Netflix – Demonstrating Why Good Strategy Matters

Netflix – Demonstrating Why Good Strategy Matters

On January 23 Netflix’ value rose to $100B. The stock is now trading north of $250/share. A year ago it was $139/share. An 80% increase in just 12 months. And long-term investors have done very well. Five years ago (January, 2013) the stock was trading at $24/share – so the valuation has increased 10-fold in 5 years! A decade ago it was trading for $3/share – so if you got in early (NFLX went public in June, 2002) you are up 83X your initial investment (meaning $1,000 would be worth $83,000.)netflix profits 2017 statista

Back in 2004 I wrote that Blockbuster was dead meat – because by going after streaming Netflix would make Blockbuster obsolete. Netflix was using external data to project its future, and thus its strategy was not to defend & extend its DVD rental business but to spend strongly to grow the replacement. In 2010 I wrote that Netflix had projected the complete demise of DVDs by 2013, and was thus investing all its resources into streaming in order to be the market leader. At the time NFLX was $15.68. Over the next year it took off, tripling in value to $42.16. By cannibalizing DVDs it’s strategy was to leave its competition in a dying marketplace.

But, investors weren’t as sure of the Netflix strategy as I was. They feared cannibalizing DVDs would cut out the “core” of Netflix and kill the company. By October, 2011 the stock had tumbled to $12 (a drop of over 70%.) But, with the stock at new lows after a year of declines I optimistically wrote “The Case for Buying Netflix. Really.” I told readers the stock analysts were wrong, and the Netflix strategy was spot-on.

Netflix went nowhere for the next year, trading between $9 and $12. But then in December, 2012 investors started seeing the results of Netflix strategy, with fast growing streaming subscriber rates. By January, 2014 the stock was trading north of $52, so those who bought when my article published made a 400% return in just over 2 years! By March, 2015 NFLX was up another 23%, to $62 when I told readers “Netflix Valuation Was Not a House of Cards.” The Netflix strategy to dominate streaming by offering its own content may have shocked a lot of people, due to the investment size, but it was the strategy that would allow Netflix to grow subscribers globally. That has driven the last jump, to $250 in just under 3 years – another 400%+ return!

Strategy matters- to company performance, and thus long-term investor returns. Netflix has been a volatile stock, and it has had plenty of naysayers. These were people looking only short-term, and fearful of strategic pivots that have proven highly valuable. If you want your company, and your investment portfolio, to succeed it is imperative you understand external trends and use them to develop the right strategy. And heed my forecasts.

Why Tesla Could Be the Next Apple – and Put a Hurt On Exxon

Why Tesla Could Be the Next Apple – and Put a Hurt On Exxon

A recent analyst took a look at the impact of electric vehicles (EVs) on the demand for oil, and concluded that they did not matter.  In a market of 95million barrels per day production, electric cars made a difference of 25,000 to 70,000 barrels of lost consumption; ~.05%.

You can’t argue with his arithmetic.  So far, they haven’t made any difference.

Charging_Tesla_Model_S_01But then he goes on to say they won’t matter for another decade.  He forecasts electric vehicle sales grow 5-fold in one decade, which sounds enormous.  That is almost 20% growth year over year for 10 consecutive years.  Admittedly, that sounds really, really big.  Yet, at 1.5million units/year this would still be only 5% of cars sold, and thus still not a material impact on the demand for gasoline.

This sounds so logical.  And one can’t argue with his arithmetic.

But one can argue with the key assumption, and that is the growth rate.

Do you remember owning a Walkman?  Listening to compact discs?  That was the most common way to listen to music about a decade ago.  Now you use your phone, and nobody has a walkman.

Remember watching movies on DVDs?  Remember going to Blockbuster, et.al. to rent a DVD?  That was common just a decade ago.  Now you likely have shelved the DVD player, lost track of your DVD collection and stream all your entertainment.  Bluckbuster, infamously, went bankrupt.

Do you remember when you never left home without your laptop?  That was the primary tool for digital connectivity just 6 years ago.  Now almost everyone in the developed world (and coming close in the developing) carries a smartphone and/or tablet and the laptop sits idle.  Sales for laptops have declined for 5 years, and a lot faster than all the computer experts predicted.

Markets that did not exist for mobile products 10 years ago are now huge.  Way beyond anyone’s expectations.  Apple alone has sold over 48million mobile devices in just 3 months (Q3 2015.)  And replacing CDs, Apple’s iTunes was downloading 21million songs per day in 2013 (surely more by now) reaching about 2billion per quarter.  Netflix now has over 65million subscribers. On average they stream 1.5hours of content/day – so about 1 feature length movie.  In other words, 5.85billion streamed movies per quarter.

