CHAPTER 3EVALUATING A COMPANY’S EXTERNAL ENVIRONMENT.docx

CHAPTER 3
EVALUATING A COMPANY’S
EXTERNAL ENVIRONMENT
McGraw-Hill/Irwin
Copyright ®2012 The McGraw-Hill Companies, Inc.
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Gain command of the basic concepts and analytical tools widely
used to diagnose the competitive conditions in a company’s
industry.Learn how to diagnose the factors shaping industry
dynamics and to forecast their effects on future industry
profitability.Become adept at mapping the market positions of
key groups of industry rivals.Understand why in-depth
evaluation of a business’s strengths and weaknesses in relation
to the specific industry conditions it confronts is an essential
prerequisite to crafting a strategy that is well-matched to its
external situation.
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3.1
From Thinking Strategically about the Company’s Situation to

Choosing a Strategy
Chapter 3
Chapter 4
Thinking
strategically
about a firm’s
external
environment
Thinking
strategically
about a firm’s
internal
environment
Forming a
strategic
vision of
where the
firm needs
to head
Identifying
promising
strategic
options
for the firm
Selecting the
best strategy
and business
model for
the firm

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3.2
The Components of a Company’s Macro-Environment
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3.1
The Seven Components of the Macro-
EnvironmentComponentDescriptionDemographicsThe size,
growth rate, and age distribution of different sectors of the
population. It includes the geographic distribution of the
population, the distribution of income across the population,
and trends in these factors.Social forces Societal values,
attitudes, cultural factors, and lifestyles that impact businesses.
Social forces vary by locale and change over time. Political,
legal, and regulatory factors Political policies and processes, as
well as the regulations and laws with which companies must
comply—labor laws, antitrust laws, tax policy, regulatory
policies, the political climate, and the strength of institutions
such as the court system.Natural environment Ecological and
environmental forces such as weather, climate, climate change,
and associated factors like water shortages.Technological
factors The pace of technological change and technical
developments that have the potential for wide-ranging effects
on society, such as genetic engineering, the rise of the Internet,
changes in communication technologies, and knowledge and
controlling the use of technology, Global forces Conditions and

changes in global markets, including political events and
policies toward international trade, sociocultural practices and
the institutional environment in which global markets
operate.General economic
conditions Rates of economic growth, unemployment, inflation,
interest, trade deficits or surpluses, savings, per capita domestic
product, and conditions in the markets for stocks and bonds
affecting consumer confidence and discretionary income.
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THINKING STRATEGICALLY ABOUT A COMPANY’S
INDUSTRY AND COMPETITIVE ENVIRONMENT
Does the industry offer attractive opportunities for growth?
What kinds of competitive forces are industry members facing,
and how strong is each force?
What factors are driving changes in the industry, and what
impact will these changes have on competitive intensity and
industry profitability?
What market positions do industry rivals occupy—who is
strongly positioned and who is not?
What strategic moves are rivals likely to make next?
What are the key factors for competitive success in the
industry?
Does the industry offer good prospects for attractive profits?

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QUESTION 1: DOES THE INDUSTRY OFFER
ATTRACTIVE OPPORTUNITIES FOR GROWTH?Defining
Growth:What is the current market size in units or sales?What
is the past, current and expected rate of growth for the
marketindustry?Considerations:Different sectorsregions of a
market grow at different rates.Growth varies with the industry’s
life cycle stage—emergence, rapid growth, maturity, and
decline.Growth does not guarantee profitability.
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3.3
The Five-Forces Model of Competition: A Key Analytical Tool
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Using the Five-Forces Model of Competition
Step 1
For each of the five forces, identify the different parties
involved, and the specific factors that bring about competitive

pressures.
Step 2
Evaluate how strong the pressures stemming from each of the
five forces are (strong, moderate to normal, or weak).
Step 3
Determine whether the strength of the five competitive forces,
overall, is conducive to earning attractive profits in the
industry.
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3.2
Common “Weapons” for Competing with RivalsCompetitive
WeaponsPrimary EffectsPrice discounting, clearance sales,
“blowout” salesLowers price (P), acts to boost total sales
volume and market share, lowers profit margins per unit sold
when price cuts are big and/or increases in sales volume are
relatively small Couponing, advertising items on sale Acts to
increase unit sales volume and total revenues, lowers price (P),
increases unit costs (C), may lower profit margins per unit sold
(P – C) Advertising product or service
characteristics, using ads to enhance
a company’s image or reputation Boosts buyer demand,
increases product differentiation and perceived value (V), acts
to increase total sales volume and market share, may increase
unit costs (C) and/or lower profit margins per unit
soldInnovating to improve product
performance and qualityActs to increase product differentiation
and value (V), boosts buyer demand, acts to boost total sales
volume, likely to increase unit costs (C)Introducing new or
improved features, increasing the number of styles or models to
provide greater product selection Acts to increase product

