Netflix’s Next Episode: Winning Back What It Lost

Posted on April 26, 2012

Streaming media and DVD rental provider Netflix is facing renewed scrutiny over its business model after announcing poor first-quarter results on Monday. The Los Gatos, Calif.-based company reported a $4.6 million loss in the quarter ending March 31, compared with a profit of $60.2 million in the year-earlier quarter. Its revenues, meanwhile, grew 21% from $718.6 million to $869.8 million. Following the news, the firm’s stock has fallen more than 19% (as of this morning).

Clearly, Netflix has yet to recover from its recent 60% price increase and failed attempt last September to spin off its DVD delivery business. The company’s U.S. customer base has eroded from 24.6 million last June to 23.4 million currently. (It also operates in Canada.)

Netflix’s problem is threefold: content partners, competitors and customers, according to Wharton operations and information management professor Kartik Hosanagar. “First, it was obvious that Netflix’s original margins were not sustainable in the long run,” he says. “Netflix secured some of its early [content] licenses at very low costs, and it was clear that the content owners would seek more the next time around.” That explains why the company’s costs have gone up over the last year — and the situation is unlikely to get better, he adds.

Increased competition is Netflix’s second hurdle, says Hosanagar. He points to the likes of Hulu and Amazon and also to streaming services being introduced by cable-TV firms like Comcast. “This competition will only get worse in the next 12 to 24 months.”

Customer loyalty represents Netflix’s third problem, he notes. “Customers used to be Netflix’s biggest strength.” But the past year “hasn’t been great for Netflix” because of several missteps — the most important of which were the debacle with pricing and the spinoff plans, he adds.

Netflix’s solutions lie in continuing to grow its customer base and “up-selling existing customers” — or launching higher-value offerings — to address the partner and competitor issues, Hosanagar says. “Going forward, the key to Netflix’s success will be to win back customer confidence. Investor confidence and Wall Street will follow.”

Filmmaker James Kerwin took a dour view of the business model behind Netflix’s streaming business in an interview with Knowledge@Wharton in January 2011, soon after Netflix announced its offering of streaming movies and videos. The company’s model is not economically sustainable, he noted, because studios will find that streaming rights cannibalize their DVD sales. He also warned that fee increases were inevitable: “Netflix is going to have to jack up the rates that their customers pay and/or they are going to have to limit the number of videos that a customer can stream per month — because the studios are going to start demanding higher rates. Otherwise, this is just going to implode.”

According to Wharton legal studies and business ethics professor Kevin Werbach, much of the criticism of Netflix “is overblown, just as the company was over-hyped earlier.” Netflix is still fundamentally well-positioned to exploit the ongoing transformation of video, he says. “Ultimately, Netflix will have to provide value-add, whether in its recommendations, knowledge of its users or ability to function as an independent ‘honest broker’ unaffiliated with all the other industry segments involved,” he notes. “The basic function of getting any content users want to any platform, whenever users want it, will become the table stakes.”

Technology companies, including Netflix, are increasingly adopting the concept of customer lifetime value (CLV), Wharton marketing professor Peter Fader noted in a recent Knowledge@Wharton article. CLV is a marketing formula based on the idea that firms should spend money up front, and sacrifice initial profits, to gain customers whose loyalty and increased business will reap rewards over the long term. According to Fader, following a CLV model can keep companies from panicking when making big strategic decisions. An example he offers is Netflix’s move to raise subscription prices as its business focus shifted from offering DVDs by mail to the streaming model. In Fader’s view, Netflix was smart in the way it split its business and pricing, but not so in the way it announced those changes.

Still, for Netflix, such “screw-ups are a blip,” he said. “Dropped subscriptions are likely to be picked up again because Netflix really doesn’t have a comparable competitor.”

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Microfinance: Successes and Challenges

Posted on April 25, 2012

Jean-Philippe de Schrevel is CEO and co-Founder of BlueOrchard Investments, and also founder and CEO of Bamboo Finance and the Oasis Fund. His companies specialize in asset management and microfinance projects that target positive social impact and produce “market” returns — 2% above LIBOR (the benchmark London Interbank Offered Rate) for the microfinance unit. In India, his organization backed a rural hospital group providing “no frills, high-quality care” to low-income patients. They have grown the profit-making company from four hospitals to 12, serving some 250,000 patients. He expects 50 hospitals and 1 million patients in two to three years. Schrevel also offers his views on the rising criticisms of microfinance, which include charges of exploitation of the poor.

