform to attract more consumers. Other similar streaming platforms like Disney Hotstar, Hulu, HBO, Amazon prime video, Showmax, etc. have also been racing to compete and chip away at the subscribers by offering similar services at lower prices (CNBC,2022) . All of these affected the major loss in subscribers, and their stock dropped drastically in April 2022. But now, it looks like the company is bouncing back and is ready to get out of the dark cloud after months as in the recently announced to have added 2.4 million subscribers in the 3 d quarter of the year which may be the result of their aggressive approach towards adding latest hits on the platform for streaming. Which even overshadowed the fact that they had already increased the prices of subscriptions earlier this year. Demand and supply curves to examine Netflix business model Netflix, an American subscription-based streaming service company, provides exclusive content which no other platform or website is legally allowed to post. As a result, people who want to watch this hyped content are inclined to buy a subscription. This indicates that a streaming platform’s market performance is majorly dependent upon the content they accommodate and advertising, which is their supply, in this case, the subscribers that are attracted towards buying their services, generate an increased demand in this market if the platform’s content is desirable Thus, demand and supply play a vital role in determining the market price and quantity through the interaction of buyers and sellers.

According to the article, in the third quarter of 2022, Netflix added 2.4 million subscribers increasing its subscription band from 220 million to 223 million subscribers. This was followed after they lost some subscribers due to an increase in the price. Below is the subscriber’s trend analysis from Q4 2019 to Q3 2022 using the demand and supply curve. CASE1 Due to the increase in covid 19 cases, many restrictions were imposed worldwide. A complete lockdown was implemented in various counties. Effect Due to the lockdown, people were isolated in their homes, disconnected from their social life. So, for many people, the most plausible way to get rid of their boredom is by streaming movies and web shows online. Thus, it impacted Netflix positively as it experienced a hike in subscribers from 167.09 to 192.95 million subscribers (approx. 25.86 Mn subscribers). Before covid, Netflix’s subscription was more like a luxury service, but now, it is a necessity due to safety and security reasons. People prefer to watch movies in their own personal space and time with their family. So, the demand curve shifted to the right, and supply was not affected because all the production houses were also closed during that time. The new equilibrium point moved rightward with both increase in price and quantity. CASE 2 In January, Netflix hiked the prices of their plan in the USA and Canada. Effect:

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The increase in the prices of all the plans seems to be a shocking decision by the company as many subscribers started to get double-minded about whether they should continue with the subscription as the competitors have a lower price. So, the demand curve will shift leftward. And the impact was seen in Q1 of 2022 as the subscribers fell by 200,000. At the same time, there was a rise in subscribers of Hotstar by 7,900,000 during that time. In the case of supply, it will remain the same as the price change will not affect it (Caporaso, 2014). CASE 3 In quarter 3 of 2022, Netflix launched new seasons of the most popular web series, Stranger Things, All of us are dead, and the movies such as The Gray man, purple heart, etc. (Whitten,2022) Effects:

Netflix added a bunch of movies and tv shows in Q2 2022, which was highly successful. Thus, the supply curve will shift rightward. They now have a total of 3600 movies and 1800 tv shows. Also, the addition of new shows and films attracted a lot of customers in the market. Hence the number of subscribers increased from 220.6 million in Q2 to 223 million in Q3 with 2.4 million new subscribers. Hence the demand curve shifted rightward as well. CASE 4 Netflix is planning to launch a new ad-supportive basic plan. This plan is $6.99, which is $3 cheaper than the basic plan. The only difference between this and the basic plan is that the viewers would get 4-5 minutes of ad per hour. Although in its first phase it will be launched in only 12 countries. Effects:

Since the company is launching a plan which is the cheapest of all, it will attract more customers from the low-income group. So due to it, the demand for Netflix will increase as it gains more subscribers, hence will shift right. However, it will not affect the supply, so that it will remain the same. It will lead to the equilibrium point to shift rightwards. The equilibrium quantity and price will both increase (ET Spotlight Special, 2022). Long-run and Short-run cost curves to demonstrate Netflix’s business strategy The largest cost component of Netflix is content and Selling, General & Admin expenses. All these expenses have grown with the demand for the service. Since Netflix shifted to a subscription- based video streaming business, they have become a scalable business, that is, the services they provide are for a fixed cost irrelevant of the user that is buying their services. But users don’t just add value to the business by paying for subscription, the technology and algorithm Netflix has developed over the years analyses the data provided for what kind of shows and movies, the users prefer, resulting in Netflix getting insights for research and development for the business which helps them produce new content that is most likely to become popular and attract more subscribers towards the platform (Netflix’s recommendation engine) works in a similar fashion as well, it filters movies and tv show recommendations customized to each individual according to their streaming history and notifies them if there is new launch that they might like. So, even if a user has not paid for subscription for the corresponding month, they will be inclined to join again, all of which helps them to reduce total average cost of production in the long-run. In the short-run when the company feels that they might not be performing well and their competitors in the market are chipping away on the subscribers they can decide to launch a tv series or movie featuring a big star or a line of content that can help shift the market in their favor, this will result in a spike over the number of subscribers and the company will be able to reduce total average cost in the short-run by gaining subscribers. and over the long run Netflix

