Analyze the Quirky Case that is attached and answer the questions belwo. Use external resourcesThe analysis write-up is not to exceed five pages (double spaced, 12pt. font, one-inch
margins). It should answer the assigned questions related to the case.If you were the CEO of Quirky:
• How would you proceed? • How have they done since the case?
• Investigate their culture — Do you think it has had a bearing on their success, or
lack there of, over the last few years?CPID 814087
ENTR 6212: Business Planning for New Ventures
Professor Tucker Marion
Northeastern University
Spring 2 2020
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ENTR 6212: Business Planning for New Ventures,
Marion − Spring 2 2020
Northeastern University
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ENTR 6212: Business Planning for New Ventures, Marion − Spring 2
Table of Contents
“IDEO: Human−Centered Service Design” by Buell, Ryan W.; Otazo, Andrew
“Netflix” by Shih, Willy; Kaufman, Stephen P.; Spinola, David
XanEdu Extra
An Excel−formatted spreadsheet containing the exhibits for the case above is available at
“Why the Lean Start−Up Changes Everything” by Blank, Steven G.
“Quirky: A Business Based on Making Invention Accessible” by Hoyt, David;
Marks, Michael
“Pascal Press: Crowdfunding a New Coffee Revolution” by McDougall, Collin;
Earth, Holly
“GoPro: The Disruptive Innovator Faces Challenges” by Dwesar, Rishi; Singh,
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REV: JANUARY 29, 2016
IDEO: Human-Centered Service Design
Each team creates its own variation of the design process in order to solve a specific challenge, but the signature
aspect of the process is that it begins and ends with the human experience.
— IDEO Partner Diego Rodriguez
Mildreth Maldonado, the CFO and chief marketing officer (CMO) of Cineplanet, Peru’s largest
cinema chain, sat in her office in Lima. In a few minutes, she would walk into a conference room and
join five of her Cineplanet colleagues for a presentation by a team of designers from IDEO, a global
design firm. In response to a rapidly changing competitive landscape, Cineplanet’s management had
hired IDEO several months before to assist with a redesign of the movie-going experience it offered its
customers. During the meeting, the IDEO team would present their emerging vision for the future of
Cineplanet—a vision they planned to prototype in one of Cineplanet’s most popular theaters.
Maldonado had been an embedded member of the design team since the beginning of the project.
During the first four weeks, they toured Peru and Chile, visiting cinemas, conducting interviews, and
observing how customers interacted with Cineplanet. This “exploratory phase” of the process had been
exhilarating, confirming much of what Maldonado had long suspected while also uncovering new
insights about latent customer needs. The next four weeks, however, had been more difficult for her.
Maldonado and the designers settled into a project space in IDEO’s San Francisco office to reflect on
what they learned in the field and to generate ideas and concepts that would serve as the foundation
for their recommendations for prototyping. Maldonado was an economist with an MBA (Tuck ’03),
and the mechanics of this “concepting phase” had been unlike anything she had previously
experienced. The concept ideation process progressed iteratively rather than linearly and seemed
counterintuitive to her at times, making it difficult for her to update and manage the expectations of
her Cineplanet colleagues.
By the time she returned to Lima, Maldonado felt more at ease with the concepting process and was
in agreement with the recommendations around which the team was converging. The IDEO team
conducted weekly conference calls with the Cineplanet core team to refine the concepts. It also kept in
daily contact with Maldonado to better understand the concerns of the other members of Cineplanet’s
leadership. Maldonado and some of her colleagues participating in the project wondered if
Cineplanet’s leadership team would support prototyping the concepts the IDEO team would
Professor Ryan W. Buell and Associate Case Researcher Andrew Otazo (Case Research & Writing Group) prepared this case. It was reviewed and
approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and
not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of
primary data, or illustrations of effective or ineffective management.
Copyright © 2014, 2015, 2016 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
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IDEO: Human-Centered Service Design
recommend. More importantly, would the leadership team appreciate the magnitude of the cultural
and organizational shifts that would be required to successfully implement those ideas?
The Evolution of IDEO
IDEO was cofounded by David Kelley, Bill Moggridge, and Mike Nuttall in 1991, with an initial
focus on product design and engineering. Like many of its competitors in the design industry at the
time, it employed industrial designers, as well as mechanical, electrical, and manufacturing engineers,
who worked in teams to design and improve products for its clients. What set IDEO apart, however,
was its human-centered approach, which fused empathy for the end user with prototyping and
iteration to design products that served unmet consumer needs.
This distinctive, human-centered innovation process eventually garnered the attention of the
national media. Most notably, in 1999, a team of IDEO designers featured on ABC’s Nightline was
challenged by the show’s producers to redesign a shopping cart in four days. The widely seen segment
captured the imagination of potential clients and helped fuel the expansion of the domains in which
IDEO operated. Whitney Mortimer (HBS ’88), IDEO partner and global marketing director, recalled,
“We got a call from a guy who was running the emergency room at DePaul University. He said, ‘If you
can do that for a shopping cart, then you can do it for an emergency room. Let’s go.’”
IDEO and its clients found that the company’s human-centered approach applied to a wide range
of challenges. IDEO partner Diego Rodriguez (HBS ’01) explained, “The human-centered design
process obviously works for products—that’s where it originated—but the beauty of it is that it’s
applicable to almost anything you might come up with as a challenge.” After 1999, IDEO continued to
expand its range of industries, most notably winning food and beverage, health-care services, and
financial services projects. The firm was increasingly focused on designing organizational change in
addition to designing new products and services for its clients. While each office initially operated
somewhat independently, in 2004, the company realigned itself around the shared purpose of creating
impact through design. Mortimer elaborated:
We saw how far design could go to address new kinds of challenges facing business
and society. The challenges were complex, they were human, and they were systemsbased. We were starting to understand how design could have broader impact and that
we needed to rethink how we talked about design. Design had been thought of as a thing
that makes noise when you drop it. It was thought of as form, objects, and beauty. It still
may be all of those things, but we weren’t focused on the noun anymore. We were focused
on the verb, and we started talking about an approach and a mindset.
The approach became known as design thinking: a human-centered approach to innovation that
integrated the needs and desires of users with the possibilities of technology and the requirements of
business. IDEO continued to expand into new domains, including government, education, and social
innovation. By 2014, its methods had evolved to include product, service, brand, digital, space,
organization, and venture design.
IDEO was a privately held firm that, in 2014, was owned by several dozen partners, including
founder and chairman David Kelley. It employed approximately 700 full-time staff, had relatively low
staff turnover, and generated approximately $150 million in revenues in 2014. It had offices in Palo
Alto, San Francisco, Chicago, New York City, Boston, London, Munich, Singapore, Shanghai, and
Tokyo.1 Some of its most famous designs included the first Apple mouse, one of the first laptop
computers, the Oral B Gripper fat-handled toothbrush, the Palm V personal digital assistant (PDA),
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and Bank of America’s “Keep the Change” savings account service. IDEO was ranked 10th on Fast
Company‘s Top 25 Most Innovative Companies list and 16th on Fortune’s list of 100 most-favored
employers by MBA students, in addition to having won 181 Industrial Design Excellence Awards, 41
Red Dot awards, 28 iF Hannover awards, 18 Medical Design Excellence Awards, 22 Webby Awards,
and the Smithsonian Cooper-Hewitt National Design Museum’s National Award for Product Design.
Embracing Ambiguity as a Team: Cultivating the IDEO Culture
As IDEO grew, it reorganized itself in response to its broad array of projects and the diversity of the
talent it employed. Ilya Prokopoff, an IDEO partner, described the company’s progression: “We think
much more intentionally now than we did when I started 17 and a half years ago about so many
things—client relationships, the quality and consistency of our work, the talent development process,
and how we plan for the future. We’re much more mindful today of where we’re going.”
This intentionality was most apparent in the thoughtful way IDEO crafted and reinforced its
culture. Practically every facet of the company—from the design of its organizational structure and
physical spaces to the way it hired, trained, organized, and managed its employees—was aligned with
supporting and reflecting IDEO’s values and building a vibrant, distinctive culture. Rodriguez
explained, “We value the ability to embrace ambiguity. You have to be comfortable with starting with
a blank sheet of paper—and even relish it. You will have moments of doubt where you’re not sure
what to do. But because we believe so strongly in creativity and the design process—that there’s a way
of solving complex problems—we help each other, support each other, and collaborate.” As Rodriguez
elaborated, IDEO’s culture was a critical enabler of its process. “Knowing how the design process
works is very different from actually being able to practice it. A lot of the things that make IDEO shine
are largely tacit, such as our culture. For that reason, we’re not afraid to talk about how IDEO ticks
because actually making it work is a whole other ballgame.”
IDEO had a very flat organizational structure. The desks of partners and senior leaders were
interspersed among those of junior designers, which promoted a spirit of openness and accessibility.
The layout of IDEO spaces engendered interaction. Project spaces were arrayed around the perimeters
of large central areas, and some featured a “front porch” that facilitated sharing between teams.
