Enterprise risk management (ERM) is defined by the Casualty Actuary Society as “a process for identifying and prioritizing critical risks facing an organization, quantifying their impact on financial and strategic objectives, and implementing financial and organizational solutions to address them.” While other definitions, and the methods of applying this process, are diverse, most ERM programs share common goals: to assess not only the individual risks to the company but the collaborative effect of all risks to the company, and to incorporate the ERM program into the decision-making culture of the company.
In a seemingly unrelated development, the mid-2000s sitcom Arrested Development has been resurrected by Netflix with much fanfare after a seven-year hiatus. Here, we will review a handful of the many ways the enterprise at the heart of Arrested Development—the Bluth Company—could have used an ERM program. Then we will venture back into reality and look at how Netflix may have followed or not followed the principles of ERM to guide its decision making over the past decade.
The Bluth Company and ERM
Arrested Development follows the Bluth family and the trials and tribulations they face, which are due to the real estate development firm founded by the family’s patriarch, George Bluth Sr. The Bluth Company reveals several exaggerated examples of the results of not actively practicing ERM. First, the simple practice of risk mitigation through insurance may have provided financial relief for a board of directors often struggling to make payroll. Your typical directors and officers (D&O) policy likely doesn’t cover “light treason,” embezzlement, fraud, bribery (oh right, and perjury). But a contractor’s general liability policy may have helped with the imminent collapse of any homes they built, if their model home is representative of their work product.
ERM also typically calls for monitoring the actions of competitors, a practice the Bluth Company presidents did not always follow. While they were usually aware of the actions of their follicly challenged rival Sitwell Enterprises, they were surprised to find they temporarily lost controlling interest of the company to the unknown Standpoor Company.
Finally, a subtle risk that the Bluth family fell into was the concentration of proprietary knowledge among a small number of key employees, or in this case just George Sr. His son Michael is left to piece together bits of information he finds while his father is at times incarcerated, on the lam in Mexico, or hiding in the attic. In the best example, George coyly tells Michael “there’s always money in the banana stand,” leading to the burning of Bluth’s Original Frozen Banana Stand, as Michael believes his father to mean the insured value of the stand rather than the literal lining of the walls with $250,000 in cash.
Netflix and ERM
While it is not clear that Netflix has implemented a formal ERM program, its actions offer illustrations of both effective and ineffective ERM.
The company was founded based on a review of the market and seeing an opportunity by providing DVD rentals without the burdens of due dates and the now defunct late fees. Unlike the Bluths, Netflix knew its competition and how to choose its battles, engaging successfully in a price war with Blockbluster Video but adjusting its goals when faced with the rise of Redbox in the DVD rental market. Netflix recognized the risk to its market share from the Redbox self-service kiosk model, choosing to seize a different opportunity by shifting its focus to its streaming video delivery system.
In 2011, Netflix seemed to stray from the ERM mindset, with two key decisions that missed the mark in regards to long-term profitability. Netflix spent the first three quarters of the year buying back stock from its investors, a relatively uncommon move in the industry that weakened its cash position. In the fourth quarter, Netflix announced it would shift its DVD rental branch to a separate entity called Qwikster—a move that seemed like a violation of ERM principles. After gauging public reaction Netflix scrapped the plan, but the poor publicity caused enough financial damage to force them to resell the stock they had bought back for a significant loss.
Recently, the actions taken by Netflix seem to be more in line with the ERM mindset. Netflix has growing operational risks from the rising costs for content and increased competition in the streaming content market, but is clearly seeing this as an opportunity to expand their model. In order to keep ahead of the field, Netflix has devised a strategy to attract new customers by providing exclusive original content, starting with the immensely successful House of Cards and recently the aforementioned Arrested Development. Netflix is taking a significant risk by investing heavily in uncharted water, a risk they hope will lead to another quarter of significant subscriber growth and higher stock prices.
There are clearly new risks as Netflix has gone against the grain with the business model it has adopted for its original content. By releasing full seasons all at once, they cannot grow a following through critical praise or word of mouth, instead hoping to capitalize on both social and traditional media buzz. Their model also allows for “binge watching,” or the viewing of an entire season in a short period of time, allowing a subscriber to see a whole season within the company’s free trial period. It appears they see this risk as less costly than going against their model of allowing customers to decide how they absorb the content. In the case of Arrested Development, this may be even more important as the show failed to develop a following on traditional television, but gained a large following posthumously through DVD and streaming video, and binge viewing may be the best way to absorb the subtleties of many of the show’s jokes.
While early returns on the Arrested Development front, both critically and in the stock market, were poor, Netflix is looking for long-term returns. In fact, the short-term returns weren’t as bad as they seemed with a week to digest. Negative initial critical reviews have turned to “generally favorable” and, after an initial dip of 6.4% on Tuesday, stock prices rebounded to close the week down 1.1%. With their increasing investment in original content and their stated willingness to give the original content project time to develop, there won’t be a definitive answer on the success or failure of this model for quite some time. However, if they followed the principles of ERM in making these decisions, it is far less likely we will see a Netflix executive in a $3,000 suit muttering, “I’ve made a huge mistake.”