differentiation and value (V), strengthens buyer demand, acts to
boost total sales volume and market share, likely to increase
unit costs (C) Increasing customization of product or service
Acts to increase product differentiation and value (V), increases
switching costs, acts to boost total sales volume, often increases
unit costs (C) Building a bigger, better dealer network Broadens
access to buyers, acts to boost total sales volume and market
share, may increase unit costs (C) Improving warranties,
offering low-interest financing Acts to increase product
differentiation and value (V), increases unit costs (C), increases
buyer costs to switch brands, acts to boost total sales volume
and market share
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3.4
Factors Affecting the Strength of Rivalry
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Competitive Pressures Associated
with the Threat of New EntrantsEntry Threat
Considerations:Strength of barriers to entryExpected reaction of
incumbent firmsAttractiveness of a particular market’s growth
in demand and profit potentialCapabilities and resources of
potential entrantsEntry of existing competitors into market
segments in which they have no current presence
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3.5
Factors Affecting the Threat of Entry
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3.6
Factors Affecting Competition from Substitute Products
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3.7
Factors Affecting the Bargaining Power of Suppliers

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3.8
Factors Affecting the Bargaining Power of Buyers
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Is the Collective Strength of the Five Competitive Forces
Conducive to Good Profitability?Is the state of competition in
the industry stronger than “normal”?Can industry firms expect
to earn decent profits given prevailing competitive forces?Are
some of the competitive forces sufficiently powerful to
undermine industry profitability?
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Matching Strategy to Competitive Conditions
Pursuing avenues that shield the firm from as many competitive
pressures as possible.
Initiating actions calculated to shift competitive forces in the
firm’s favor by altering underlying factors driving the five
forces.
Spotting attractive arenas for expansion, where competitive
pressures in the industry are somewhat weaker.

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QUESTION 3: WHAT FACTORS ARE DRIVING INDUSTRY
CHANGE, AND WHAT IMPACTS WILL THEY
HAVE?Strategic Analysis of Industry Dynamics:
Identifying the drivers of change.
Assessing whether the drivers of change are, individually or
collectively, acting to make the industry more or less attractive.
Determining what strategy changes are needed to prepare for the
impacts of the anticipated change.
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3.3
The Most Common Drivers of Industry ChangeChanges in the
long-term industry growth rate
Increasing globalization
Changes in who buys the product and how they use it
Technological change
Emerging new Internet capabilities and applications
Product and marketing innovation
Entry or exit of major firms
Diffusion of technical know-how across companies and
countries
Improvements in efficiency in adjacent markets
Reductions in uncertainty and business risk
Regulatory influences and government policy changes

Changing societal concerns, attitudes, and lifestyles
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Developing a Strategy That Takes the Changes
in Industry Conditions into AccountWhat strategy adjustments
will be needed
to deal with the impacts of the changes in industry
conditions?What adjustments must be made immediately?What
actions must we not take or should we cease to do now?What
can we do now to prepare for adjustments we anticipate making
in the future?
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QUESTION 4: HOW ARE INDUSTRY RIVALS
POSITIONED—WHO IS STRONGLY POSITIONED
AND WHO IS NOT?A Strategic GroupIs a cluster of industry
rivals that have similar competitive approaches and market
positions:Have comparable product-line breadthSell in the same
price/quality rangeEmphasize the same distribution channelsUse
the same product attributes to buyersDepend on identical

technological approachesOffer similar services and technical
assistance
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Typical Variables for Differentiating the Market Positions of
Key Competitors on Group MapsPrice/quality range (high,
medium, low)Geographic coverage (local, regional, national,
global)Product-line breadth (wide, narrow)Degree of service
offered (no frills, limited, full)Distribution channels (retail,
wholesale, Internet, multiple)Degree of vertical integration
(none, partial, full)Degree of diversification into other
industries (none, some, considerable).
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Follow-upWhich strategic group is located in the least favorable
market position? Which group is in the most favorable
position?Which strategic group is likely to experience increased
intragroup competition? Which groups are most threatened by
the likely strategic moves of members of nearby strategic