Employees were encouraged to express themselves, which extended to the design and personalization
of their work environments. Walking through an IDEO office, one might encounter a seven-foot-tall
sea monster costume, an oversized origami sculpture, a Nordic fish lamp, or collections of past
products and design prototypes. Posters of IDEO’s core values and sticky notes from brainstorming
sessions covered the walls. (See Exhibit 1 for a list of its core values.)
IDEO’s leaders were passionate about finding exceptionally talented people, in a variety of
domains, who would stimulate and enrich the firm’s culture. In 2013, the company received more than
17,000 applications for 60 jobs. In particular, when seeking to hire a new designer, managers often
looked for individuals who met a T-shaped profile. “A T-shaped person is someone who is world class
in at least one thing—the vertical stroke of the T—and fluent in many other things—the horizontal
stroke,” described Rodriguez. “That combination is what we rely on. The beauty of IDEO is that we
can take almost any group of T-shaped designers, and so long as the right skill sets are in the room, we
know that they’re going to come up with something remarkable.” “T-shaped people are our special
ingredient,” said Mortimer. “Without them, you have really smart people who are rock stars of
whatever field they come from, but they can’t collaborate.”
A premium was placed on identifying collaborators among potential recruits. “I look for life
experiences which involve achieving some meaningful goal by being part of a team,” explained
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Rodriguez. “And whether it was a championship soccer team or an awesome band—or even an awful
band—the important thing is that you enjoyed the experience of creating with other people. Many
people at IDEO will report significant life experiences in sports and/or music.” People were
encouraged to seek help from all of their coworkers, including those at the very top of the organization. 2
Likewise, the firm’s leadership often sought assistance from all qualified individuals, regardless of
seniority.3 “I believe that the more complex the problem, the more help you need,” said Tim Brown,
IDEO’s CEO. “And that’s the kind of stuff we’re getting asked to tackle, so we need to figure out how
to have a culture where help is much, much more embedded.”4
IDEO’s culture of helping was structured into its employees’ schedules. Staff sometimes had gaps
between projects and spent that time assisting their peers with projects unconnected to their own
work.5 This allowed teams to tackle assignments from many different perspectives, as IDEO’s
employees came from a wide array of backgrounds, including psychology, linguistics, and business,
among many others.6 They underwent both formal and informal review processes to ascertain their
contribution to the firm’s culture of helping.
Teams were thoughtfully assembled from available employees on a project-by-project basis. IDEO
leadership considered multiple factors, including expertise, skill sets, personalities, growth aspirations,
development needs, and the cross-pollination of perspectives. “It’s not an equation—this method of
pulling together the perfect team. It’s an intensely human process,” explained Rodriguez. He
Each project is a chance for people to get feedback and talk about where they want to
go with their careers. David Kelley has a teeter-totter diagram he draws. On one end is a
heart, and on the other is a dollar sign. The balance between the two is not something
we’re trying to resolve in the moment, but we do aspire to balance it over time. We may
have had someone work on a project that wasn’t exactly their cup of tea. So on the next
one we’ll try and create an extra special experience to balance out the heart side a bit more.
We’re trying to help people have the most fulfilling design experience they can.
When possible, project leaders and potential team members were engaged at a very early stage so
that they could help shape the scope and design of a project. Rodriguez explained, “Being part of the
team putting together a project means that you’re going to be even more interested in working on it.
And then, basically, we’re giving you a chance to shape your work reality.”
When IDEO and Cineplanet began exploring a possible collaboration to reimagine the movie-going
experience for the emerging middle class in Peru, Scott Paterson, an IDEO project leader with a
background in art and architecture, joined Prokopoff to participate in the early conversations. Together
with the Cineplanet management team, they scoped out the project. Paterson and Prokopoff worked
together to identify other designers who could join the project team. Greg Burkett, Emily Eisenhart,
and Rosaria Mannino, IDEO designers with a complementary set of skills, were scheduled to be
available, and expressed interest during conversations with Paterson about the project. All four
eventually boarded a plane bound for Peru in early February 2014.
Peru’s Rising Middle Class
Peru was located on the western coast of South America, to the north of Chile, south of Ecuador and
Colombia, and west of Brazil and Bolivia. (See Exhibit 2 for a map of Peru.) It had an official population
of 29.8 million people in 2013.7 Lima, the country’s capital and largest city, was home to an estimated
8.7 million people.8 With a GDP of $203.8 billion, Peru was categorized as an upper-middle-income
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country by the World Bank.9 Between 2002 and 2012, it had the fastest-growing economy in Latin
America.10 (See Exhibit 3 for a chart of GDP growth in selected Latin American countries.) Between
2003 and 2013, average wages grew by 7%, while the percentage of the population that lived on less
than $2 a day simultaneously decreased by 28%.11 Total consumer spending, which grew from 30.7
billion solesa in 2008 to 41.5 billion soles in 2014, became one of the country’s driving economic
Following the resolution of the pervasive social and political unrest of the 1990s and early 2000s,
Peruvians felt much safer attending public venues. Middle-class families suddenly felt physically and
financially secure enough to begin visiting concerts, sporting events, and movie theaters. Peru’s
growing middle class (approximately 60% of the population in 2014) spent more money and demanded
more services.14,15,16 Lizandro Vargas, a Universidad de Piura professor, stated that Peruvians “now
have internet access, cable TV, and spend large sums of money on entertainment, going out to eat,
films, and other ways of leisure, [a trend that] may be observed [in] every age span; those who have
the money will invest in technology and spend it on entertainment.” 17
Increased disposable income allowed Peruvians to spend more money on entertainment, and going
to the movies became one of their favorite pastimes.18 The number of Peruvian movie theater customers
doubled between 2006 and 2012.19 In 2013, a record number of 35 million movie tickets were sold in
Peru, an increase of 13% over the year before.20 Peruvian behavior was emblematic of a larger Latin
American trend, where aggregate box-office revenues increased by 73% between 2008 and 2012,
making it the fastest-growing movie-watching region in the world. (See Exhibit 4 for a breakdown of
global box-office growth.)21 Movie theater companies raced to meet demand. In 2013, Peru counted 69
movie theaters that held 473 individual viewing rooms. 22 By 2015, those numbers were expected to
grow to 87 and 600, respectively.23 By 2012, 76% of all movie theaters in the country were found in the
capital.24 However, as demand increased in the provinces, cinema companies began to dedicate a
higher percentage of their growth to cities and towns outside of Lima. 25
In 1998, three Peruvian friends completed their MBAs at the University of Pennsylvania Wharton
School and decided that they wanted to return to their home country to found a startup. 26 After
conducting research into several domestic markets, they noted the number of moviegoers had declined
from 15 million in 1981 to 3 million in 1995 and concluded that their country’s entertainment sector
was significantly underserved.27,28 In 1999, they founded Nexus Film Corp. and bought Cineplex, a
movie theater chain that operated three cinemas in Lima.29 The company’s name was changed to
Cineplanet in 2000.30 In 2004, Cineplanet expanded into Chile under its Movieland franchise by
acquiring four cinemas from Cencosud, but also decided to rename its Chilean operations Cineplanet
in 2012. It opened two additional Chilean cinemas (Costanera and Concepción) that same year. In
October 2013, Cineplanet further expanded its presence in Chile by acquiring a cinema complex from
Cine Hoyts, a Santiago-based cinema company.
Cineplanet quickly became the largest cinema company in Peru in terms of number of theaters,
tickets sold, and net income.31 In 2013, it accounted for 40% of all trips to the cinema in the country. In
addition to its status as market-share leader, Cineplanet was a leader in technology and service
innovation among Peruvian cinemas. In 2008, for example, it became the first cinema company in Peru
a The nuevo sol was the official currency of Peru. It was also referred to as the “sol” (“soles” in the plural). As of August 2014,
one sol traded for 0.35 U.S. dollars.
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to offer 3D movies to its customers. As a response to a perceived demand for higher-quality amenities
and services, it introduced its Cineplanet Prime movie theaters into the Chilean market in July 2012
and into the Peruvian market in February 2013. Prime moviegoers in the San Borja movie theater could
expect to pay 40 soles, as opposed to 20 soles for adult general admission or 25 soles for 3D general
admission.32 In return, they were offered larger, ergonomically designed, reclining seats; a larger
screen; food and beverage service; individual lamps and tables; and a full bar.33 (See Exhibit 5 for a
picture of the Cineplanet Prime seats.) In 2014, Cineplanet became one of the first cinema companies
in Peru to begin converting its analog projector systems to a digital format. However, despite
Cineplanet’s position as a market leader, it still sought opportunities to improve.
Cineplanet’s Redesign Goals
Cineplanet’s management hoped to offer new services to the country’s growing middle class in
order to allow it to further expand into what it considered an underserved market. Furthermore, it
perceived the Peruvian middle class’s growing demand for services as an opportunity and impetus for
innovation. “Consumers are becoming much more sophisticated,” said Fernando Soriano, Cineplanet’s
CEO. “We are doing extremely well, and this is exactly the time when we should invest. Look at
Blockbuster. They didn’t invest in their company when things were good and they went out of
business. We don’t want the same thing to happen to us.”