 An edited transcript of the interview is accessible below.

Download Microfinance: Successes and Challenges

 

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India Levels Its Education Playing Field

Posted on April 24, 2012

The Supreme Court of India recently gave the green light to the Right of Children to Free and Compulsory Education Act of 2009. Better known as the Right to Education (RTE) Act, it ensures free education for children between the ages of six and 14 who belong to economically weaker segments of society.

The main provision of the RTE directs all schools — including private schools, with the exception of those run by certain religious and linguistic minority groups — to reserve 25% of their seats for students from underprivileged backgrounds in their neighborhoods. Any school that does not comply with the RTE rules will be derecognized by the government. This goes into effect beginning with the 2012-2013 academic year.

The government expects the RTE to provide a level playing field to the vast number of children who are unable to access quality education because of economic and social constraints. According to Kapil Sibal, India’s union minister of human resource development, the RTE “is an attempt at affirmative action and social integration.” In an article in the daily newspaper Times of India, Sibal noted that if the RTE Act is implemented “in the right spirit … [it] could well become a model for the world to emulate.”

But the move has raised concerns among private schools. One issue is around the financing of the scheme. According to the RTE, the government will bear the additional cost incurred by the schools. But it is expected that government grants will only meet part of the expense; the rest of the cost will be passed on to regular fee-paying students. Then there are concerns over creating parity between different levels of education and exposure. There is also a fear that local politicians will use the provisions of the act to pressure schools in order to gain brownie points among voters. In a recent column, T.V. Mohandas Pai, chairman of Manipal Global Education Services, noted: “The RTE will give power to school inspectors for enforcement, creating a source of harassment and corruption.”

Experts also suggest that the act could have an adverse impact on investments in the education sector. Talking to business daily The Economic Times, Manish Sabharwal, chairman of TeamLease Services, said: “Just as government subsidies do not reach those who need it, 25% of the seats will not go to the poor. RTE will not get our kids educated, but [it] declares war on education entrepreneurship.” Added Vishal Jain, president of wealth management at Nadathur Investments: “The idea of RTE is noble, but the implementation is not appropriate.”

Currently, around 90% of schools in India are either directly operated by the government or funded by it. However, it is estimated that 40% of school-going children attend private schools. In contrast, in the U.S. more than 80% of children attend government-run schools. In U.K., the number is over 90%.

Experts say that instead of compelling the non-aided private sector schools to reserve 25% of their seats, the RTE should first focus on improving the quality of education in government schools. Justice K.S. Radhakrishnan, the dissenting judge in the Supreme Court verdict, noted that the government cannot free itself from its obligations by “offloading or outsourcing [them] to private … actors like unaided private educational institutions, or coerce them to act on the state’s dictates.” According to Pai: “The [RTE] is a chimera and gives a perfect excuse to the government to abdicate its responsibility to improve [education] quality.”

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Can Inflation Cure the Eurozone?

Posted on April 23, 2012

Does the eurozone need a dose of higher (but still generally low) inflation to help solve its economic and financial quandary? The word coming out of the International Monetary Fund’s (IMF) Global Financial Stability Report released Wednesday suggests the answer is a qualified “yes.”

The Financial Times notes that the IMF has again called for interest rate cuts by the European Central Bank (ECB), while further recommending additional liquidity injections through the newly created Long- Term Refinancing Operation (LTRO) and more sovereign bond purchases.

That is not necessarily a prescription for inflation, of course. But the IMF has flagged the risk of a deflation-debt spiral in Greece, Ireland and Spain — three countries receiving IMF support — and the article reported that the IMF has forecast that “inflation was likely to fall below the ECB’s target — below but close to” 2% to 1.5% in 2013.