groups?
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Useful Questions to Help Predict the Likely Actions of
Important RivalsWhich competitors’ strategies are achieving
good results?Which competitors are losing in the marketplace or
badly need to increase their unit sales and market share?Which
rivals are likely make major moves to enter new geographic
markets or to increase sales and market share in a particular
geographic region?Which rivals can expand product offerings to
enter new product segments where they do not have a
presence?Which rivals can be acquired? Which rivals are
financially able and looking to make an acquisition?
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QUESTION 6: WHAT ARE THE KEY FACTORS FOR
FUTURE COMPETITIVE SUCCESS?Key Success FactorsAre
the strategy elements, product and service attributes,
operational approaches, resources, and competitive capabilities
that are necessary for competitive success by any and all firms
in an industry.Vary from industry to industry, and over time
within the same industry, as drivers of change and competitive
conditions change.

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Identification of Key Success Factors
What product attributes and service features buyers strongly
affect buyers when choosing between the competing brands of
sellers?
What resources and competitive capabilities are required for a
firm to execute a successful strategy in the marketplace?
What shortcomings will put a firm at a significant competitive
disadvantage?
1
Videos for Use with the Netflix Case. Two pertinent videos are
available to accompany your use
of the Netflix case:
-minute video of a Bloomberg News interview with
Netflix CEO Reed Hastings on
February 18, 2009. This interview covers the movie rental
industry, the future of the movie
industry, and costs inherent in renting movies. It can be
accessed at
http://www.youtube.com/watch?v=Z_jWgzGjkrY&feature=fvw.

1. How strong are the competitive forces in the movie rental
marketplace? Do a five-
forces analysis to support your answer.
Below is a representative five-forces model of competition in
the movie rental industry:
http://www.youtube.com/watch?v=Z_jWgzGjkrY&feature=fvw
2
ompeting in movie rentals—a
strong to fierce competitive
force that is likely to intensify in the years ahead
In assessing this competitive force, you should be directed to
refer to and utilize the presentations
in Table 3.2, Figure 3.4, and the discussion on pp. 55-59 of
Chapter 3.
You should conclude that rivalry among Netflix, Blockbuster,
Redbox, and other movie rental
competitors (especially video-on-demand providers that stream
movie rentals directly to the
renter’s TV or PC) seems destined to grow more intense. All
competitors are scrambling to attract

the patronage of individuals/households that rent movies—the
battle for sales revenues and market
shares is very contested and seems destined to become more
fierce. Rivalry is centered on such
factors as
• Price of movie rentals (rented either individually or via a
subscription plan); variety of
subscription plans to choose from.
• Convenience in renting movies (including returning rented
DVDs).
• Breadth of selection (size and diversity of movie rental
library).
• Availability of the DVD (are all the copies out on rental or are
some available either in the
store/kiosk or in distribution inventory ready to be shipped?).
Customers tend to be annoyed
when the DVD they want to rent is not immediately available.
Of course, DVD availability is not a factor when the rented
movie is being streamed over the
Internet by video-on-demand providers.
• Ease of browsing through all the selections to determine which
movies to rent.
• Policies and fees (if any) regarding how long the renter can
keep the DVD (or view the movie

if it is downloaded or rented online).
• Advertising and promotion—Much of the advertising is being
done online in the case of both
Blockbuster and Netflix; however, Blockbuster utilizes in-store
promotions on a regular basis.
But the DVD rental business is not one that is a heavy user of
TV, radio, and newspaper
advertising on a regular basis.
• Image and reputation.
Most movie rental competitors pursue some version of a
differentiation strategy to try to set
themselves apart on the basis of one or more competitive
factors.
Several factors were working to intensify rivalry among movie
rental industry participants:
• All rivals are actively and busily launching fresh promotional
initiatives (the free trials and
unlimited streaming at Netflix, for example) and engaging in
new marketing tactics and
market maneuvers (Redbox’s rush to deploy more of its
distinctive red kiosks and
Blockbuster’s initiatives to reinvent itself) to spur their movie
rental revenues and build a