Company leaders wanted to pursue a differentiation strategy and keep Cineplanet ahead of its
competition. “We are conscious of the fact that we don’t sell movies, popcorn, or soft drinks. We sell
an experience,” said Soriano. “Are our services sufficiently attractive for consumers to choose us? That
is why we chose to work with IDEO. How do we get the client to want to come to the cinema, and not
just for those products? We have to change the thought process of the people who go to the cinema
simply for the movies.”
Management planned to increase Cineplanet’s growth rate over the coming years. As of 2013, the
company operated 24 theater complexes in Peru that served 13 million customers and operated another
7 in Chile that served 2.6 million customers. By 2016, it planned to construct 18 additional complexes
in Peru and 5 more in Chile to serve a total of 30 million clients in both countries. “Most of our prior
decisions were based on assumptions that we made about the customer or about what would work
best from an operational point of view,” said Maldonado. “Now that we are a mature business, we’re
entering another phase of growth for the company where we’re focusing on what our customers say
they really need. I think we’ll find a lot of new opportunities from this new point of view.”
Cineplanet’s management also wanted the redesign to go beyond simply introducing new products
and services. It planned to institute significant cultural changes within the company. “In terms of
methodology, our culture is highly operational. We’re trying to learn how to approach and learn from
our customers. We need to change how our staff members are talking to customers and how they serve
them,” explained Maldonado. “This is not a onetime project. It’s just the beginning of something new
inside the firm.” With that in mind, Rafael Dasso, the president of Cineplanet’s board, decided to join
Maldonado and Soriano as a part of the core team, as well as Alvaro Sedano, chief programmer;
Veronica Vallarino, chief of marketing; and Hernan Carranza, chief innovation officer at Intercorp’s
Innovation Lab, Cineplanet’s strategic partner.
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Implementing IDEO’s Human-Centered Design Process at Cineplanet
When the IDEO designers landed in Lima, they joined Maldonado, who became an embedded
member of the project team. Together, they launched into IDEO’s design process, which began in an
exploratory manner before transitioning iteratively and organically into “concepting” and prototyping.
Exploratory Phase: Inspiration and Research
The first phase of any IDEO project was exploratory in nature. Through observation and synthesis,
project teams researched a broad array of topics associated with their brief before identifying and
focusing on the narrower set of relevant data they would ultimately use to create and test possible
design solutions. This conscious broadening and narrowing effort was repeated in some form in all
three phases of IDEO’s design process, as designers would fluidly alternate between divergent and
convergent thinking. Through divergent thinking, designers sought to multiply options and create a
broad set of choices. Then, through convergent thinking, they would funnel through the possibilities,
eliminating options and making choices. As CEO and president Tim Brown explained, “The process of
the design thinker looks like a rhythmic exchange between the divergent and convergent phases, with
each subsequent iteration less broad and more detailed than the previous ones.” 34
Empathy and “human-centeredness” were central to IDEO’s design process. 35 The exploratory
phase’s first step involved intensive research of and interaction with consumers, industry experts, b
extreme users,c analogous examples,d and a variety of other sources in order to gain inspiration and
insights into a product’s or service’s current and potential uses, benefits, and pain points. e Its designers
constantly sought to place themselves and their clients in the end-users’ shoes.36 In practical terms, this
often meant watching users interact with a product in real time and picking up on problems that would
be impossible to gauge from a purely theoretic or analytical perspective. 37 Rodriguez described the
importance of empathy:
In essence, what you do in the human-centered design process is go out into the world
to gain empathy for somebody else’s existence. All of us have a different story, so it’s
really important to understand what’s happening in someone’s life and how your design
solution might change it for the better.
The IDEO team began the Cineplanet project a week and a half before traveling to South America.
They conducted research on Peruvian and Chilean cultural practices, investigated how people in Peru
and elsewhere spent their leisure time, and learned about movie-going experiences around the world
in order to have a base to work from when they arrived in the country. Once in Peru, they also sought
b IDEO considered individuals with in-depth knowledge of an economic sector to be industry experts. For example, team
members on the Cineplanet project conducted extensive interviews with experts in food, movie distribution, and cinemas.
Interviews with Cineplanet company experts were referred to as “looking in,” while interviews with outside experts were
referred to as “looking out.”
c Extreme users were individuals who either were particularly passionate about products or services or used them in manners
that diverged significantly from their designed purposes, often employing workarounds. Their needs, desires, or behaviors were
amplified relative to those of mainstream users.
d When conducting analogous research, designers examined examples of how organizations in different sectors solved issues
relevant to those faced by the product or service they were designing. For instance, the design team on the Cineplanet project
sought inspiration from hotel checkout systems and e-commerce websites when hypothesizing different possible cinema
payment methods. They also interviewed food vendors and event planners to broadly explore other facets of movie-going.
e Pain points were aspects of a product or service that were considered inefficient, irritating, or unpleasant by consumers and
that presented opportunities for design improvements.
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inspiration from the different ways people gathered and socialized by visiting parks, churches, and
other public spaces. Their goal was to provoke unconventional modes of thinking that pushed the
boundaries of possible future design solutions. The team spent their first week in Peru in Lima, where
they met with Cineplanet executives, visited various theaters, and conducted interviews with industry
experts (i.e., filmmakers and experts on piracy). Next, they took a bus trip to Huancayo, a city in the
Andes, where they interviewed users, DVD merchants, and other participants in the movie space. A
week later, they traveled to Santiago, Chile, to conduct more user interviews in a different market. The
designers spent their final week in Lima, where they synthesized what they learned and began
brainstormingf about what they would concept when they returned to San Francisco.
Throughout the phase, the team sought to understand larger societal trends and acclimate to the
region’s varied movie-going cultures and idiosyncrasies. “It’s really easy to assume that because you
do something all the time that you then know everything there is to know about it,” said Burkett. “Peru
is a different country and a totally different culture. So, if we applied what we think about movies in
the U.S. to what’s happening here, then it won’t be helpful to the end goal.” Maldonado explained her
own experience as an embedded client team member and cultural liaison in the first phase of the IDEO
It worked out much better than I thought in the beginning because I had to learn the
methodology, but we learned how to work together. That’s why I feel very much a part
of the team, and not just a client. I was the link that helped the team understand how the
Peruvian market and the Peruvian customer work. It’s not just about my knowledge of
the industry, but also about being able to relate to our culture, our people, and to
understand the customer.
An indispensable part of conducting research involved sitting down with a product’s or service’s
current or potential clients in a relaxed setting for extended interview sessions that lasted between one
and a half and two hours. It was also a concrete expression of IDEO’s emphasis on human-centered
design. Maldonado explained why: “It is very important to conduct interviews in a customer’s home
because they feel much more comfortable. It takes them a while to talk, but it is totally different from a
questionnaire or survey. I think you can get much richer insights than with more traditional research
methods.” Eisenhart elaborated on the importance of context in interviews:
You want, as much as possible, to conduct interviews in-context and surrounded by a
user’s typical environment or the tools of their trade. For the Cineplanet research, we
wanted to interview people in their home because that’s where many of them consume
media—on smartphones, laptops, or in their in-home movie theaters. That way, people
could point to their devices and DVDs and show us what their routine is. We also wanted
to interview people in the cinema, because we were trying to understand behaviors and
mindsets at the cinema itself. Chances are you would uncover something much more
authentic asking someone while they’re waiting in line how they feel about the line rather
than once they’re home or a few days later.
This component of the process differed from traditional market research, because IDEO’s designers
did not generally attempt to aggregate input from a representative sample of consumers. Instead, they
sought inspiration by gathering as much feedback as possible from both “average consumers” as well
f Brainstorming was a process by which designers thought expansively and without constraints about possible solutions.
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as those on the extreme ends of the distribution. The team then condensed those stories into insights
about the users’ desires and motivations.
In preparing for an interview, IDEO team members usually began with an emergent line of inquiry
they wished to explore. For instance, the project team wished to discover whether going to the cinema
in Peru was a social or individual experience. From that starting point, they developed a set of
exploratory objectives and an interview outline. That outline included several exercises that were
designed to get customers and industry experts to communicate their latent needs. One such exercise
involved asking customers during an interview to recall their past week and reconstruct an in-depth
“daily diary.” Burkett explained, “It helps us understand how they spend their time and how the
cinema fits into it. It’s usually very hard for people to abstractly remember exactly what they did. They
don’t think about their lives in an explicit fashion. This helps us get it all out and understand what they
were thinking when they made their decisions.” Another exercise involved asking industry experts to
physically sketch out complex systems and processes on a piece of paper. “One morning, we talked to
the number-one distributor in Lima,” said Mannino. “We had him write down the process of making
a deal, what the bargaining pieces looked like, and where the power dynamics lie. We’re very visual
people, so we like to have some piece of paper we can use to redirect the conversation and act as a
unifying item to go back to.”
