A Business Model of the Netflix Ecosystem

All companies, without exception, create value from their relationships with other business actors in their environment. Together with their competitors and with regulators who set the rules of the game, they form an ecosystem of economic actors that depend on each other to survive and thrive. In the online economy, ecosystems have become vast and can be the source of enormous profits . How does this work?

To understand how you can benefit from your ecosystem, you need ecosystem business model. What does such a model look like? A business model of your ecosystem should make a map of the actors and relationships in your ecosystem and explain how you make a profit out of these relationships.

Current business modeling techniques focus on single companies and we need new techniques for designing and analyzing ecosystem business models. The techniques should clarify how the ecosystem creates value and what your strategic options for surviving and thriving in the ecosystem are. In this blog I describe such an approach.

To make things concrete I use Netflix as an example. Afterwards, I will summarize the takeaways by listing the strategic questions about ecosystems that we have encountered. A white paper with a more detailed analysis is available free of charge.

What is an ecosystem business model?

Business ecosystems exist because they allow their participants to survive and thrive. For example, actors in the Netflix ecosystem are studios, consumers, investors, Netflix itself, platforms used by Netflix, and competitors of Netflix. They participate in the ecosystem because this contributes to their survival and well-being. Correspondingly, we define an ecosystem business model as

a conceptual model of how actors in an ecosystem create, deliver and capture value for each other.

Note the difference with the standard definition of a business model, which talks about only one actor that delivers value for a customer. In an ecosystem business model, we show how all actors create value for each other, including the customer.

The structure of an ecosystem business model

There are four keywords in the definition: create, deliver, capture, value. Correspondingly, our ecosystem business models have four parts. Because the value proposition is core, I put it first. Because the expected of each actor follow from their role in the ecosystem I put that last. The four components are then:

1. Value propositions of the actors in the business ecosystem.
2. The actor network in which value is delivered.
3. The profit model by which the ecosystem actors capture value.
4. The capabilities by which the ecosystem actors create value.

Example: the Netflix ecosystem

(1) Value propositions of the Netflix ecosystem.

A value proposition is a description of the value that customers can expect from a product. But which value proposition do we mean here? The Netflix ecosystem contains movie studios, cable TV, movie theatres and many other players. Each player has its own value proposition. Writing down all of these makes a very long list.

Perhaps we can save ourselves time by writing down the value proposition of the ecosystem as a whole? The Netflix ecosystem as a whole delivers entertainment content to consumers. That is its value proposition. But we do not have hierarchical control over the ecosystem and all its members. We want to focus on one or perhaps a few actors and understand how they create value from the ecosystem.

In this example we focus on Netflix. Here is the Netflix value proposition.

Netflix value proposition

Product:

• On-demand video streaming (international)
• DVD rental (U.S.A. only).
• Distinguishing features are personalized recommendations and a large content library, which includes content local to cultural areas and original content produced by Netflix.

Customers & contexts:

• Individuals in the age range 17–60, watching from home.
• Households with income levels of $30 000 and more.
• Three customer segments: people who are too busy to go out and shop for movies, people who are frequent renters and movie buffs, and people who want to get the most value for their money.
• Customers are divided into over 2000 taste communities.

Alternatives & differentiators:

• Other streaming providers. Differentiators: Netflix is the oldest VoD brand, has the largest repertoire of movies, has prize-winning content, supports a wide range of devices including mobile, provides high-quality connection, and has a simple subscription scheme.
• Movie theatres. Differentiators: Netflix offers the comfort of home and has different from movie theatres, including Netflix originals.
• Cable TV. Differentiators: Netflix offers on-demand movie watching, shows no ads, and allows binge-watching.

(2) The value network of the Netflix ecosystem

The actors in an ecosystem perform value-adding activities and offer the result of these activities to each other. This is what makes it valuable to be in the ecosystem. In the value network created this way. business actors provide products (goods or services) to each other. The value network of the Netflix ecosystem looks as follows.