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does the same numerous times that helps the company to keep a low total cost of the business. While looking at Netflix's business model, the company was not afraid of losing money in the short run because it used that as a strategy to earn more profits for the business. Netflix always tries to increase the content available, where the consumers will be excited about current trends in the film industry. This is shown by SRC1, SRC2 and SRC3, curves spanning a period. From the illustrations above, in the short run when the company wants to attract more subscribers to bring down their average fixed costs, they launch content based on their analysis which results in more user subscriptions. And as the variable cost increases over time with users losing interest in the old content, they repeat the cycle and that is demonstrated in the long-run curve. As it can be observed in the long-run cost curve illustration, the long-run cost for their business goes down over time as they invest in producing desirable content to increase their subscriber quantity, we can observe how the rise in the number of subscribers have increased their profits many times over from the past 5 years as they worked on producing more content, with the help of data displayed in the table below.

(Iqbal ,2022) In 5 years as their subscriber count grew and doubled, their profit was almost multiplied by 10, indicating, even though Netflix has been spending way more on production, operations, and marketing now than ever before and still making enormous profits. Netflix and the Zero Marginal cost economics The Netflix Business model has been described as brilliant. The continued existence and survival of any company is in the ability to manage the cost element viz-a-viz the price. For Netflix, it is brilliant when its cost does not change regardless of how many units of a particular product are served, or at least, the change is near zero (0). Zero marginal cost is when the cost to produce or offer an additional unit to subscribers in the long-run is zero or approaches zero. Marginal cost impacts the rate of growth of most companies. Firms that produce tangible commodities record extra costs in distribution, or on raw materials to manufacture an additional unit. These additional costs define marginal costs. Netflix has a great advantage with respect to marginal cost. Netflix is an OTT (over the top) delivery company that can afford to push for the addition of millions of subscribers, increasing its revenue without any significant impact on the marginal cost. Netflix runs a horizontal value chain that allows it to expend a fixed cost on infrastructure once, then continue to extract value over time. This capacity is enabled by digitization technologies and a Platform business model that enables/supports and concentrates on value-sharing among millions of consumers. The rationale is that there is almost no additional cost incurred by Netflix as the video is streamed because the fixed cost of the film production is once, and the infrastructure or content right expenses are once too. This is also the reason Netflix can afford to charge as low as $9 on a subscription plan. The low plan cost will facilitate market growth. The market growth is supported by technologies, the internet of things (IoT), and artificial intelligence. As long as Netflix continues to grow its subscriber base, and remains innovative, the company will remain profitable due to the scalability of its services and product. Market Competition Analysis The market structure that Netflix operates under is an oligopoly. In an oligopoly market, only a few companies control the entire market. The competitors of Netflix are Disney Hotstar, Amazon prime, HBO max, and Hulu. There are barriers to entering this market because of the capital required to initiate such streaming business and the ability to comply with licensing agreements. The streaming market competition has increased significantly since Netflix was established. Also, the chances of a price war are high in this market. This means if they decide to drop their prices, the others also must lower their costs to stay in the competition. The market’s current state is evident because all significant providers have comparably priced product packages. With Netflix as the market leader, they have a considerable influence over this market. If Netflix decides to reduce prices, Hulu and Amazon must also reduce customer costs or risk losing customers to Netflix.