What has happened to old leaders as this happened?  Sony hasn’t made money in 6 years.  Motorola has almost disappeared.  CD and DVD departments have disappeared from stores, bankrupting Circuit City and Blockbuster, and putting a world of hurt on survivors like Best Buy.

The point?  When markets shift, they often shift a lot faster than anyone predicts. 20%/year growth is nothing.  Growth can be 100% per quarter.  And the winners benefit unbelievably well, while losers fall farther and faster than we imagine.

Tesla was barely an up-and-comer in 2012 when I said they would far outperform GM, Ford and Toyota.  The famous Bob Lutz, a long-term widely heralded auto industry veteran chastised me in his own column “Tesla Beating Detroit – That’s Just Nonsense.”

Mr. Lutz said I was comparing a high-end restaurant to McDonald’s, Wendy’s and Pizza Hut, and I was foolish because the latter were much savvier and capable than the former.  He should have used as his comparison Chipotle, which I predicted would be a huge winner in 2011.  Those who followed my advice would have made more money owning Chipotle than any of the companies Mr. Lutz preferred.

The point? Market shifts are never predicted by incumbents, or those who watch history.  The rate of change when it happens is so explosive it would appear impossible to achieve, and far more impossible to sustain.  The trends shift, and one market is rapidly displaced by another.

While GM, Ford and Toyota struggle to maintain their mediocrity, Tesla is winning “best car” awards one after another – even “breaking” Consumer Reports review system by winning 103 points out of a maximum 100, the independent reviewer liked the car so much. Tesla keeps selling 100% of its production, even at its +$100K price point.

So could the market for EVs wildly grow?  BMW has announced it will make all models available as electrics within 10 years, as it anticipates a wholesale market shift by consumers promoted by stricter environmental regulations. Petroleum powered car sales will take a nosedive.

The International Energy Agency (IEA) points out that EVs are just .08% of all cars today. And of the 665,000 on the road, almost 40% are in the USA, where they represent little more than a rounding error in market share.  But there are smaller markets where EV sales have strong share, such as 12% in Norway and 5% in the Netherlands.

So what happens if Tesla’s new lower priced cars, and international expansion, creates a sea change like the iPod, iPhone and iPad?  What happens if people can’t get enough of EVs?  What happens if international markets take off, due to tougher regulations and higher petrol costs?  What happens if people start thinking of electric cars as mainstream, and gasoline cars as old technology — like two-way radios, VCRs, DVD players, low-definition picture tube TVs, land line telephones, fax machines, etc?

What if demand for electric cars starts doubling each quarter, and grows to 35% or 50% of the market in 10 years?  If so, what happens to Tesla?  Apple was a nearly bankrupt, also ran, tiny market share company in 2000 before it made the world “i-crazy.” Now it is the most valuable publicly traded company in the world.

Already awash in the greatest oil inventory ever, crude prices are down about 60% in the last year.  Oil companies have already laid-off 50,000 employees.  More cuts are planned, and defaults expected to accelerate as oil companies declare bankruptcy.

It is not hard to imagine that if EVs really take off amidst a major market shift, oil companies will definitely see a precipitous decline in demand that happens much faster than anticipated.

To little Tesla, which sold only 1,500 cars in 2010 could very well be positioned to make an enormous difference in our lives, and dramatically change the fortunes of its shareholders — while throwing a world of hurt on a huge company like Exxon (which was the most valuable company in the world until Apple unseated it.)

[Note: I want to thank Andreas de Vries for inspiring this column and assisting its research.  Andreas consults on Strategy Management in the Oil & Gas industry, and currently works for a major NOC in the Gulf.]

Netflix Valuation is Not a “House of Cards”

Netflix Valuation is Not a “House of Cards”

The Netflix hit series “House of Cards” was released last night.  Most media reviewers and analysts are expecting huge numbers of fans will watch the show, given its tremendous popularity the last 2 years.  Simultaneously, there are already skeptics who think that releasing all episodes at once “is so last year” when it was a newsworthy event, and no longer will interest viewers, or generate subscribers, as it once did.  Coupled with possible subscriber churn, some think that “House of Cardsmay have played out its hand.

So, the success of this series may have a measurable impact on the valuation of Netflix.  If the “House of Cards” download numbers, which are up to Netflix to report, aren’t what analysts forecast many may scream for the stock to tumble; especially since it is on the verge of reaching new all-time highs.  The Netflix price to earnings (P/E) multiple is a lofty 107, and with a valuation of almost $29B it sells for just under 4x sales.

Netflix House of CardsBut investors should ignore any, and in fact all, hype about “House of Cards” and whatever analysts say about Netflix.  So far, they’ve been wildly wrong when making forecasts about the company.  Especially when projecting its demise.

Since Netflix started trading in 2002, it has risen from (all numbers adjusted) $8.5 to $485.  That is a whopping 57x increase.  That is approximately a 40% compounded rate of return, year after year, for 13 years!