loyal customer base. The large number of fresh strategic
initiatives on the part of various
movie rental rivals heightens rivalry.
• Low switching costs on the part of buyers—it is pretty easy
for people wanting to rent a
DVD to (a) go to one store location or another to rent a DVD or
(b) switch their subscription
from Netflix to Blockbuster or some other subscription service
or (c) order the movie through
their cable provider or some other video-on-demand provider.
• Some rivals have utilized rock-bottom subscription rates (and
free trials) and low rental fees
as a means of attracting new customers—a factor which
intensifies rivalry. Redbox only
charges $1 per day for a movie DVD obtained from its kiosks. It
is unclear to what extent
subscription prices might fall to the extent movies are streamed
directly over the Internet
rather than being sent-and-returned by mail. Streaming delivery
is undoubtedly less costly
3

than DVD distribution by mail.
• Rivalry increases when one or more rivals are dissatisfied with
their market position and
launch moves to bolster their standing at the expense of rivals.
A case can be made that
Netflix, Blockbuster, Redbox, the cable TV companies,
streaming video providers, and
Internet sites offering downloadable movie rentals are likely to
make further moves to bolster
their unit volumes and market positions. All movie rental
competitors seem to be actively
attempting to grow their business.
• Rivalry is likely to increase significantly as “wave of the
future” video-on-demand
(streaming movies over the Internet) becomes the most common
means of delivering rented
movies to individuals/households—the capability of
individuals/households to watch
streamed movies without a hassle is starting to explode. Class
members should (quite
correctly) see video-on-demand as a new technology-driven way
of delivering movie-
viewing services to consumers—growing use of the movie-
streaming channel will greatly

increase the competitive pressures on companies like
Blockbuster and Redbox with brick-
and-mortar and kiosk movie rental locations. Over time, there is
reason to expect that movie
rental competitors with VOD capability will take substantial
sales and market share away
from most other types of movie rental providers.
• Rivalry increases as the product offerings of rivals become
more standardized. We see the
differentiation between Netflix’s online product offering and
the online offering of
Blockbuster as growing smaller, not larger. And, in the future,
the main differentiating factor
among VOD providers will be the size and content of their
respective movie libraries.
However, the image/reputation differentiation between Netflix
and Blockbuster is growing
stronger, despite Blockbuster’s presence in the online movie
rental business—Netflix’s
number of subscribers dwarfs that of Blockbuster’s subscriber
base. And there will be
continuing differentiation among movie rental providers based
on the means of delivery
(streaming versus providing a physical DVD).

On the other hand, there is at least one factor acting to make
rivalry somewhat weaker—
somewhat rapid growth of the market for movie rentals,
especially in the VOD/streaming
segment. Most of us are likely to take the position that the
demand for VOD/streaming movie
rentals will grow briskly in the years ahead. There are already
clear signs that Netflix subscribers
are shifting in greater numbers to streamed delivery as opposed
to mail delivery. Rapidly growing
preferences of individuals/households toward watching
streamed movies acts to weaken rivalry in
the VOD/streaming channel—but in this case, the market
growth is probably not fast enough to
override all the factors acting to intensify rivalry.
We think it is hard to be definitive about just where the overall
market demand for movie rentals is
in the life-cycle. The VOD/streaming rental segment is almost
certainly in the rapid growth stage.
However, demand for DVD rentals at retail stores is stagnant at
best and at places like
Blockbuster/Movie Gallery has been eroding rapidly—as
evidenced by Blockbuster’s dismal
prospects and the recent demise of Movie Gallery. Video-on-

demand has big growth potential as
of 2010 and beyond. The growth potential of renting movies
from vending machines is unclear,
but would not seem to qualify as a “wave of the future”
distribution channel relative to the Internet
and VOD segments. Redbox’s growth is tied to the appeal of its
conveniently-located kiosks, its
$1 per day rental fee, and the decline in business at Blockbuster
and Movie Gallery (some of
which can be attributed to Redbox stealing customers away
from Blockbuster, Movie Gallery, and
other local movie rental stores. Thus, the overall growth
prospects of the combined movie rental
segments is a mixed bag.
4
—a weak to moderate to strong competitive
force, depending on the segment or
means of distribution.
refer to and utilize the presentation
in Figure 3.5.

