Final answer:
Netflix faced increased competition from services offering both physical and digital media, and the company underestimated the demand for physical DVDs over streaming. This misjudgment of customer preferences and the elasticity of demand for their services led to an incorrect estimate of customer retention.
Step-by-step explanation:
At the time of the case, Netflix faced a strategic issue primarily concerning increased competition. There was a proliferation of substitute services like Vudu, Amazon Prime, Hulu, and Redbox offering similar or overlapping services which provided easier access for consumers who still preferred physical media over digital streaming. The management's missteps included a failure to accurately judge the elasticity of demand and an underestimation of the consumer's preference for physical DVDs over streaming content. As competitors provided convenient access to DVDs through kiosks, many consumers found this more appealing than navigating online streaming.
Lastly, the management of Netflix had not fully accounted for customer preferences and tastes, and the allure of close substitutes, which led to their miscalculation regarding the number of customers leaving the service. This oversight was significant given the changing landscape of media consumption at the time.