Germany’s historically based fear of inflation aside for the moment, wouldn’t a modest uptick in European inflation make it easier for indebted countries, companies and individuals (and the banks they owe money to) to retire debt? And even if toggling the inflation switch up a notch is politically a non-starter, shouldn’t eurozone officials at least be very afraid of falling below the target, given the risks of deflation?

“This is precisely what I, and many others, have been saying,” says Wharton management professor Mauro Guillen. “Growth must come first, and debt reduction and fiscal balance later. The problem is that the politicians have no credibility. So the markets think that they will get growth now and forget about fiscal discipline later. It’s essential that Germany and the ECB help change that perception so that European countries in the periphery can start growing again.”

But despite a ringing deflation warning from the IMF — known for advocating relatively mainstream economic remedies — on the importance of maintaining adequate liquidity, the ECB seems squarely focused on an inflation threat, based on one of its first public statements following the IMF report.

Peter Praet, of the ECB’s executive board, made it clear in a speech to Germany’s finance ministry on Thursday, the day after the release of the IMF report, that containing inflation will continue to be a key policy at the multilateral bank. While acknowledging that the current crisis in Europe is “exceptional” and a real threat to the prosperity of the region and the world requiring a “forceful response,” he said many factors limit the range of official response regarding any increase in liquidity.

For one thing, the weak budget positions of many countries place “severe constraints on the capacity of governments to – somehow – spend their way out of the crisis.” Even in the face of calls for more action from monetary authorities, and presumably from organizations such as the IMF, Praet said, “we cannot afford to take measures that entail the risk of adverse economic consequences, such as moral hazard in fiscal policies or an unanchoring of inflation expectations.”

Wharton finance professor Franklin Allen points out that many observers believe that a dose of mild inflation, particularly in Germany, would be an effective adjustment policy. “It would also be much less painful than having prices fall in the periphery countries.” But this “assumes that the ECB can easily control the inflation level. This is quite difficult in the current environment. They may well end up increasing asset price inflation rather than consumer price inflation,” creating another bubble. The ECB  could also overshoot. “Even if they are successful, there is likely to be an adverse political reaction in Germany. So my guess is that the ECB will not try to do this.”

This all comes against a background of a huge bank deleveraging in Europe, according to the IMF report, that could drastically reduce the amount of credit banks can offer to businesses — an additional reduction in liquidity that could tamp down economic growth. Sovereign risks, weak euro-area growth, high rollover requirements and the need to strengthen capital cushions are forcing banks to shrink their balance sheets “by as much as $2.6 trillion (2 trillion euros) through [the end of] 2013, or almost 7% of total assets,” the report notes. “[Our] estimate is that about one-fourth of this deleveraging could occur through a reduction in lending.”

The IMF projects global economic growth at 3.5% in 2012, up 0.2 percentage points from its forecast at the beginning of the year. It projects a 0.3% contraction for the eurozone economy, a bit improved over the 0.5% contraction forecast in January.

Christine Lagarde, managing director of the IMF, recently discussed the merits of austerity measures in an exclusive interview with Knowledge@Wharton.

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Sports by the Numbers: Predicting Winners and Losers

Posted on April 20, 2012

Over the past six weeks, Wharton statistics professor Abraham Wyner and several MBA students, along with Wharton practice professor of legal studies and business ethics Scott Rosner, studied data provided by ESPN to determine whether the amount of money that sports teams pay for their players can predict how well the team will perform. Here is what they found:

Surprisingly, among the major American professional sports, it is ice hockey for which performance is most predictable, given team salary data. In baseball, salary matters a lot, but there is still tremendous uncertainty as to predictability — i.e., teams that don’t spend a lot can actually win more games than teams that do. In football, how much a team spends on its players has very slight predictive power, due to a strong revenue sharing system and salary caps, among other reasons.

Basketball is not as easy to predict as hockey or baseball, but it’s easier than football. Again, such factors as individual coaches, strategies and combinations of teams and players can all influence outcomes. The fifth sport, European soccer, was by far the most predictable of the five. Based on data related to the European premier league, Wyner and his students concluded that the teams that spend the most money on players win year after year. “Not only do they win, but we know they are going to win,” says Wyner.