In 2010, the windows for entering the brick-and-mortar segment
of the movie DVD rental
business and the mail-delivery subscription segment are pretty
much closed. It will become
increasingly difficult for new entrants using business models
like Netflix or Blockbuster or
Redbox to overcome entry barriers and capture enough business
to compete profitably. And trying
to go head-to-head against Netflix (and to a much lesser extent
Blockbuster) in the online
subscription segment seems unattractive as well (the entry
barriers are high). We ought to
recognize that the barriers to entry into online subscription
segment of the movie rental business
are moderately high for enterprises wanting to cover a large
geographic area and compete on a
“national” scale:
• The costs of developing a Web site.
• Developing order fulfillment capability to equal the short
delivery times offered by Netflix
and Blockbuster.
• The added investment in DVD inventories.
• Expenditures for advertising and promotion needed to draw

visitors to the web site and
convert them into paying subscribers. (From case Exhibit 3,
students can see that Netflix is
spending over $200 million annually on marketing.)
In the brick-and-mortar movie rental segment, there may be
very limited entry opportunities for
small niche players in local markets to get into renting movie
DVDs to customers living near their
store locations. It is relatively easy for a local retailer to open a
DVD rental outlet and compete on
a very small scale for business within a 2-5 mile radius; but
such entry poses little direct threat to
Blockbuster and Redbox (or even Netflix) as of 2010.
Clearly, the biggest entry threat into the movie rental
marketplace in 2010 and beyond are
enterprises that enter the video-on-demand or streaming movie
rental segment. But we think
the remaining time to enter is growing short. The most likely
entry candidates into the video-on-
demand or Internet-streaming segment are those few companies
that have the resources and name
recognition to compete successfully against Netflix and other
present video-on-demand providers
(for instance, cable TV providers and the phone companies

offering TV and other entertainment
services). The near-term entry threat from this type of
competitor is relatively high (since
there are signs that VOD/Internet streaming is on the verge of
exploding (many TVs and DVD
players are either Internet-ready or have built-in Internet access
capability) and Google is
launching Google TV.
New entry by resource-rich companies with good name-
recognition (like Google TV—which
enables household to combine their regular TV experience with
the capability to access videos
anywhere on the Internet) will almost certainly trigger fierce
competitive pressures as all
VOD/streaming competitors tout the merits of a movie-watching
service that allow viewers to rent
movies “on-demand” and watch the rented movie directly on
their big-screen TVs within minutes
of placing the order. In short, technology is advancing in a
manner that makes video-on-demand
more and more feasible and more and more attractive to Netflix,
other movie rental Internet sites,
cable and broadband providers, and perhaps others (including
the movie studios themselves). A

variety of movie rental providers are gearing up to offer video-
on-demand. The owners of
Hulu—NBC Universal; ABC’s parent Walt Disney; and Fox
Entertainment’s parent, News
Corp—had announced plans to begin offering a premium service
for $10 per month that would
provide a bigger library of TV shows to watch. Amazon.com
might prove to be a factor in the
VOD segment.
5
As more and more households sign on for broadband service and
as download speeds advance,
then delivering all kinds of entertainment products via high
speed Internet means will almost
certainly catch on with individuals/households. People with
iPads and PCs may also become
regular users of VOD..
Hence, the entry threat into the movie rental industry should be
viewed as moderate to strong, but
with time running out to enter (since it will become increasing
difficult for a new entrant to

overcome the leads of the incumbent and soon-to-enter VOD
providers (which now includes
Netflix—indeed, Netflix seems to be driving the transition to
streaming). First-mover
advantages and late-mover disadvantages are in play here.
ion from substitutes—a moderately strong
competitive force depending on the extent to
which consumers prefer to rent movies versus seeing them at the
movie theaters or buying movie
DVDs for their own personal library.
refer to and utilize the presentation
in Figure 3.6.
There are currently three principal substitutes for renting
movies: (1) buying movie DVDs and/or
the DVDs of new and old TV shows for one’s own personal
library, (2) watching a movie on any
of various TV channels (such as Bravo, Turner Classic Movies,
HBO, Cinemax, Starz, and other
premium movie channels typically available from cable,
satellite, and telecommunications
providers), and (3) seeing the desired movie at movie theaters.
Buying movie DVDs has recently

become less expensive (but still not as cheap as renting a movie
from any of several sources),
since the strategy of some movie makers is now to price new
releases of movie DVDs low enough
to cause more and more people to buy a movie DVD rather than
rent it. To a lesser extent, another
substitute is watching movies on all the various TV channels.
However, the selection of movie
DVDs at retailers like Wal-Mart or Best Buy or Target is
nowhere near as broad as the selection
available for rental from Netflix, Blockbuster, and other rental
providers—which, for movie
enthusiasts, limits the appeal of substitutes for movie rentals.
In addition, there are hordes of entertainment substitutes for
watching movies altogether—but
these other entertainment forms may not be good substitutes for
people who prefer to watch
movies in their home at their own convenience and are frequent
or dedicated movie watchers.
All things considered, we should conclude that substitutes for
renting movies are a relatively
strong competitive force, given that
• Acceptable substitutes are readily available and competitively
priced (in some cases).