Throughout the exploratory phase, the designers often sketched out impromptu drawings to
communicate possible solutions to interviewees and other members of the project team. (See Exhibit 6
for an example.) The team referred to these sketches as “sacrificial concepts.”g “They allow us to see
how people perceive our ideas from a very nascent state. In a sense, sacrificial concepts are really the
earliest form of prototyping,” described Burkett. “People fill in what they’re imagining,” added
Paterson. “We’re not beholden to [these concepts]. We sketch them out really quickly, and if someone
doesn’t connect to them, we just throw them away because we’ve not really invested in them, we’re
not emotionally attached.” Even discarded concepts would continue to inform the designers’ thinking,
as they iterated toward workable solutions.h When users rejected concepts, designers were able to learn
why particular approaches would be ineffective, sparking new avenues of exploration. Moreover,
pieces of discarded concepts could be iteratively recombined to form new testable ideas.
The nature of the Cineplanet project i often forced the project team to separate during fieldwork.
After team members gathered information through stories, testimonies, observations, or other sources,
they regrouped and conducted what the team referred to as “downloading sessions.” While not a
common term across IDEO, these downloading sessions served as a mechanism for individuals to
communicate what they learned to the rest of the group and for the team to reflect on shared
experiences. “Downloading is storytelling, and it’s the first step of synthesis. When we’re
downloading, we get the rest of the team up to speed and synthesize what we heard and saw in the
field,” said Eisenhart. “It’s about moving from observations and stories to abstract themes and insights
that span across users. What themes are surfacing and what are the opportunities for design here?”
g The project team’s occasional use of the term “sacrificial concept” differed completely from how it was sometimes used in
marketing and advertising. In advertising, the term described offering clients a purposefully subpar solution before presenting
a much more viable option. In the design process, “sacrificial” was instead used to connote the team’s willingness to share and
explore nascent ideas, parting with those that were not deemed viable.
h Iteration was a key element of IDEO’s design process. It referred to the process of successively creating new versions of an idea
and improving it with each repetition by incorporating the learning from previous attempts.
i For the Cineplanet project, the team wanted to cover more territory and interview a larger number of people during their month
abroad. Furthermore, the team preferred to limit the number of designers present during interviews so as not to overwhelm
interviewees. The necessity of a Spanish translator constrained the number of designers who could participate.
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The designers then created profiles of the customers to organize their needs and behaviors and figure
out what archetypes they might fall into. (See Exhibit 7 for the customer profile form used by the IDEO
team.) As the exploratory phase neared completion, the IDEO designers worked to understand the
experiences they had had in the field. The synthesis of raw data and insights into discrete and digestible
narratives was crucial to the next stage of the design process.
Concepting Phase: Ideation
In the “concepting” phase, designers used insights from the exploratory phase to generate
hypotheses about solutions that would meet the latent needs of customers. The goal of concepting was
to bring ideas to life visually so that people could respond to them. The designers also began
considering which ideas would be made tangible, and how. The phase served as another period of
divergence in IDEO’s design process, as the designers drew upon their field experiences to consider a
broad range of possible solutions. To aid in the process of concepting, designers sought frameworks
that distilled the behavioral patterns and themes they observed in the field. Once they created a
framework, they stress-tested it by considering it from the perspectives of multiple customers. j This
assisted their brainstorming and testing of a wide array of possible solutions. However, the process
was highly iterative, as designers moved between frameworks and brainstorming. (See Exhibit 8 for
IDEO’s brainstorming rules.)
Team members discussed emerging concepts vigorously. During this process, designers would
often reflect on user stories, frameworks, and behaviors to assess the alignment of potential solutions
with the insights that surfaced in the previous phase. Simultaneously, the business implications of
concepts and the technical considerations of their implementation were explored to ensure efficacy
from multiple angles. “At IDEO, we value strong ideas that are loosely held,” said Rodriguez. Team
members took ownership of their ideas, but they were also expected to be willing to abandon or refine
them if they were on the wrong track, learning as they went. Along the way, many concepts would be
reconceived multiple times, as the designers iteratively converged on a set of possible solutions that
could be tested during the prototyping phase.
For the Cineplanet engagement, after the exploratory phase in South America, the project team
moved into a space in the San Francisco office for concepting. Courtney Song, an IDEO designer with
a background in architecture and visualization, joined the team to help with the remaining phases of
the project. The team brainstormed ideas to address problems and pain points that had surfaced in the
field. One such example was how Cineplanet customers should pay in the movie theater. Several
concepts were offered by the team members. One involved a cashless, alternative payment method that
ranged from a conventional card to a customer wristband, which could operate in concert with a mobile
app. (See Exhibit 9 for an example of concept boards for the Cineplanet project.)
The team thoroughly debated and tested the merits of each concept. During weekly calls, the project
team shared collections of concepts with Cineplanet’s core team and solicited feedback that could be
incorporated into successive design iterations. Since the designers were thoughtful about how concepts
would integrate with each other, the suites of concepts presented changed shape from week to week.
However, they converged upon a common thread that surfaced early during the team’s exploration:
movies were social experiences that were meant to be shared with others. This insight eventually
evolved into the theme that “Cineplanet is for sharing.”
j Designers would regularly consider how an insight that arose from one customer interviewee would be perceived by others
they interviewed who exhibited different behaviors, or were in a different living situation or economic bracket. In other cases,
designers would follow up with customers they had met in the previous phase to ask them additional questions.
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The designers thought critically about how they might test each concept. “Throughout concept
development, we constantly keep in mind how we’re going to prototype what we come up with,” said
Paterson. “We’ll have three and a half, four weeks to then develop the concepts and how we are going
to prototype them.” Saturday, May 3, the date when the team was scheduled to present the live
prototype in an actual cinema with real customers, was rapidly approaching.
Prototyping Phase: Getting Tangible
Prototypes were manifestations of concepts that consumers could interact with directly, which
enabled IDEO designers to accumulate feedback on design ideas that had resonated with users during
the previous phases. In essence, they were means to test and refine ideas with greater fidelity. Tangible
prototypes were physical objects that could be touched and manipulated, such as a greeting kiosk or
seating array. However, prototypes could also be intangible. For example, an employee could be
trained in a role or script for a new type of client interaction, such as offering customers information
on products. Both kinds of prototypes were usually only refined to the point at which customers could
fully grasp the concepts being tested without being distracted by their roughness. For instance, a
seating arrangement prototype might be composed of plastic instead of more robust materials, because
it only had to last long enough for the designers to get live feedback on users’ interests, behaviors, and
interactions with it.
During field testing, designers would observe whether users engaged with the prototypes, if the
prototypes served their intended purposes, whether customers utilized them in unanticipated ways,
and whether unforeseen problems arose. In addition to direct observation, designers might ask
customers questions about their experiences or leave questionnaires, which customers could fill out of
their own volition. Throughout the process, the use and orientation of prototypes would be constantly
altered and manipulated by designers. For example, IDEO team members might rearrange the pylons,
ropes, and signage at the entrance of an amusement park every half hour to discover which layout
produced the fastest line. Designers would often “prototype on the fly,” rapidly mocking up and
iterating impromptu solutions triggered by real-time observations. Larger service projects (such as the
redesign of a cinema) necessitated that the team operate in stages around individual or groups of
prototypes, which were arrayed in separate stations within the venue. Designers typically spent one to
two hours (depending on the number and scope of the prototypes) observing and collecting feedback
from customers interacting with prototypes in a station. Then they would pack it away before moving
on to observe the next one.
Throughout this process, designers and client employees outside of the project team who were
assisting with the field test would constantly communicate in order to bring as many perspectives as
possible to bear on the performance of the prototypes. For example, a designer with a background in
business operations might have ideas on how to improve a prototype’s efficiency. Another designer
with a degree in behavioral psychology might see patterns in how a prototype affected group
dynamics. A client employee who was familiar with the normal behavior of a business’s customers
might be well placed to predict and note how a prototype might integrate with the existing operation.
Taken together, these different viewpoints would help the team pinpoint how to improve prototypes
through successive iterations as they drove toward a solution that could be implemented. (See Exhibit
10 for a “prototype download form,” used to capture data on a prototype’s performance.)
At the end of a day of field testing, the IDEO team members would organize a final meeting with
the client employees. They would urge everyone in the room to share stories of what they had
experienced during the day. Designers would encourage the participants to go beyond simply
describing facts in order to understand the context and particularities of customer and employee
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experiences. They would elicit and record the details and emotions that arose during customer
interactions with the prototypes. They would look for stories that recounted users’ frustrations,
excitement, surprise, joy, or indifference. They would utilize these insights to weave a narrative,
ascertain the effectiveness of the prototypes, and facilitate improvements and implementation. Upon
the phase’s completion, the designers synthesized their observations into suggestions for how the client
might improve its operation. The client organization then used IDEO’s concepts, insights, data, and
results to further test and refine the prototypes, before moving into implementation.
The Meeting
Maldonado greeted her colleagues and the IDEO team as she walked into the conference room. The
Cineplanet executives were excited to see which concepts the IDEO designers wanted to prototype. As
Maldonado sat next to Paterson, she wondered whether the Cineplanet team would understand the
magnitude of the change the company was about to undergo. Cineplanet could not simply implement
a few prototypes and continue conducting business as usual. Instead, the concepts constituted a new
system that would require deep organizational and cultural changes. If Cineplanet chose to adopt
them, it would have to shift from a company that emphasized and excelled at operations into a business
that focused much more on its customers’ needs and desires. That would entail changing not only its
cinema layouts, but also its training, hiring, IT, services, and products. The room eventually fell silent,
and Paterson began the presentation.
