Siyuan Liu: Netflix’s Secret Weapon

Link to Siyuan Liu’s Linked-In profile

I am pleased to host another student guest post, this time by Siyuan Liu. This is the 28th student guest post this semester. (The final exam is today, but there is at least one more to come.) You can see all the student guest posts from my “Monetary and Financial Theory” class at this link.

When he visited Ann Arbor last year, Hal Varian said that the new thinking about what insurance companies do emphasizes the fact that they have the data and therefore the knowledge about what the biggest dangers are and how to address those dangers. Siyuan’s analysis of Netflix is in that spirit. It may look like the video files it distributes are the key to its business, but Siyuan argues that the data files on customers’ preferences are just as important in understanding the nature of its business. 

Netflix’s competitive advantage lies in the way it uses its large customer database.

Netflix caught my attention because of a news from Wall Street Journal, saying that it is entering into the feature films market by making movies that studios no longer will. Netflix is an interesting firm pioneering online streaming media. What makes it stand out among its competitors is its efficient use of its customer base.

Netflix does many interesting things. First, it has a decent selection of drama, picking ones that have a certain group of loyal audiences; second, it foresees popular programs; lastly, it is planning to produce its original programs, aiming at a blank market where certain types of movies are not made by major film producers.

The rising streaming media industry puts wind in Netflix’s sails as it builds up its user database.  Entertainment products enjoy a highly inelastic demand of economic situations because watching sports games, dramas and shows is the cheapest and simplest way to relax. Online streaming provides people with the convenience to watch almost anything at any time without waiting for the channels to broadcast, which no doubt attracts large amount of traditional TV audiences. Netflix, starting almost the earliest, has become a major provider, and is the first site that most people will turn to when it comes to online streaming. By the end of September in this year, Netflix already had 69 millions of subscribers for its streaming services.

Similar to Alibaba, the e-commerce giant who doesn’t solely rely on service charges, membership fee is not the only goal of Netflix, neither. As Alibaba uses the platform to identify profitable businesses, Netflix uses its large customer database to trace users’ preferences and thus to pick programs strategically. This is the secret of how Netflix captures people’s hearts. And this also helps cut cost: when only ‘valuable’ programs are shown, unnecessary funding spent on those licenses will be saved. For example, only 6.5 out of 7 seasons of the classic Mad Man are available on Netflix, probably because not many people are interested in the rest 0.5 seasons.

Besides picking available shows, it is even good at predicting good ones before they become popular. Take House of Cards for instance, Netflix outbid all other networks when MRC approached them because it believed the show was incredibly promising for it covers many elements that its users are interested in, politics being one of them. Eventually the show turned out to be extremely successful. With statistical tools, Netflix is going further than many of its peers.

Moreover, Netflix has been exploring new markets. It is entering high-quality television series to produce its original programs. Targeting at a ‘blank market’ - movies that are not made by major film makers – as long as statistics show there’s a market behind a type of movie, Netflix will go for it . Since it doesn’t rely on 'box tickets’, its goal is to attract the people who are fond of these exclusively offered programs to become members, which again adds to its database. Then this becomes a virtuous cycle.

What else can Netflix do? It may be thinking of cooperating with movie producers to release films online, soon, since it seems to be the trend for film distribution. It simply won’t give away any chance to expand its business. In any case, with its powerful database and expansion of its business domain, Netflix will keep growing for many years to come.