• Buyer costs to switch to substitutes are relatively low.
• Many consumers are familiar with and comfortable with using
substitutes (buying their own
movie DVDs, going to movie theaters, and watching movies on
TV).
• There are many, many entertainment substitutes for watching
movies altogether.
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ning power and leverage of suppliers—a
moderately strong competitive force,
depending on the type of supplier.
refer to and utilize presentation in
Figure 3.7.
We should recognize that movie studios have considerable
bargaining power and leverage over
Netflix, Blockbuster, and other movie rental enterprises because
of their power to heavily
influence the price and other terms and conditions under which
their movie DVDs will be
supplied to movie rental providers. Movie studios are already in

a powerful position to dictate the
dates when their movie DVDs will be released to all the
different movie rental providers.
The movie studios will, in all likelihood, become even more
powerful and able to command
higher prices in making their movies available for streaming.
Netflix and other VOD/streaming
providers can expect to pay higher fees in gaining the
agreement of movie studios to stream their
titles. Why? Because VOD providers will compete on the basis
of having a large library of titles
available for streaming. Since the movie studios own these
libraries, they will be able to secure
bigger fees in making their titles available to particular VOD
providers.
Other suppliers to movie rental participants, however, are
relatively weak and have little or no
bargaining power. Web site services, servers, mail services for
shipping and returning DVDs, and
the services required for operating retail stores can all be
obtained from a variety of sources at the
going market price.
DVDs—a weak competitive force

In assessing this competitive force, students should be directed
to refer to and utilize the
presentation in Figure 3.8.
• Individuals have virtually no power to bargain for a lower
price on movies they rent from
Netflix, Blockbuster, or other movie rental providers. They can
choose to rent or not at the
going rates or to subscribe or not to one rental plan or another,
but no one individual is in a
position to negotiate the terms and conditions under which he or
she will rent a movie DVD
from Netflix or Blockbuster or Redbox or a cable TV company
or any other video-on-demand
provider.
Conclusions concerning the overall strength of competitive
forces: Competitive
pressures in the movie rental industry are pretty strong and are
likely to grow stronger in upcoming
years as video-on-demand and Internet streaming become the
dominant means of distributing rented
movies. Currently, we see rivalry as far and away the strongest
of the five competitive forces, followed
by competition from substitutes and the bargaining power of
movie studios. We see the bargaining

power of the movie studios as growing stronger as the transition
to streaming accelerates.
But while collective competitive pressures are fairly strong and
likely to intensify, they are now not so
strong as to prevent many movie rental companies—especially
Netflix—from being profitable. Up to
this point, the movie rental companies (with the exception of
Blockbuster and Movie Gallery) have
able to cope with rivalry, the bargaining power of the movie
studios, and the competitive pressures
from substitutes. It would not, however, come as a shock if the
bargaining power of the movie studios
begins to squeeze the profitability of VOD/Internet streaming
providers as they demand bigger fees in
return for granting streaming access to the libraries of movie
titles.
The dismal financial performance of Blockbuster and Movie
Gallery confirm that competitive
conditions for earning attractive profits are pretty tough.
Netflix, on the other hand, is doing very, very
well from the standpoints of revenue growth and financial
performance. (This is true of Redbox, as
well, which is the subject of the next case)

7
2. What forces are driving change in the movie rental industry?
Are these driving
forces likely to have a favorable or unfavorable impact on
competitive intensity
and future industry profitability?
You may want to direct students to pages 72-76 and Table 3.3 in
Chapter 3 in singling out the driving
forces that are at work in the movie rental industry.
We should identify many of the following as driving forces:
gical changes related to the Internet.
• Many TVs and DVRs were now Internet ready or had built-in
Internet connectivity (which is
reflective not only of technological change but also of product
innovation).
• The technology of streaming rented movies directly to big-
screen high-definition TVs is
improving very quickly, thus enabling streaming and VOD to
become the “wave of the
future” in delivering rented movies to viewers. Netflix is
providing subscribers with unlimited
movies selections via streaming as part of its regular
subscription price and the percentage of
Netflix subscribers watching streamed movies is rising briskly.