While his analysis of the five different sports is relevant to owners and managers of sports teams, it is not part of his statistical research, which focuses more on scientific fields. But one research area overlaps both business and science: data mining — the process of discovering patterns out of large data sets, or as Wyner describes it: “extracting gems from a mine full of stuff, some of it valuable and some of it not, and looking for patterns that you can apply to your business.”

Wyner doesn’t like the term “data mining,” because “it means that you don’t know what you are looking for.” In fact, many companies don’t. As has been widely noted over the past few years, businesses collect such a huge amount of data, often on their customers, that they are drowning in information they have no idea how to effectively use. The right approach, says Wyner, is for companies to ask themselves what kinds of problems they have and, then, what data is available to solve those problems. “Instead, companies tend to say, ‘Here is this data: What can we find in it that might help us solve this problem?’ The term ‘data mining’ is pejorative because it suggests that managers let the data drive the problem, instead of letting the problem drive the data analysis.”

Referring to his study of the five sports, Wyner says that the owners and managers of the teams “should rely on data to make business decisions — rather than let these decisions be driven by tradition, history, what was done last year, inertia, convention or custom.” Some of the conclusions he and his team reached in their analysis go against conventional wisdom. For example, “we found that, in baseball, spending money on pitching is far more effective than spending money on hitting,” Wyner notes. “Convention says that you spend more money on hitting because more of your players are hitters. But we found that you get a more productive dollar when it’s spent on pitching.”

In basketball, spending money on the centers and forwards was more productive than spending it on the guards. “Part of that could be due to salary caps,” says Wyner. “[Miami Heat pro guard] Lebron James gets the same salary as a good but not great guard because of a cap. But James is so much better than everyone else. So it’s hard to argue that spending money on a guard is going to be a good investment for a team that doesn’t have Lebron James.” In other words, teams should put their salary cap maximum on a center because they get more value than they would putting it on a guard.

In hockey and baseball, Wyner concludes that defense is a more productive investment than offense (pitching is considered defense). In football, however, Wyner and his team found no obvious value proposition. “We’re not sure why, except that maybe it’s because on-field performance is so unpredictable on a yearly basis. Coaching, and the entirety of the team, matter more than any individual player you can acquire, even a quarterback. The problem is, there are too many quarterbacks who are paid a lot of money who don’t do well. That distorts the statistical view.” Football teams are built to be on parity with one another, Wyner adds. “Whatever they are doing to make football competitive, it’s working. It’s good for the fans and the owners, probably not so great for the players.”

Everything that the research team has done for baseball “can be done for your company,” Wyner adds. “You just need to collect the data that drives your business and analyze it.”

In addition to research interests that include probabilistic modeling, information theory, data compression, boosting and temperature reconstructions, Wyner is a huge baseball fan, which explains the title of one of his co-authored papers: “Bayesball: A Bayesian Hierarchical Model for Evaluating Fielding in Major League Baseball.” For those who skipped statistics in school, Bayesian methodology integrates information from a number of different sources – in this case, knowledge of player distribution as well as historical data on all players, for example – to infer or predict the performance of one unit, in this case, the fielding ability of one player.

The article, according to its abstract, focuses on a relatively under-explored topic: “the use of statistical models for the analysis of fielding based on high-resolution data consisting of on-field location of batted balls.” The abstract notes that the authors – including, besides Wyner, Wharton statistics professor Shane T. Jensen and Kenneth E. Shirley, a statistics researcher at AT&T Labs — “combine spatial modeling with a hierarchical Bayesian structure in order to evaluate the performance of individual fielders while sharing information between fielders at each position.”

 

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Facebook Passwords, Privacy and the Lack of Legal Protection

Posted on April 19, 2012

Reports that some employers are requiring job candidates to hand over their Facebook log on information have caused an outcry over perceived violations of personal privacy — and even calls for a federal investigation by some members of Congress.

But U.S. job seekers and the currently employed as well  should exercise caution, according to Wharton legal studies and business ethics professor Janice Bellace. She says in the U.S., anyone trying to challenge such a practice in court would have almost no legal ground to stand on. “People think they have more rights than they actually have; they seem to think they have rights that are just not there,” she says.