There are more actors in the ecosystem than shown in the diagram and this only serves as an example. Groups of business actors playing the same role are boxed by a rectangle.

In the middle we see Netflix with its subsidiaries. Netflix can produce original content in its subsidiary ABQ studios. It acquired the comic book company MillarWorld to develop new content, and StoryBots to develop educational content for children.

Intellectual property holders such as DreamWorks and others license content to Netflix and its competitors. Game companies allow game streaming on Netflix and its competitors. Original content for Netflix is produced by producers, writers, actors, etc. Many of these content producers may also work for other IP holders. Blackrock and others invest in Netflix and perhaps also in its competitors (not represented to keep the diagram simple). BMG manages IP rights for Netflix outside the USA.

Netflix uses a number of platforms: AWS for storing content, Internet Service Providers (ISPs) for streaming and for local content storage, banks for payments, and trade shows to connect to stakeholders in the entertainment space. And of course it uses postal services to send and receive DVDs.

Consumers watch streaming content. Gwyneth Paltrow’s Goop uses Netflix as a platform to sell health advice to consumers. Netflix has partnered with airlines to offer its streaming technology and content in airplanes, whichy improves the serviuce that an airline gives its customers.

Finally, Netflix’ ecosystem also contains a host of competitors that aim for the same market and may use the same underlying platforms.

The Netflix profit model

The ecosystem model can be analyzed on economic viability if we quantify the cash flows in it. Quantification requires a refinement of the model. Some actors must be added (marketing and sales channels to be paid) and all business relationships must be refined into economic transactions in which value objects are traded against cash or other value objects. See the accompanying white paper for a refinement of this value model with some quantification.

The quantified value network can then be used to run profitability estimates and sensitivity analyses. To assess the long-term viability of the Netflix business model, we need to assess whether the net present value of a long-running scenario is positive. Software on our web site can do these computations for you.

As a starter for such an analysis project I show a classification of expenses and revenues of Netflix itself.

Netflix profit model

Netflix revenue

• Three subscription plans (basic, standard, premium)
• DVD rental in the USA
• Fees from companies like Goop for the use of the Netflix as a platform for their products
• Fees from airline partnerships

Netflix expenses

• Marketing and sales (advertising, payments to affiliates & device partners, first-month fee)
• License fees
• Production of original content
• Payments for servers and colocation
• Cloud service fees to AWS
• DVD postage fees paid to postal service
• Payment processing fees for banks

Netflix technology capabilities

Actors need IT capabilities needed to participate in the ecosystem. Technological capabilities are the domain of enterprise architecture, which is about the business processes and IT infrastructure of a company. To assess technology capability for ecosystem participation we need to assess network-facing capabilities such as information sharing and coordination. And we need to assess IT capabilities needed to perform the value activities identified in the value network model shown above.

Netflix technology capability model

Information sharingCoordination

• Netflix must distribute its app to app stores and provide a support channel for customers.
• Netflix has defined the Open Connect standard for Streaming content.

Value-adding technology

• To realize its core product (streaming), mentioned in the value proposition, Netflix needs high-performing streaming capabilities that connect it with customers.
• To achieve its recommendation capability (mentioned in the value proposition), Netflix needs powerful analysis and recommendation capabilities.

Takeway: Nine strategic questions about your ecosystem business model

To sum up, the ecosystem business model of a company like Netflix consists of four components, shown below. At each level, important strategic questions need to be answered.

What is not in an ecosystem business model

Compared to the well-known Business Model Canvas, an ecosystem business model omits elements that are company-internal. Specifically, it omits internal activities such as R&D, administration, HR, and its associated cost, and it omits internal resources such as staff, user data and content, and its associated cost. It adds the value network and the possibility to quantify the model and run scenarios.

A second aspect that I have omitted above is ecosystem governance. An ecosystem is not a hierarchy and governance is decentralized, although some players will be more powerful than others. The viability of an ecosystem business model cannot be assessed independently from ecosystem governance. I will dive into ecosystem governance in a later blog.

Sources used for the Netflix example are