For some years now, cable
and satellite TV companies had been promoting their VOD
services and making more movie
titles available to their customers—their customers could use
their TV remotes to place orders
and instantly watch a movie from a list of several hundred
selections that changed
periodically. This technology-driven growing interest in
watching VOD and streamed
movies is probably the biggest and most important driving force
in the movie rental
business as of 2010.
• The number of households with high-speed broadband Internet
service was growing—which
broadened the market for both VOD delivery (and Internet
streaming) of movies.
• The 2009 requirement that all TV stations in the United States
use digital technology and
equipment to broadcast all their programs had resulted in (a)
growing consumer interest in
purchasing big-screen TVs with high-definition capability and
(b) far more programs
(including movies on various movie channels) being transmitted
in high-definition format.
-

emerging switch from renting DVDs to watch
movies to watching Internet-streamed or movies from VOD
providers. This switch away from
renting a physical DVD is having and will continue to have a
profound effect on the entire movie
rental marketplace.
• Prices for wide-screen, high definition TVs have been
dropping rapidly and picture quality
was exceptionally good, if not stunning, on increasing numbers
of models—all of which has
spurred sales. Big-screen TVs enhanced the experience of
watching movies at home.
• Moreover, streaming movies to subscribers is far cheaper than
mail delivery/return or
operating rental locations (stores or kiosks) where customers
can obtain/return rented DVDs.
• Many new TVs were Internet ready or had built-in Internet
connection capability, which
facilitated watching Internet streamed movies. In addition,
increasing numbers of devices
were appearing in electronics stores that enabled older TVs to
be connected to the Internet and
receive streamed movies from online providers with no hassle.
Households with Internet

capable TVs were expected to become big users of streamed
movies and to search out
providers of on-demand movies.
Renting a streamed movie could be done either by using the
services of Netflix, Blockbuster
Online, Amazon Video-on-Demand, Apple’s iTunes, and other
streaming video providers or
by using a TV remote to click to an on-demand provider of
filmed entertainment (such the on-
8
demand service of a cable or satellite TV provider).
• Rapid increases in the number of household having digital
video recorders (DVRs) which
made it simple to record a TV program or movie and then replay
it at a convenient time.
Falling prices for DVRs with Blu-ray technology were spurring
sales of DVRs—which could
translate into growth in movie rentals for home viewing. In
2010 more than 85% of U.S.
households had some kind of DVD player or player-recorder.
Increasing numbers of

households had Blu-ray DVD players or player-recorders; such
devices enhanced the caliber
of the in-home movie-watching experience when viewing a Blu-
ray-enabled movie DVD.
Growing numbers of movie DVDs were available with Blu-ray
technology (usually at a
higher rental fee).
• The growing number of devices (in addition to TVs and
DVRs) with Internet streaming
capability (video game consoles, iPads, iPhones, PCs, and so
on)
• The push by Netflix and others to watch streamed movies
rather than rent physical DVDs;
Netflix’s unlimited streaming feature is having a significant
market impact.
• The recent appearance of movie rental kiosks—Redbox and
Blockbuster Express
-sharing programs that facilitated
pirating of downloadable movies—
however, streamed movies were much harder to pirate (which
resulted in movie studios more
amenable to granting movie rental providers the rights to stream
a bigger portion of a movie

studios content library). Movie studios were very leery of
pirating because of the resulting erosion
of sales of movie DVDs.
Conclusions: The combined impact of these driving forces in
the marketplace should be analyzed
by answering three questions:
movie rentals? We should
conclude that the driving forces will likely result in growing
overall demand for movie rentals (via
either the Netflix subscription-based business model (with
unlimited streaming) or via video-on-
demand/streaming technology and devices).
competition in the movie rental
business? The weight of evidence indicates that the driving
forces will all act to intensify
competition among the various movie rental providers. All the
new entrants offering
streaming/video-on-demand will be trying to wrest rental
revenues and market share away from
traditional movie rental providers. The movie rental kiosks will
prove to be strong competition for

Blockbuster and other local brick-and-mortar providers rental
DVDs. There will be vigorous
competition across all the different distribution channels—
brick-and-mortar rental stores, movie
rental kiosks, mail delivery/return of rented DVDs, Internet
streaming, and VOD/pay-per-view.
the movie rental companies? We
think the best answer here is probably yes in the case of
competitors with the ability to supply
movie rentals on demand via streaming/VOD technology.
However, brick-and-mortar movie
rental providers are highly vulnerable to the driving forces.
The DVD rental marketplace is likely to be fast-changing for
some years to come, as all the driving
forces come into play and the battle among new and existing
rivals shakes out.
9