For example, she notes that employment law for decades has said that non-unionized workers could always be fired for taking actions that publicly disparage their employers. But 30 years ago, doing so was relatively complicated, and catching workers in the act was just as difficult. “When I was in law school, we used to read about cases where it did happen because it was so unusual,” Bellace recalls. “If you were talking to your friends about how much you hated your boss, you probably did it face-to-face. Although technically, under the law you might have gotten in trouble, nobody ever knew about it.”

But social media has been a game changer. “Technology has made it so much simpler for employees to get into trouble,” Bellace says. Years ago, an employee might have written a letter to a newspaper tearing apart an employer, “but it took time to sit down and type it out. Now you can Tweet it so simply. People say things before their mind stops them and says, ‘What am I doing?’”

The law is equally devoid of traction for potential employees who might be asked to provide access to their Facebook accounts, Bellace notes. “It has always been the case that employers could ask others about you for a reference and, if you refuse to give them names, they can refuse to hire you,” she says. “I’m not saying it’s right or wrong, but it’s the state of the law.”

So why are the current incidents causing such an uproar? “Employees think that their private life is protected by some right of privacy and that either a current or potential employer shouldn’t be able to invade their private lives.” But, legally, in the U.S. there is little guarantee of that, Bellace says.

“Parts of the Bill of Rights refer to the right of the citizen or person against the state,” she notes. “No state can come into your house and ask to read your diary or computer files without a search warrant. It doesn’t say anything about an employer.” Last week, Maryland legislators passed what is believed to be a first of its kind bill that prohibits employers from requiring job applicants to hand over access to private social media accounts. States including California, Michigan, Minnesota and Illinois are considering similar legislation. Bellace says that she knows of no previous state law that explicitly offers this right of privacy, nor any case law that would support an argument in court, “although we may begin to see that.”

She points out that circumstances are very different in other countries where statutes exist that recognize an individual’s right to privacy. In Germany, for example, laws date back to the post World War II era when officials there sought to ensure that people could not be fired from their jobs for aspects of their personal lives, as they had been under the Nazi regime. A few years ago, Bellace attended a conference in Australia and recalls that the organization later couldn’t get a list of attendees from the Australian firm it hired to plan the convention because the law in that country prohibits the sharing of data without permission from the individual.

“Some of these countries developed laws before social media took off,” she notes. “That adds an interesting wrinkle in those countries because they are building on a foundation of law that says you own your information.”

Bellace says even people in the U.S. who try to sue an employer – one who has asked for access to social media accounts — on the grounds of discriminatory hiring practices (because the accounts may contain information such as an applicant’s age or race) may have trouble making a case. The employer could argue that it is asking all job candidates to provide the access and thus applying the policy broadly, Bellace points out, and if that is the case, the job seeker would have to prove that the company violated the law after checking out the entire applicant pool, which could be harder to prove.

“How do you know why others didn’t get hired? How do you know why you didn’t get hired?” Bellace asks. “That’s why employment lawsuits are so hard to bring.”

She predicts that there will eventually be further changes in the law “because younger people used to interacting with others online through social media will be more disturbed by what they view as an unreasonable intrusion into their private lives and therefore may propose legislation.” But Bellace adds that it will be some time “before people completely coalesce around this notion that you have a right to a private life and privacy in online communications.”

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Apple Turnover

Posted on April 18, 2012

For Apple, it’s a case of “what comes down must go back up” — or at least it seems to be so far. Over the past week, the company’s stock had five consecutive drops in price, falling from an all-time high of $644 on April 10 to $580.13 on April 16 — a 9.9% loss.

According to an article in The Wall Street Journal, the decline lowered Apple’s recent $600 billion market capitalization by more than $50 billion. (To put that in perspective, the Journal notes that Hewlett-Packard’s total market cap is $48 billion.) But in a dramatic turn on Tuesday, the company’s stock price bounced back by 5.1% — its biggest single-day dollar increase — to close at $609.70, adding back nearly $27.5 billion in market capitalization. (As of 3:00 p.m. today, the company’s stock was trading at around $611.)