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Exhibit 1
IDEO’s Core Values
Be Optimistic
Take Ownership
Embrace Ambiguity
Talk Less, Do More
Learn from Failure
Make Others Successful
Adapted from “Little Book of IDEO,” IDEO website,
html#beoptimistic, accessed March 2014.
Exhibit 2
Map of Peru
“Peru,” CIA World Factbook website,, accessed February 2014.
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Exhibit 3
Annual GDP Growth in Selected Latin American Countries
Annual GDP
Growth %
Latin American and the
Adapted from “Country and Region Specific Forecasts and Data,” World Bank website,, accessed February 2014.
Exhibit 4
International Box-Office Growth (billions USD)
% Change 2012
vs. 2011
% Change 2012
vs. 2008
Europe, Middle East, and Africa
Asia Pacific
Latin America
Adapted from Motion Picture Association of America 2012 Annual Report, p. 5,, accessed March 2014.
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Exhibit 5
Cineplanet Prime Seating
“Vive la Experencia de Cineplanet Prime,” Cineplanet website,,
accessed September 2014.
Exhibit 6
“Sacrificial Concepts” from the Cineplanet Project
Casewriter photos.
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Exhibit 7
Customer Profile Form for the Cineplanet Project
The conversation made us realize that we should
Top need:
Favorite concept:
A few good quotes from the conversation:
A month from now, what are the 3 things we
should remember about this conversation?
Unusual or interesting behaviors we noticed:
Any initial thoughts/ sketches about a concept for
this particular user?
IDEO and Cineplanet project team.
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Exhibit 8
IDEO’s Brainstorming Rules
Defer judgment.
Encourage wild ideas.
Build on the ideas of others.
Stay focused on the topic.
One conversation at a time.
Be visual.
Go for quantity.
Exhibit 9
IDEO Concept Boards for the Cineplanet Project
Casewriter photos.
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IDEO: Human-Centered Service Design
Exhibit 10
Prototype Download Form for the Cineplanet Project
Download Form
To be completed after each prototype
1. Overall, how did customers react to the prototype?
2. What worked well?
3. What didn’t work well? What would you do differently next time?
4. What was the most common question you received?
5. What was most surprising to you?
6. What other things does this prototype make you want to test?
Other comments:
IDEO and Cineplanet project team.
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1 “Contact,” IDEO website,, accessed March 2014.
2 Teresa Amabile, Colin M. Fisher, and Julianna Pillemer, “IDEO’s Culture of Helping,” Harvard Business Review 92 (JanuaryFebruary 2014): 4.
3 Amabile et al., “IDEO’s Culture of Helping.”
4 Amabile et al., “IDEO’s Culture of Helping.”
5 Amabile et al., “IDEO’s Culture of Helping,” p. 7.
6 Alfonso Neri, “The Deep Dive,” ABC News Nightline, February 9, 1999.
7 “Peru,” CIA World Factbook website,,
accessed February 2014.
8 “Peru,” CIA World Factbook website.
9 “Peru Data,” World Bank website,, accessed February 2014.
10 “Peruvian Consumers in 2020: A Look into the Future,” Euromonitor, accessed February 2014.
11 Andres Schipani, “Peru Boom Spurs Growth of Middle Class,” Washington Post, January 9, 2013,, accessed February 2014.
12 “Peru Consumer Spending,” Trading Economics website,,
accessed February 2014.
13 Schipani, “Peru Boom Spurs Growth of Middle Class.”
14 Andres Schipani, “Peru’s Middle Class Prospers from Investment-Driven Growth,” Financial Times, November 28, 2013,, accessed February 2014.
15 “Peruvian Consumers in 2020: A Look into the Future.”
16 Schipani, “Peru Boom Spurs Growth of Middle Class.”
17 “Business Environment: Peru,” Euromonitor, accessed February 2014.
18 Abraham Taipe Ballena, “¿Por qué el 2015 Podría ser el Año del Boom del Cine Comercial en el Perú?” El Comercio Portafolio,
December 23, 2012,,
accessed February 2014.
19 “Los Peruanos van más al Cine: el País Facturó más de 125 Millones de Dólares en 2012,” Portada, February 26, 2013,, accessed February 2014.
20 Taipe Ballena, “¿Por qué el 2015 Podría ser el Año del Boom del Cine Comercial en el Perú?”
21 Motion Picture Association of America 2012 Annual Report, p. 5,
8012-58fca3abdf1b.pdf, accessed March 2014.
22 Taipe Ballena, “¿Por qué el 2015 Podría ser el Año del Boom del Cine Comercial en el Perú?”
23 Taipe Ballena, “¿Por qué el 2015 Podría ser el Año del Boom del Cine Comercial en el Perú?”
24 “Los Peruanos van más al Cine: el País Facturó más de 125 Millones de Dólares en 2012.”
25 Taipe Ballena, “¿Por qué el 2015 Podría ser el Año del Boom del Cine Comercial en el Perú?”
26 “Nuestra Empresa,” Cineplanet website,, accessed February 2014.
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27 “Nuestra Empresa.”
28 “Nuestra Empresa.”
29 “Nuestra Empresa.”
30 “Nuestra Empresa.”
31 “Nuestra Empresa.”
32 “Cineplanet San Borja,” Cineplanet website,, accessed
February 2014.
33 “Cineplanet Anunció Apertura de las Primeras Salas Prime en el Perú,” Agenda Empresarial, February 5, 2013,, accessed February 2014.
34 Tim Brown and Barry Katz, Change By Design: How Design Thinking Transforms Organizations and Inspires Innovation (New
York: Harper Business, 2009).
35 Tom Kelley and David Kelley, “Why Designers Need Empathy,” Slate, November 8, 2013,
d_kelley.html, accessed March 2014.
36 Kelley and Kelley, “Why Designers Need Empathy.”
37 Kelley and Kelley, “Why Designers Need Empathy.”
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REV: APRIL 27, 2009
Late one afternoon in January 2007, Reed Hastings had just concluded a meeting with his senior
management team in the King Kong board room at Netflix’s corporate headquarters in Los Gatos,
California. Hastings, the founder and CEO of the company, which pioneered online DVD rentals, was
preparing to unveil Netflix’s highly anticipated entrance into the online video market. Many industry
observers believed that the ability of customers to order movies through their computers for instant
viewing, commonly referred to as video-on-demand (VOD), would quickly impact the large user
base for Netflix’s core business.
Hastings looked across the third floor of the office building and the conference rooms named for
some of his staff’s favorite films. A love of movies clearly ran deep among Netflix employees, and he
was confident that one way or another, his team would maintain the company’s position as a leader
in the home video market. But, as he reflected upon the years of investment and discussions
surrounding the new feature that Netflix would be offering its customers, he could not help but think
of the merits of the paths not chosen.
As the management team filed out of the board room around him, Hastings returned his thoughts
to the present. While he believed that the DVD rental market would remain healthy for years into the
future, he knew that this announcement would impact not just the market’s perception of his
company but its ability to sustain its position as a giant in the media industry. With new resolve,
Hastings returned to his desk to review his forthcoming announcement one more time.
Company Background
Netflix, an online subscription-based DVD rental service, was first conceived by Hastings after he
discovered an overdue rental copy of Apollo 13 in his closet. After paying the $40 late fee, Hastings, a
successful entrepreneur who had already founded and sold a software business, began to consider
alternative ways to provide a home movie service that would better satisfy customers. The business
that emerged from Hastings’ frustration was a rental company that used the U.S. Postal Service to
deliver DVDs to its subscribers. By year-end 2006, subscribers could use Netflix’s website to choose
from among over 70,000 different titles held on over 55 million DVDs. Through its 44 distribution
centers across the country, Netflix could deliver to more than 90% of its 6.6 million subscribers within
a single business day. Netflix’s flagship subscription plan offered unlimited monthly rentals,
Senior Lecturers Willy Shih and Stephen Kaufman and David Spinola (MBA 2007) prepared this case. HBS cases are developed solely as the basis
for class discussion. Certain details have been disguised. Cases are not intended to serve as endorsements, sources of primary data, or
illustrations of effective or ineffective management.
Copyright © 2007, 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
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allowing customers to hold up to three movies in their possession at any one time for a monthly fee
of $17.99. For the year ending December 31, 2006, Netflix had achieved revenues of nearly $1 billion,
generating free cash flow of $64 million. (See Exhibit 1 for Netflix financials.)
The History of Home Video Rental
When Netflix was founded in 1997, the home video market was a fragmented industry largely
populated with “mom-and-pop” retail outlets. Customers rented movies, primarily on VHS cassette,
from a retail location for a specified time period, usually between two days and one week, and paid a
fee of $3 to $4 for each movie rented. The market leader was rental giant Blockbuster Inc.
Blockbuster’s success was based on the insight that movie rentals were largely impulse decisions. To
customers deciding at the last minute that a given night was “movie night,” the ability to quickly
obtain the newest release was a priority. Statistics showed that new releases represented over 70% of
total rentals.