3. What does your strategic group map of this industry look
like? Is Netflix well-
positioned? Why or why not?
Strategic group maps are beneficial for determining relative
company placement in the industry. A
good strategic group map should utilize two strategic variables
that differentiate the various
competitors in the movie rental marketplace.
We can choose among any of several strategic variables to
divide the DVD rental industry into
strategic groups and illustrate the different market positions
they occupy. We have chosen to employ
breadth of product line (in terms of number/variety of movies
offered) and the type of distribution
channel or approach to getting the movie rental to customers for
viewing. Other possibilities for axes
might include scope of geographic coverage and
image/reputation/brand name recognition—there is
not always one single best strategic group map.
A representative strategic group map is shown in Figure 1 (it
matches what class members will be
using in the Connect-based exercise for this case).
Once we have come up with a map, then we think we should
press them for their evaluation of what

we learn from the map. Any of the following questions can be
posed to help draw out their views:
—Netflix or
Blockbuster? (We favor Netflix because of its lead
in migrating to VOD technology and devices for delivering
rented movies to subscribers.)
itioned? (Our
answer is that companies with the
capabilities to be successful in the VOD channel are best
positioned.)
(Traditional brick-and-mortar movie rental stores)
ely to benefit from the
impacts of industry driving forces? (Movie
rental providers that have strong Internet streaming/VOD
delivery capabilities)
impacts of industry driving forces?
(Traditional brick-and-mortar movie rental stores and movie
rental kiosks)
On the whole we like Netflix’s position on the map, especially
since it can move vertically over time
and is rapidly enhancing its ability to migrate to an Internet
streaming delivery system. However,

Blockbuster is improving its streaming/VOD capabilities, but it
trails Netflix in this regard. If
Blockbuster got into VOD, it would be a potent competitor in
the sense of being able to access the
casual DVD movie rental customer (via its large network of
retail stores and VOD) and the heavier
movie-watching segment (via online ordering/mail delivery,
Internet streaming, and VOD)—in other
words, it would be positioned in all the delivery channel
segments (local stores, movie rental kiosks,
mail delivery/return, streaming, and VOD.
We are not particularly enthused about the attractiveness of the
market positions of any of the brick-
and-mortar-only or kiosk-only movie rental providers. This
segment of the movie rental industry
seems destined to lose sales and market share in the years ahead
because it is most vulnerable to
competition from Internet streaming/VOD providers and
mail/delivery/return providers.
10

FIGURE 1 A Representative Strategic Group Map of the DVD
Rental Industry
We should definitely like the position that Netflix has on the
strategic group map shown above, for
two reasons. It has both mail delivery and streaming capability.
It has a wide variety of titles in its
movie library. These put it in very strong position to come out a
winner (the clear market leader) as
streaming becomes the preferred method of delivery and as in-
home movie watchers select a streaming
provider.
4. What key factors will determine a company’s success in the
movie rental industry
in the next 3-5 years?
We see perhaps as many as 5 key success factors for companies
that want to make money in providing
movies for home viewing:
episodes and maybe even video games. But a
wide variety of movie titles seems absolutely essential.
the near-term, online DVDs

rentals (delivered and returned via mail); the value of having
brick-and-mortar stores scattered
across the landscape that consumers patronize to get the movies
they want to view is going to
become less and less important.
11
-known brand name/reputation that draws customers
to use that movie rental provider’s
service as opposed to obtaining movie rentals from rivals.
-
rental basis) and convenient
movie rental delivery arrangements. Individuals/households that
don’t watch a sufficient number
of movies in their homes to justify a monthly subscription fee
are likely to go to nearby brick-and-
mortar stores/kiosks to obtain physical DVDs or else watch
rented movies that can be accessed
from various VOD providers at an acceptable price.
ract and retain a subscriber/customer base that
is large enough to be profitable.

In order for a movie rental competitor to be profitable, it must
be able to generate sufficient
revenues to cover its operating expenses (which can be fairly
substantial if a company is to rank
among the industry leaders). There are very definitely scale
economies in the online rental segment,
so a company must attract a sufficient number of
subscribers/customers to keeps its costs low and
its prices competitive. In this regard, a well-known brand name
and reputation will be a valuable
competitive asset.

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