Despite the rebound, analysts have been searching for reasons behind Apple’s initial steep price decline — with some speculating that the stock simply came down because it was overvalued and seemed “like a helium-filled balloon,” as one Wall Street Journal columnist wrote. Don Huesman, managing director of the Wharton Innovation Group, points out that the company’s stock price has nearly doubled over the course of a year. ”That’s not based on reasoned analysis — that’s emotion at work,” he says. “The company isn’t twice as promising today as it was a year ago, even given an untroubled leadership transition.”

Others have blamed rumors that Apple plans to launch a cheaper “mini” version of its iPad, which some analysts predict could cannibalize the company’s sales, according to the Journal. “Apple’s stock price is based on forecasts of its earnings far into the future,” notes Wharton finance professor Jessica Wachter. “Because its price is based so much on [the company's] future growth, even small revisions in expectations of these growth rates can cause very large stock price changes.”  

Wharton operations and information management professor Kartik Hosanagar suggests that the recent decline in the company’s stock could be “partly due to profit-taking on the part of some big investors, and partly due to the [U.S. Department of Justice] lawsuit against Apple,” announced on April 11, which alleges that the firm conspired with publishers to raise e-book prices. (Apple has since denied the allegations.)

Because the price drop was so dramatic — as the Journal notes, it was just shy of the 10% change that analysts would call a “correction” — investors may be losing at least some of their confidence in Apple, observers say. But Hosanagar disagrees. “Personally, I would be cautious about over-interpreting such short-term trends. I don’t see investor confidence [in Apple] waning by any means.”

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For High-skilled Workers, the Visa Race Is On

Posted on April 17, 2012

At the current pace of applications, U.S. visa grants for skilled workers will soon exhaust the existing caps, Wharton experts and others tracking migrant job trends say.

The latest data released today by U.S. Citizenship and Immigration Services (USCIS) show that since the beginning of April — the start of the annual H-1B visa application window, which extends through September — the department has received 30,300 applications for the 2013 fiscal year. That total includes 20,600 H-1B applications counting toward the general 65,000 cap, and 9,700 petitions toward the 20,000 cap for individuals with advanced degrees.

“The prime driver is economic activity picking up in the U.S.,” says Ravi Aron, senior fellow at Wharton’s Mack Center for Technological Innovation and a professor at the Johns Hopkins University Carey Business School. Indian IT services companies are boosting their U.S.-based workforce as American companies increase investments in capital-intensive IT systems, he notes. Indian and Chinese workers have traditionally accounted for the bulk of the demand for H-1B visas, followed by Mexicans and Filipinos.

If the current pace continues, the annual cap on visas could be reached in the next few months, predicts immigration attorney Cyrus Mehta of Cyrus Mehta Associates in New York City. In part, Mehta attributes the growing demand for H-1B visas to increased startup activity in the New York City area, especially in mobile applications and IT security.

U.S. employers “are more confident about hiring again,” according to Laura Danielson, chair of the immigration practice at the Minneapolis, Minn.-based law firm Fredrikson & Byron, which specializes in representing Chinese entrepreneurs and employees. H-1B demand is surging among her clientele in the medical devices, automotive, biotechnology and IT industries, she says, adding that employers looking for skills in the STEM professions (science, technology, engineering and mathematics) often find them among Chinese professionals.

The IT industry is still “the greatest mover,” notes USCIS press secretary Christopher Bentley. U.S. employers are “requiring workers from India and China in greater proportions.” However, the current spike in H-1B visa applications is not as high as it has been in earlier years, according to USCIS spokesman William Wright. In 2008 and 2009, the H-1B visa cap was reached in the first week of the application season. Visas for those with “advanced degrees” were exhausted in the first week in 2008, and within a month in 2009.

Mehta points out that some of the current demand could be spillover from a recent rash of controversial denials of L1B visas (for specialized knowledge workers) by the consulate in Chennai, India. According to both Mehta and Danielson, the U.S. government must raise the H-1B visa caps in order to compete effectively with other countries. “Studies have repeatedly confirmed that many of these immigrant professionals will go on — in greater numbers than our American work force — to develop patents, create businesses and provide a net job growth to our economy,” Danielson notes.

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