Much of Blockbuster’s growth strategy revolved around opening new locations, both to expand
geographic coverage and to increase penetration and share in existing markets. In 2006, Blockbuster
had 5,194 U.S. locations, of which 4,255 were company owned, with the balance franchised. Locations
were chosen based upon a careful review of local data, including customer concentration and
proximity to competition, focusing on highly visible stores in high-traffic areas. Management
commonly proclaimed that “70% of the U.S. population lives within a 10 minute drive of a
Blockbuster,”1 highlighting how its retail network offered unmatched convenience to impulse movie
renters. Stores were staffed primarily with part-time employees, averaging 10 staff members per store
plus one manager. Occupancy and payroll represented a significant percentage of total costs.
The nationwide network of Blockbuster outlets carried a similar selection of movies, offering
about 2,500 different titles per store. Shelf space in each store was mostly dedicated to hit movies,
with the newest releases receiving the most prominent positioning. Locations acquired multiple
copies of popular and high-profile movies, at a cost of about $18 per film or DVD, in anticipation of
high customer demand at the release date. Blockbuster’s financial success depended on maximizing
the days that any individual movie was out for rent. Stores were reluctant to stock large numbers of
lesser-known and independent films, since the demand for these titles was inconsistent. With a
relatively narrow selection of mostly familiar movies, customers could generally select a title with a
limited amount of advice from the sales staff. In time, each Blockbuster retail outlet would begin to
sell previewed copies of its new releases at a discount, generating incremental return on its
investment and clearing shelf space for the next wave of new movies.
Traditionally, any movies not returned to the same location from which they were rented by the
end of the specified rental period were subject to extended viewing fees, or “late fees.” In 2004, these
fees represented over $600 million for Blockbuster, or about 10% of revenues. In addition to the
revenue benefit, late fees served a critical asset utilization function for Blockbuster. They encouraged
a timely return of each rented film, allowing it to be rented by another customer. In their absence,
delayed returns could lead to increased levels of stockouts, costing Blockbuster incremental rental
opportunities as well as reducing customer satisfaction.
When Netflix went public in 2002, Blockbuster was enjoying record levels of revenue and
profitability amidst a period of industry expansion. According to research reports cited in
1 Pete Barlas, “Blockbuster Borrows from Netflix’ Playbook, but Stays Offline Monthly DVD Rental Program Subscribers,”
Investor’s Business Daily, August 12, 2002.
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Blockbuster’s 2002 public filings, DVD players were present in 37% of U.S. television households, up
from 24% the prior year. The increase in the popularity of the DVD format had helped to grow
industry movie rental revenues from $8.5 billion to $8.7 billion. The year 2002 also represented
Blockbuster’s fifth consecutive year of same-store sales growth, and the Blockbuster brand achieved
nearly 100% recognition with active movie renters.
Netflix History
Netflix was founded in 1997 during the emergent days of Internet retailing, when online competitors
to traditional “brick-and-mortar” retail stores were gaining prominence. Rather than attempt to attract
customers to a retail location, Netflix offered home delivery of DVDs through the mail.
When its original website was launched in early 1998, most available movies for rent in video
stores used the VHS cassette format. In contrast, Netflix concentrated efforts on early-technology
adopters who had recently purchased DVD players. Its marketing strategy was to develop crosspromotional programs with the manufacturers and sellers of DVD players, providing a source of
content for customers. Hastings elaborated on Netflix’s goals in its early days: “We were targeting
people who just bought DVD players. At the time our goal was just to get our coupon in the box. We
didn’t have too much competition. The market was underserved, and stores didn’t carry a wide
selection of DVDs at the time.”
Netflix’s website included a search engine that allowed its customers to easily sort through its
selections by title, actor, director, and genre. Using this search engine, customers built a list of
movies, called a queue, to be received from Netflix. Netflix sent movies to its subscribers based on the
order of titles on the list, with subscribers receiving a new movie from their queue upon the return of
a currently outstanding film.
Rather than replicate the model of video rental chains and lease retail locations, Netflix depended
on the U.S. Postal Service to deliver DVDs to its subscribers. DVDs are small and light, enabling
inexpensive delivery and easy receipt by nearly every potential U.S. customer. Hastings related how
he determined that the delivery performance offered by the USPS was satisfactory: “I went out,
bought a whole bunch of CDs and started mailing them to myself to see how quickly they would
come back and what condition they would be in. I waited for two days—and they all arrived in
perfect condition. All the pieces started to fall into place after that.”2
Netflix initially used a pricing model similar to that offered by traditional video stores. Customers
chose their film using the company’s website, were charged $4 per movie rented plus a $2 shipping
and handling charge, and were expected to return films by a specific due date or be charged extended
rental fees.
Hastings and his team used the models of the most successful Internet retailers of the time
to identify characteristics they thought might appeal to customers: (1) value, (2) convenience, and
(3) selection. Hastings referred to value customers as “eBay customers,” those to whom Internet
shopping was an opportunity to target a great deal. Convenience and selection, in contrast, attracted
the “Amazon customers,” those who used online shopping as an alternative to traveling to retail
outlets and choosing among limited in-stock offerings.
2 Aline Van Duyn, “DVD Rentals pass their screen test,” Financial Times, October 4, 2005, p. 15.
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Netflix’s early strategy extended beyond DVD rentals. While marketing a 2000 IPO, management
described the company as the ultimate online destination for movie enthusiasts. Along with the
DVD-by-mail service, Netflix was offering its recommendation system to any user, whether they
were a subscriber or not, creating a Web portal rather than simply a subscription service. Hastings
described this early strategy: “Our 2000 prospectus was spun towards things that were hot . . . it
reflected a tension in our strategy. We would offer price comparisons, theater tickets. That strategic
tension didn’t resolve itself until the bubble crashed. That summer we realized we weren’t going to
make it unless we did it on rentals. . . . It was a cash-induced strategic focusing.”
This focus was forced in part by the rapid adoption rate of DVD players among U.S. households,
which became the fastest technology adoption in history. U.S. household penetration, at 5% in 1999,
leapt to 13% by 2000, a level that attracted the attention of other channels. DVDs started being sold at
large retailers such as Best Buy and Wal-Mart and began replacing VHS cassettes on the shelves of
traditional video rental outlets. As this transition occurred, the convenience advantage that Netflix
offered to DVD viewers suffered in comparison to the video stores. The company shelved its plans
for an IPO and struggled through a large layoff as it began to adjust its business model in an effort to
reach profitability. Chief among Hastings’ concerns were the general customer dissatisfaction with
Netflix’s value proposition and the high cost of building a DVD library to support the growing
subscriber base.
Feedback from early customers revealed a frustration with Netflix charging rental prices in line
with competing retail locations while providing a slower delivery service. Neil Hunt, the company’s
chief product officer, described Netflix’s motivation for shifting to its popular no-late-fee subscription
model in 1999:
Pricing had been a discussion point for a long time. Our original model didn’t work—we
needed to overcome the shipping delay. It just wasn’t a high enough value product to
overcome the delivery waiting time. We spent a lot of money to market to and attract new
customers, and they wouldn’t be repeat renters. We were spending $100 to $200 to bring in a
customer, and they would make one $4 rental. There was no residual value.
Hastings believed that moving to a prepaid subscription service could provide better value to
Netflix’s customers and also turn their longer delivery times into an advantage. The first iteration of
the subscription model allowed customers to have four movies in their possession at once and receive
up to four new films each month. Hunt explained the effectiveness of the new pricing model: “We
turned the disadvantage of delivery time into having a movie at home all the time. The value to
Netflix of having our movies in the customers’ homes at all times was our key insight.”
Very soon afterwards, Netflix adjusted its pricing system again, offering unlimited rentals for the
first time. Subscribers could now keep three movies at a time and exchange them as frequently as
they liked. Hunt explained the reasons behind this quick adjustment in strategy:
We made the observation that this change would dramatically simplify the program and
make it easier to explain the service. It also allowed us to market a more compelling value
proposition. The term “unlimited” is great marketing. . . . We had some vigorous debates
about this, but in the end it was a leap of faith. The dot-com boom was still in full growth
mode, and everyone around us was growing fast. It wasn’t the time to do months of testing
and analysis. We had to make some bets and not worry about getting it wrong. At that time,
the ones who got it right would succeed, and the ones who got it wrong wouldn’t be around.
With this change in pricing, the company added a new group of fans for whom movie rentals
were a regular part of their daily entertainment. Many of these high-volume customers were turned
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off by the high cost of paying for each movie being rented yet still chose to rent from video stores
because of limited alternatives. Others were dissatisfied with how large late fees inhibited their
ability to view movies at the times most convenient to them. If “movie night” was not an event but an
ordinary form of entertainment, the option to hold movies beyond a two-day rental period was
important. For these frequent viewers, Netflix’s “all you can eat” model was an attractive alternative
to the traditional per-day fee structure.