This oligopolistic characteristic of the streaming market has been perfected over time, considering those mentioned above. A clear result of this is the disruption of the remarkable tranquility that Netflix had within the streaming market, which led it to surpass its competitors in content. Netflix's remarkable tranquility within the streaming market led it to surpass its competitors in content, developing one of the largest online libraries and becoming an aggregator of content from other studios and large media companies (CNBC,2022). Licensed content accounted for 93.2% of Netflix's catalogue in 2017(CNBC,2022,5:36), a year in which the situation of the company and the market, in general, began to change considerably. Netflix's demand has been directly affected by the increase in the competition since its main revenues come from licensed programs made by other production companies, which, upon sizing the size of the market and its dynamism, went from being simple creators of content for licensing to being their own platforms with ample economic support as they are part of large business groups, which has allowed them to go to market with a vast range of products at highly competitive prices, thus managing to snatch a large part of the market worldwide from Netflix. (CNBC,2022) To try to mitigate the impact that Netflix received when it lost a large part of its licensed content, it has decided to increase its own content production from 2.8% in 2016 to 50.7% by 2022, (CNBC,2022,7:57) thus considerably increasing its production budget. Despite this new strategy and colossal investment, Netflix's main revenues are derived from licensed content today (CNBC,2022). This situation puts the company at even greater risk and gives an advantage to its competitors. This situation has generated a considerable increase in the subscribers of the main competitors, while the increase in its own subscribers has decreased significantly, and this is due to the quality of the substitute product that represents the competition against Netflix since it is easily replaceable by them in the event of a change in the subscription price and the increase in the amount of product offered. All these are characteristics of an oligopolistic market, which is a closed market with few suppliers that are substitutable among themselves in the event of a price change and an increase in the number of products offered since, in the end, they all provide the same service, which is to entertain the public. The following graphs summarize the number of subscribers that each of the principal members of the streaming market has gained since 2021, as well as their product offerings and subscription prices and their position in the market.

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(Iqb al ,2022); (Richter,2022) US (United States) video streaming app market share 2021 to 2022 (%) (Curry,2022)

Conclusion In conclusion, Netflix has a vision of “becoming the best global entertainment distribution service” the company must pay attention to microeconomic factors to foster future prospects. The increasing number of Netflix subscribers shows a future where Netflix may be used as a primary source of entertainment. Netflix is offering original content to a sizable customer base which is exclusive to their platform. Nevertheless, competition abounds, increasing the influence of competitors, with some television stations offering free content. Therefore, it can be determined that this change in demand or loss of market share has been directly affected by the increased supply of competitors and their lower prices and the quality of substitute products among them. The company requires demand and supply curves to analyze their market more properly and to make sure that they are correctly using all their resources and thus being at an efficient output; if not, those extra resources could be wasted, and the competitors can take advantage of the situation in the long-run. And from the analysis derived by short-run and long-run curves it can be observed that if the company continues to add subscribers, their fixed costs in short-run periods will go down and in the long-run they will be able to further reduce their production costs with an increased revenue stream, resulting in higher profits. Pricing is another crucial factor, which is why the zero marginal cost magic is the game changer. Technology is a crucial driver as well for Netflix to continue analyzing customer data and preferences to serve them. Whether Netflix will continue to outpace the competition is a question only time will tell. References Bird, S. (2021,July 26) How zero marginal cost economics will revolutionise the built world. Aurecon. https://www.aurecongroup.com/insights/zero-marginal-cost-economics Caporaso, T. (5 May 2014). The Effects of Supply and Demand on Netflix Pricing Strategies | Supply and Demand Chain Executive. The Effects of Supply and Demand on Netflix Pricing Strategies | Supply and Demand Chain Executive (sdcexec.com) CNBC. (2022, September 25). How Netflix Lost Its Edge To Disney+ [Video]. YouTube. https://www.youtube.com/watch?v=yk5KDzBf4FI&t= 158s Curry, D. (20 July 2022). Video Streaming App Revenue and Usage Statistics. Business of Apps. https://www.businessofapps.com/data/video-streaming-app-market/

ET Spotlight Special (03 November, 2022). Netflix rolls out cheapest ad-supportive basic plan. Here are all the details about price & other features. The Economic Times News. https://economictimes.indiatimes.com/news/new-updates/netflix-rolls-out-new-cheapest- ad-supportive-basic-plan-here-are-all-the-details-about-price-other-features/articleshow/ 95276100.cms Iqbal, M. (27 October 2022) Netflix Revenue and Usage Statistics. Business of Apps. https://www.businessofapps.com/data/netflix-statistics/ Meltzer, R. (7 July 2020). How Netflix Utilizes Data Science. Lighthouse Labs . https://www.lighthouselabs.ca/en/blog/how-netflix-uses-data-to-optimize-their-product Richter, F. (26 October 2022). Streaming Price Hikes Leave Customers with Tough Choices. Statista https://www.statista.com/chart/27983/prices-of-video-streaming-subscriptions- in-the-us/ Whitten, S. (2022, October 18). Netflix adds more than 2.4 million subscribers, reveals details about password-sharing crackdown . CNBC. https://www.cnbc.com/2022/10/18/netflix-nflx- earnings-q3-2022.html

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