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Netflix: The Public Relations Box Office Flop Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Netflix: The Public Relations Box Office Flop case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Netflix: The Public Relations Box Office Flop case study is a Harvard Business School (HBR) case study written by Jana Seijts, Paul Bigus. The Netflix: The Public Relations Box Office Flop (referred as “Netflix Subscribers” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Communication, Customers, Leadership, Organizational culture, Pricing, Strategy.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment




Case Description of Netflix: The Public Relations Box Office Flop Case Study


On the morning of September 19, 2011, the chief executive officer (CEO) of the online movie provider Netflix Incorporated (Netflix) became witness to growing public discontent and media criticism. The previous evening the CEO had announced on the company blog that Netflix would be splitting into two separate entities. With the proposed change, the Netflix DVD-by-mail service would be spun-out and renamed Qwikster. The move would leave the Netflix brand to focus on offering online streamed entertainment. This was not the first time Netflix had caused large scale consumer frustration, as a few months earlier in July 2011, the company had announced it would be increasing rates as much as 60 per cent. The result was a loss of over one million Netflix subscribers by September 2011, representing the first time the company had ever lost subscribers from one quarter to the next. Although the split into two separate entities could be seen as a good business strategy, Netflix did not follow through with a well-developed communication plan. Moving forward, both Netflix and Qwikster had become symbolic of a bad two-headed monster movie, with Netflix management in desperate need to develop better communications with disgruntled consumers, or risk losing additional subscribers and lucrative profits to a number of growing competitors.


Case Authors : Jana Seijts, Paul Bigus

Topic : Leadership & Managing People

Related Areas : Communication, Customers, Leadership, Organizational culture, Pricing, Strategy




Calculating Net Present Value (NPV) at 6% for Netflix: The Public Relations Box Office Flop Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10001811) -10001811 - -
Year 1 3467011 -6534800 3467011 0.9434 3270765
Year 2 3963049 -2571751 7430060 0.89 3527100
Year 3 3971256 1399505 11401316 0.8396 3334343
Year 4 3231423 4630928 14632739 0.7921 2559590
TOTAL 14632739 12691797


The Net Present Value at 6% discount rate is 2689986

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Internal Rate of Return
2. Net Present Value
3. Payback Period
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Netflix Subscribers have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Netflix Subscribers shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.




Formula and Steps to Calculate Net Present Value (NPV) of Netflix: The Public Relations Box Office Flop

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Leadership & Managing People Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Netflix Subscribers often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Netflix Subscribers needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10001811) -10001811 - -
Year 1 3467011 -6534800 3467011 0.8696 3014792
Year 2 3963049 -2571751 7430060 0.7561 2996634
Year 3 3971256 1399505 11401316 0.6575 2611165
Year 4 3231423 4630928 14632739 0.5718 1847577
TOTAL 10470168


The Net NPV after 4 years is 468357

(10470168 - 10001811 )






Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10001811) -10001811 - -
Year 1 3467011 -6534800 3467011 0.8333 2889176
Year 2 3963049 -2571751 7430060 0.6944 2752117
Year 3 3971256 1399505 11401316 0.5787 2298181
Year 4 3231423 4630928 14632739 0.4823 1558364
TOTAL 9497837


The Net NPV after 4 years is -503974

At 20% discount rate the NPV is negative (9497837 - 10001811 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Netflix Subscribers to discount cash flow at lower discount rates such as 15%.



Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Netflix Subscribers has a NPV value higher than Zero then finance managers at Netflix Subscribers can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Netflix Subscribers, then the stock price of the Netflix Subscribers should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Netflix Subscribers should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.




References & Further Readings

Jana Seijts, Paul Bigus (2018), "Netflix: The Public Relations Box Office Flop Harvard Business Review Case Study. Published by HBR Publications.