Subscription costs, the expense of acquiring movies for rent, were still a major burden. Hunt
explained the impact that customer demand had on managing the cost of building their film library:
We began struggling with a new problem. Half of the DVDs we were shipping out were
brand new. We realized that we had to fix that. Top new releases received a lot of external
marketing support and as a result had strong customer awareness and demand. Of course,
those movies were the most expensive to acquire. . . . We couldn’t just blindly promote movies
that already had external demand generation. We needed to stimulate demand on the older
and less known movies and things already in our catalog. By marketing from the rest of the
“tail” we could drive the average price down of building our catalog.
Netflix initially relied on traditional merchandising to complement its search engine and connect
subscribers to the company’s library of titles. A small number of employees highlighted different
films on the website’s homepage each week, effectively providing the same recommendations to all
subscribers. Hunt explained the consequence of this marketing technique:
We started with a system that relied heavily on editorial content, but we realized that an
editor could only write so many Web pages. Five movies would be highlighted on the website,
then everything that was promoted was instantly rented out. That changed to a different five
movies each day of the week, and they were all still instantly rented out. We tried to improve
the system to ensure that subscribers weren’t referred to movies they had already rented.
Eventually, we realized that the promotional value of writing the editorial blurbs was zero.
Realizing the inadequacy of the traditional merchandising system, Netflix engineers developed a
proprietary recommendation system to better balance customer demand. Upon signing into a new
account for the first time, customers took a short survey to identify their favorite movie genres, as
well as rate-specific movie titles from one to five. Netflix’s proprietary algorithm then relied upon
these survey results and the respective ratings of millions of similar customers to recommend films to
its subscribers. The recommendations page not only included a list of titles with a ranking of how
closely they matched the customer’s preferences but also a synopsis of the film, a description of why
the film was being recommended, and a collection of reviews from other subscribers. As customers
rated each movie they saw, Netflix’s software refined its understanding of that customer’s preference
and more accurately recommended movies that would appeal to him or her.
Key to the success of Netflix’s inventory management was a filter placed between the output of
the recommendation system and the results shown to the subscriber, screening for those movies that
were out of stock. The intent was to avoid frustrating a customer by recommending a title that was
not immediately available, but a side benefit was that new releases were rarely on recommendation
lists, as they were the most likely films to be in short supply. The system increased the utilization of
Netflix’s library of films by satisfying customers with movies already acquired and in stock, rather
than requiring the purchase of more copies of newer films. Compared to traditional video rental
outlets, where new releases would make up over 70% of total rentals, new releases represented less
than 30% of Netflix’s total rentals in 2006. Hunt explained the power of Netflix’s recommendations:
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The recommendation system will pick the best movie for a customer, period. But it has to
be something that can ship overnight. High-demand new releases are less visible because they
are less frequently in stock. However, the customer benefits from this system. We have
recognized improved customer satisfaction by eliminating the “bait and switch” perception.
Most revealing about the value of the recommendations is that ratings are three-fourths of a
star higher on recommended movies compared to new releases.
While the investment in software engineering was modest, this shift marked a cultural battle
within the company with those who remained loyal to the traditional merchandising system.
Hastings described his insistence on this change by highlighting another benefit: “A personalized
experience is the benefit of the Internet. If you can otherwise do it offline, people won’t pay for it
online. If our Internet offering was going to be better than stores, we had to find something stores
couldn’t do well.”
Movies are a taste-based product, for which many titles are consumed only once. As such,
consumers must make a series of purchases without knowing for sure if they will like the product.
Netflix’s website resonated with subscribers because they so frequently enjoyed the less well-known
films recommended to them that they might not otherwise have seen. This software established a
relationship with customers that was not matched by part-time employees at a retail video store, nor
easily replaceable upon switching to a competitor’s service. Netflix’s size and growth rate also
generated a positive “network effect” from its large customer-generated rating system. Because it had
the largest collection of movie ratings in the world, customers recognized that they were more likely
to have their tastes and preferences accurately reflected in recommendations from Netflix’s site than
any other offered by a competitor.
Even with the increased customer awareness of lower-profile films that Netflix’s recommendation
system generated, building the company’s movie library still represented a major use of cash. As a
small player in the video rental market, Netflix had no direct relationships with the major studios. It
filled its film library through relationships with a small number of movie distributors, at prices that
reflected minimal discounts. Up-front costs forced Netflix to choose carefully when stocking new
films and often resulted in fewer than the desired number of copies of a title being acquired. As a
result, one of the major sources of customer dissatisfaction was the inability to rent new releases in a
timely manner. Netflix took steps to address this by hiring Ted Sarandos as chief content officer to
manage content acquisition. Sarandos, who joined Netflix in May 2000 from Video City, a major U.S.
video rental chain, led Netflix’s transition to revenue-sharing agreements with the major studios:
We were handicapped with vendors when I first arrived because other Internet vendors at
the time had not been successful. As a pure rental business that was 100% subscription based
and 100% Internet based, we were reinventing the wheel on three dimensions for the studios.
However, it is very much a relationship business working with the studios, and I had worked
with those people all of my career, so I managed to bring my relationships with me from my
prior company. Within a year, Netflix had negotiated direct revenue-sharing agreements with
nearly all the major studios.
Rather than pay an up-front price of $20 per DVD, the studios would reduce their unit up-front
price in return for a fee based on the title’s total number of rentals for a given period of time. Hastings
described this transition with the company’s suppliers: “We spent more money, not less, with the
studios but got bigger customer satisfaction. It was like paying 20% more and getting two times the
number of copies.”
The benefit of the new relationships with the studios extended beyond lowering the acquisition
costs for high-demand releases. Hastings recognized early on the number of customers who were
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frustrated with the poor selection offered at many video stores, where shelf space is focused on hit
movies and new releases. Customers interested in exploring a much broader range of movie titles
were left unsatisfied by their options. Sarandos explained: “The thing that Reed and I connected on
before I even joined Netflix was the promise of a business model that promoted lesser-known
movies. Films outside of the top 20 are not distributed widely. If you didn’t see a movie within six
months of when it was in the theaters, it often disappeared forever.”
The use of a national inventory allowed Netflix to satisfy the diverse demands of movie watchers,
serving the same number of customers as a local network of Blockbuster retail locations with far
fewer copies of a given movie title. Sarandos explained the difference in economics:
Half the equation of packaged media is allocation—getting the right amount of product in
the right locations. This was more of a challenge for products that did not enjoy broad
promotion. The trade radius of a single video store was so small that even a single copy of a
lesser-known film had lousy economics. By using a national inventory, we avoid that issue. We
never have overstocks on one side of town with understocks on the other side. Using the
subscribers’ queues provides a great deal of data. By looking into the demand in the near
future, we can replicate near-perfect inventory. Overall, we can satisfy demand in an area with
about one-third to one-fifth of the inventory needed by a retail chain.
In the summer of 2001, Netflix operated out of a single distribution center located in Sunnyvale,
California. While several years of operations had allowed for improvements in this center, the
majority of the country was still not able to enjoy next-day delivery of their rented movies. These
extended delivery times were a barrier for Netflix in attracting and retaining customers in those
regions. Hastings explained: “Post Office variability was long on cross-country mail. . . . It essentially
meant one-week delivery times. So in the summer of 2001, we realized that regions with overnight
delivery were being disproportionately successful. We tested the theory by upgrading Sacramento.
The numbers popped quickly.”
Netflix’s Sunnyvale distribution center could serve the San Francisco Bay Area with overnight
delivery. But while outbound mail from Sunnyvale could reach Sacramento overnight, returns often
took several days. Netflix tested Sacramento by arranging with the Postal Service to intercept returns
at a Sacramento mail-sort center and then truck them to Sunnyvale. This would shorten the
turnaround dramatically. Added Hastings, “As we added centers in Boston, New York, and D.C.,
they started performing like the Bay Area.”
Armed with this evidence of success, Netflix quickly opened more distribution centers across the
country, and subscriber numbers continued to respond to the improved delivery service. The
company promised 500,000 subscribers to its investors in its 2002 prospectus and delivered 700,000 at
the time of the May 2002 IPO. These changes in Netflix’s pricing and cost structure allowed the
company to reach profitability for the first time in the quarter ending June 2003. After establishing the
viability of this business model, Netflix continued to build its subscriber base and upgrade the
customer experience by opening new centers (see Exhibit 2 for Netflix’s operating statistics). The
centers themselves were inexpensive investments; it cost about $60,000 to convert an existing
warehouse to Netflix’s needs. The company continually added centers to improve upon its
nationwide coverage and reduce delivery time to its customers. With the number reaching 44 by
early 2007, over 90% of subscribers could be reached within one delivery day. The improved ability
for Netflix to provide next-day delivery to more regions of the country allowed it to compete more
successfully with retail video stores for new customers drawn by all three of the targeted
characteristics of convenience, value, and selection.
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Netflix considered delivery time to be the key measure of customer satisfaction and continually
sought to improve the operations within each of its existing distribution centers. Much of the process
of opening return envelopes and filling outgoing mailers with DVDs was still performed manually.
