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The end of Netflix?

Netflix stock plunges as Starz ends contract talks…

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Everyone’s heard of Netflix… everyone’s watched a movie or gone to a friend’s place to watch a movie sent from Netflix. It was a big hit several years ago when you could pay a simple fee every month and then receive whichever movie that had just been released or had been released for a while to DVD in the mail and get as many movies as you wanted, one after another, as long as you remembered to mail back in the previous movie. Netflix got even bigger when technology advanced and movies could be streamed online. No longer did customers have to wait until the snail mail would finally reach their mailbox. Now, they could simply use their Internet and find the movie that they wanted to watch and stream it right then and there at their leisure.

No wonder Netflix became such a big hit so quickly

However, with people now turning to the computer to constantly stream movies or TV shows, Starz, Netflix’s main partner in getting these movies has decided to end talks of renewing their contract with Netflix after the present 4 year contract ends due mainly because of financial reasons.

So how exactly does this article relate to what students at Cornell are learning in INFO 2040, Networks?

Well, let’s think of this using game theory… What gains does Starz have and what gains does Netflix have now? What does the payoff matrix look like? Well of course there are financial incentives, which is what started the contract between these two. However, now, take a look at the present and let’s see how game theory can be applied to this situation.

In the past, Starz earned money with Netflix and Netflix saved money by using Starz’s streaming content licenses in order to stream movies to their customers. However, with prices increasing, this causes the demand for streaming movies to skyrocket (due to the convenience), Starz could earn more money by going with other providers instead of renewing the contract with Netflix. So what situations are there?

The two options of Starz are that they could ask and receive more money from another company or renew the contract with Netflix (possibly asking for some more money, but not nearly as much as the other companies). The two options of Netflix are that they could either try to renew the contract (as long as Starz agrees to it) or pay for their own streaming content licenses. So let’s take a look at what the payoff would be for each one…

So in the situation that Starz asks for more money and gets a better contract with another company, then Netflix regardless gets no profit (or worse, loses money). So if Starz were to get a better contract and Netflix wanted to renew, the outcome would be (10, 0).

However, if Starz were to get a better contract and Netflix were to pay for its own streaming content licenses without even trying to renew, then the outcome would be (10, -10). In both situations, Netflix is at a loss but Netflix is at a bigger loss when it has to pay its own streaming content licenses due to the huge amount of money they’d lose. So it would be safer for Netflix to attempt to renew with Starz. However, Starz (regardless of what Netflix does) is better off without Netflix in these two cases.

However, another option in this situation that Starz could pick would be to renew the contract with Netflix. This would still bring in some profit for Starz but just not nearly enough and hence a smaller value for payoff. So in this situation, Netflix could try to renew the contract and be successful and therefore the outcome would be (3, 10) with this being the best possible situation for Netflix. However, if Netflix chose to not renew and therefore pay for its own contract, the outcome would be (0, -10).

As seen from this situation, the best choice Netflix has is to try its very best to renew with Starz (which we see in real life since Netflix, according to the article, had been trying extremely hard to renew it and called the problem a ‘temporary contract issue’ in all hopes that it would only be temporary). However, for Starz, its best response would be to get a better contract in order to make a bigger profit.

Clearly, the two businesses are rational and following the idea of Game Theory where they are trying to do what is in their best interest and which will give the best outcome for them making it a dominant strategy.


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