But it has not been a smooth ride. After starting (all numbers rounded for easier reading) at $8.50 in May, 2002 the stock dropped to $3.25 in October – a loss of over 60% in just 5 months.  But then it rallied, growing to $38.75, a whopping 12x jump, in just 14 months (1/04!) Only to fall back to $9.80, a 75% loss, by October, 2004 – a mere 9 months later.  From there Netflix grew in value by about 5.5x – to $55/share – over the next 5 years (1/10.)  When it proceeded to explode in value again, jumping to $295, an almost 6-fold increase, within 18 months (7/11).  Only to get creamed, losing almost 80% of its value, back down to $63.85, in the next 4 months (11/11.)  The next year it regained some loss, improving in value by 50% to $91.35 (12/12,) only to again explode upward to $445 by February, 2014 a nearly 5-fold increase, in 14 months.  Two months later, a drop of 25% to $322 (4/14).  But then in 4 months back up to $440 (8/14), and back down 4 months later to $341 (12/14) only to approach new highs reaching $480 last week – just 2 months later.

That is the definition of volatility.

Netflix is a disruptive innovator.  And, simply put, stock analysts don’t know how to value disruptive innovators. Because their focus is all on historical numbers, and then projecting those historicals forward.  As a result, analysts are heavily biased toward expecting incumbents to do well, and simultaneously being highly skeptical of any disruptive company.  Disruptors challenge the old order, and invalidate the giant excel models which analysts create.  Thus analysts are very prone to saying that incumbents will remain in charge, and that incumbents will overwhelm any smaller company trying to change the industry model.  It is their bias, and they use all kinds of historical numbers to explain why the bigger, older company will project forward well, while the smaller, newer company will stumble and be overwhelmed by the entrenched competitor.

And that leads to volatility.  As each quarter and year comes along, analysts make radically different assumptions about the business model they don’t understand, which is the disruptor.  Constantly changing their assumptions about the newer kid on the block, they make mistake after mistake with their projections and generally caution people not to buy the disruptor’s stock.  And, should the disruptor at any time not meet the expectations that these analysts invented, then they scream for shareholders to dump their holdings.

Netflix first competed in distribution of VHS tapes and DVDs.  Netflix sent them to people’s homes, with no time limit on how long folks could keep them.  This model was radically different from market leader Blockbuster Video, so analysts said Blockbuster would crush Netflix, which would never grow.  Wrong.  Not only did Blockbuster grow, but it eventually drove Blockbuster into bankruptcy because it was attuned to trends for convenience and shopping from home.

As it entered streaming video, analysts did not understand the model and predicted Netflix would cannibalize its historical, core DVD business thus undermining its own economics.  And, further, much larger Amazon would kill Netflix in streaming.  Analysts screamed to dump the stock, and folks did.  Wrong.  Netflix discovered it was a good outlet for syndication, created a huge library of not only movies but television programs, and grew much faster and more profitably than Amazon in streaming.

Then Netflix turned to original programming.  Again, analysts said this would be a huge investment that would kill the company’s financials. And besides that people already had original programming from historical market leaders HBO and Showtime.  Wrong.  By using analysis of what people liked from its archive, Netflix leadership hedged its bets and its original shows, especially “House of Cards” have been big hits that brought in more subscribers.  HBO and Showtime, which have depended on cable companies to distribute their programming, are now increasingly becoming additional programming on the Netflix distribution channel.

Investors should own Netflix because the company’s leadership, including CEO Reed Hastings, are great at disruptive innovation.  They identify unmet customer needs and then fulfill those needs.  Netflix time and again has demonstrated it can figure out a better way to give certain user segments what they want, and then expand their offering to eat away at the traditional market.  Once it was retail movie distribution, increasingly it is becoming cable distribution via companies like ComCast, AT&T and Time Warner.

And investors must be long-term.  Netflix is an example of why trading is a bad idea – unless you do it for a living.  Most of us who have full time day jobs cannot try timing the ups and downs of stock movements.  For us, it is better to buy and hold.  When you’re ready to buy, buy. Don’t wait, because in the short term there is no way to predict if a stock will go up or down.  You have to buy because you are ready to invest, and you expect that over the next 3, 5, 7 years this company will continue to drive growth in revenues and profits, thus expanding its valuation.

Netflix, like Apple, is a company that has mastered the skills of disruptive innovation.  While the competition is trying to figure out how to sustain its historical position by doing the same thing better, faster and cheaper Netflix is figuring out “the next big thing” and then delivering it.  As the market shifts, Netflix is there delivering on trends with new products – and new business models – which push revenues and profits higher.