However, with careful hiring practices and thorough time and motion studies, Netflix’s employees
could open and restuff an average of 800 DVDs per hour, allowing the entire distribution center
network to ship over 1.6 million DVDs per day. (See Exhibit 3 for photos of the distribution center
Netflix’s relationship with the USPS grew. While the USPS was facing a general decline in firstclass mail, Netflix represented its fastest-growing first-class customer. Along with receiving the
standard discount for presorting of its outbound envelopes by zip code, Netflix worked with the
USPS to reduce the time it took to receive a movie return. Rather than deliver returns to the
distribution center of origin, the USPS brought the easily recognizable red Netflix envelopes to the
closest Netflix distribution center. And recently, Netflix began using multiple “truck routes,”
supporting each distribution center to expedite returns. This shortened turnaround time for new
movies and improved the overall customer experience.
As the company added subscribers, content acquisition continued to grow in importance for
Netflix. Sarandos explained:
For a technology company like Netflix, we are the group that is most dependent on art.
What we do is probably 70% science, 30% art. Our buying staff has to have their finger on the
pulse of the market to make their decisions. A high box-office performer won’t necessarily be a
high video performer, and vice versa. The box office is an indicator, as a proxy for awareness,
but not for demand. . . . If rental demand for a title is lower than we forecast, it is a tax on the
overall economics of Netflix’s model. Even with the benefit of profit sharing, it is a margin
eroder. If we underforecast demand, the problem is correctable, but it takes time.
As Netflix built its film library, it grew in importance as a distribution channel for many small and
independent film studios. For lower-profile and independent films that did not enjoy the advertising
support of major releases, generating customer awareness was a major priority. As Netflix became
known as the best source for lesser-known movies, the studios began to look upon this partnership
with increasing favor. Sarandos explained:
It wasn’t all about fulfilling demand for mainstream videos. We were also providing the
studios large markets for their films that they were having trouble reaching. And for the
independent films, Netflix can be the dominant channel, representing between 60% and 75% of
the earnings for some films. At Netflix, a lesser-known film can really succeed on its merits.
Hotel Rwanda, the Don Cheadle film about the genocide in Rwanda, is an excellent example.
It enjoyed some box-office sales, but generally it was a difficult topic and a difficult film to
market, with a low viewership. At Netflix, however, it is our fourth-most-rented film. The rest
of the top 10 are movies you would expect, but there is this wonderful independent film right
there at number four. More people have seen it at Netflix than at the box office.
In 2006, Netflix evolved from its de facto marketing efforts and began acquiring the distribution
rights to certain independent films through its Red Envelope Entertainment subsidiary. Sarandos,
who led this initiative, explained the shift in strategy:
Red Envelope Entertainment is 90% about content acquisition. While we do distribute films
in other channels, including retail and other video stores, we did this to bring more excellent
movies to DVD. Of the 100 films that are featured at a festival such as Sundance, only 10 will
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make it to DVD. We are looking through the other 90 films for top-tier content to bring to our
By helping to bring high-potential films to market, Netflix hoped to enhance its reputation as the
highest-quality source of independent films, a designation that contributed to its popularity.
As it was for many subscription-based services, customer churn was a critical issue for Netflix. In
an average month in 2006, 3.6% of customers would cancel their subscription. In 2002, that churn rate
was even higher, at 6.3%. Since customer acquisition was a major expense, retaining existing
customers and reclaiming old ones who had previously unsubscribed was a key opportunity.
Originally, customers wishing to unsubscribe had to deal with a salesperson by phone, who
attempted to convince the customer to retain their account. In 2002, the company changed its
approach completely. Customers could unsubscribe online from Netflix as easily as they had been
able to join. The only request was that they complete a brief survey explaining why they left.
Hastings believed that it was more fruitful to encourage departing customers to return later on than
attempt to coerce unwilling customers to stay: “We were on the AOL style of it being really hard to
cancel our service. We realized, ‘This is stupid. It’s a false savings.’ We turned it off, enabling the
customer to unsubscribe on the website. We had a 30-day burst of churn, but we are convinced that it
led to return visitors.”
Instead of making Netflix a difficult service to leave, Hastings wanted to make it a service that
former customers would return to. Customers appreciated the personalized aspect of Netflix’s
service, a dimension that continued to improve. The proprietary recommendation system grew more
accurate in predicting a user’s taste as the number of films rated by a subscriber increased. Hastings
also emphasized the role of the customer’s queue as a major retention tool: “Our explicit strategy is to
invest in things that are strategically relevant to customer satisfaction potential. The key invention
behind our subscription model is the queue. Our average queue length is 50 movies. It turned out to
be an amazing invention. It’s our biggest switching cost.”
Just as importantly, a customer’s profile was maintained if they left Netflix. If the customer were
to return, everything was already in place, as if they had never left. Hastings found that growing the
business in the face of a high churn rate was easier if many lost customers eventually returned.
Blockbuster Responds
Early public statements by Blockbuster dismissed the notion that its customers would benefit from
an online rental business. In May 2002, a spokesperson addressed the online rental market:
“Obviously, we pay attention to any way people are getting home entertainment. We always look at
all those things. We have not seen a business model that’s financially viable long-term in this arena.
Online rental services are ‘serving a niche market.’”3
Three months later, clarifying that Blockbuster did not intend to launch an online business to
compete with Netflix, a spokesperson announced, “We don’t believe there is enough of a demand for
mail order—it’s not a sustainable business model.”4 Furthermore, the 2002 annual report made only a
cursory mention of the threat posed by online rental websites, with no mention at all in the “Risks”
3 Brian McClimans, “Frustration leads to new Internet, mail DVD service,” Associated Press Newswires, May 18, 2002.
4 Pete Barlas, “Blockbuster Borrows from Netflix’ Playbook, but Stays Offline Monthly DVD Rental Program Subscribers,”
Investor’s Business Daily, August 12, 2002.
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section. Not until 2003 did Blockbuster’s management publicly discuss Netflix by name as a threat to
their core business model.
Blockbuster did not formally respond to Netflix until the introduction of Blockbuster Online in
2004. The offering first appeared in the company’s disclosures in 2003, which included a tersely
worded intent to launch an online subscription service during 2004. This service, closely matching
Netflix’s business model, offered subscribers a far greater selection of movies than was available in
stores. When Blockbuster finally did enter the marketplace, it did so with what Hastings described as
a “land grab” mentality, undercutting Netflix’s pricing in an aggressive effort to recover lost market
share. Blockbuster also tried to improve the performance of its service and distinguish itself from
Netflix by integrating its online offering with its traditional store-based business. By using crosspromotions, giving in-store rental coupons to online customers, and stocking online rental requests
out of its store inventory, Blockbuster attempted to find ways to productively utilize its existing
resources and improve performance for its customers. While by the end of 2006 Blockbuster Online
had grown to 2.2 million members, the 2006 annual report reported that Blockbuster Online still
required meaningful advertising support and continued to suffer from “significant” operating losses.
In the words of Hastings in 2005: “We’re just thankful Blockbuster didn’t enter four years ago.”5
Blockbuster also unveiled its “no late fees” program, effective at all of its stores on January 1, 2005.
Blockbuster felt that its competitors, most importantly Netflix, were differentiating their business
offering from Blockbuster’s due to the absence of late fees in their service offerings. This change in
business strategy was not without a cost. In addition to the $60 million of marketing and
implementation costs of the program, Blockbuster chose to forgo about $600 million of revenue by
eliminating late fees. While early signs suggested this program resulted in increased traffic and rental
volumes, it did not offset the loss of revenue as base movie rental revenue grew only 5%.
During Netflix’s rise, industry observers anointed video-on-demand (VOD) as the “next big
thing” in home video. VOD was viewed as the marriage of pay-per-view programming combined
with Internet downloading of entertainment, including movies and TV shows. The expectation was
that viewers would search through a vast library of movies online and then watch a film on their
normal TV set in a full-screen, DVD-quality format. The increasing popularity of content delivery
methods such as high-definition pay-per-view and streaming Internet video, as well as the
participation of some significant well-funded players in the media industry, suggested that a VOD
service fully integrating personal computers and television was not a question of “if” but “when.”
Online Video Alternatives
Netflix had been following the development of VOD since the company’s inception, and Hastings
sorted the available forms of Internet video into three groups. The first was advertising-supported
video. Comparable to standard network television, newspapers, and magazines, this would include
content that would be interrupted by regular advertising. Due to the gap between potential
advertising revenue and content acquisition costs, this channel would have difficulty supporting
new-release feature-length films. More common content was expected to be user-generated video,
television-style programming, and older films. Online participants in this space in early 2007
5 Gary Rivlin, “Does the Kid Stay in the Picture?” The New York Times, February 22, 2005.
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included YouTube and various network websites that contained streaming video (such as
The second channel would offer digital file ownership. This approach was similar to purchasing
the latest bestseller at a bookstore or a DVD from a traditional retailer and would focus on featurelength films. Sites would let customers permanently download a film to a limited number of devices,
similar to the purchase of music files on popular sites such as Apple’s iTunes. Revenue would not be
generated through advertising but through the actual sale of content, at prices comparable to the
retail price of DVDs.
The final channel was the online video rental and pay TV. This channel was characterized by
limited rights and finite durati…
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