That’s why it would have been smart to buy Netflix any time the last 13 years and simply held it.  And odds are it will continue to drive higher valuations for investors for many years to come.  Not only are HBO, Showtime and Comcast in its sites, but the broadcast networks (ABC, CBS, NBC) are not far behind.  It’s a very big media market, which is shifting dramatically, and Netflix is clearly the leader.  Not unlike Apple has been in personal technology.

Why Microsoft is Still Speculative

Why Microsoft is Still Speculative

Hope springs eternal in the human breast” (Alexander Pope)

As it does for most investors.  People do not like to accept the notion that a business will lose relevancy, and its value will fall.  Especially really big companies that are household brand names.  Investors, like customers, prefer to think large, established companies will continue to be around, and even do well.  It makes everyone feel better to have a optimistic attitude about large, entrenched organizations.

And with such optimism investors have cheered Microsoft for the last 15 months.  After a decade of trading up and down around $26/share, Microsoft stock has made a significant upward move to $41 – a new decade-long high. This price has people excited Microsoft will reach the dot.com/internet boom high of $60 in 2000.

After discovering that Windows 8, and the Surface tablet, were nowhere near reaching sales expectations after Christmas 2012 – and that PC sales were declining faster than expected – investors were cheered in 2013 to hear that CEO Steve Ballmer would resign.  After much speculation, insider Satya Nadella was named CEO, and he quickly made it clear he was refocusing the company on mobile and cloud.  This started the analysts, and investors, on their recent optimistic bent.

CEO Nadella has cut the price of Windows by 70% in order to keep hardware manufacturers on Windows for lower cost machines, and he announced the company’s #1 sales and profit product – Office – was being released on iOS for iPad users.  Investors are happy to see this action, as they hope that it will keep PC sales humming. Or at least slow the decline in sales while keeping manufacturers (like HP) in the Microsoft Windows fold.  And investors are likewise hopeful that the long awaited Office announcement will mean booming sales of Office 365 for all those Apple products in the installed base.

But, there’s a lot more needed for Microsoft to succeed than these announcements.  While Microsoft is the world’s #1 software company, it is still under considerable threat and its long-term viability remains unsure.

Windows is in a tough spot.  After this price decline, Microsoft will need to increase sales volume by 2.5X to recoup lost profits.  Meanwhile, Chrome laptops are considerably cheaper for customers and more profitable for manufacturers.  And whether this price cut will have any impact on the decline in PC sales is unclear, as users are switching to mobile products for ease-of-use reasons that go far beyond price.  Microsoft has taken an action to defend and extend its installed base of manufacturers who have been threatening to move, but the impact on profits is still likely to be negative and PC sales are still going to decline.

Meanwhile, the move to offer Office on iOS is clearly another offer to defend the installed Office marketplace, and unlikely to create a lot of incremental revenue and profit growth.  The PC market has long been much bigger than tablets, and almost every PC had Office installed.  Shrinking at 12-14% means a lot less Windows Office is being sold. And, In tablets iOS is not 100% of the market, as Android has substantial share.  Offering Office on iOS reaches a lot of potential machines, but certainly not 100% as has been the case with PCs.

Further, while there are folks who look forward to running Office on an iOS device, Office is not without competition.  Both Apple and Google offer competitive products to Office, and the price is free.  For price sensitive users, both individuals and corporations, after 4 years of using competitive products it is by no means a given they all are ready to pay $60-$100 per device per year.  Yes, there will be Office sales Microsoft did not previously have, but whether it will be large enough to cover the declining sales of Office on the PC is far from clear.  And whether current pricing is viable is far, far from certain.

While these Microsoft products are the easiest for consumers to understand, Nadella’s move to make Microsoft successful in the mobile/cloud world requires succeeding with cloud products sold to corporations and software-as-service providers.  Here Microsoft is late, and facing substantial competition as well.

Just last week Google cut the price of its Compute Engine cloud infrastructure (IaaS) platform and App Engine cloud app platform (PaaS) products 30-32%.  Google cut the price of its Cloud Storage and BigQuery (big data analytics) services by 68% and 85% as it competes headlong for customers with Amazon.  Amazon, which has the first-mover position and large customers including the U.S. federal government, cut prices within 24 hours for its EC2 cloud computing service by 30%, and for its S3 storage service by over 50%. Amazon also reduced prices on its RDS database service approximately 28%, and its Elasticache caching service by over 33%.

To remain competitive, Microsoft had to react this week by chopping prices on its Azure cloud computing products 27%-35%, reducing cloud storage pricing 44%-65%, and whacking prices on its Windows and Linux memory-intensive computing products 27%-35%.  While these products have allowed the networking division formerly run by now CEO Nadella to be profitable, it will be increasingly difficult to maintain old profit levels on existing customers, and even a tougher problem to profitably steal share from the early cloud leaders – even as the market grows.

While optimism has grown for Microsoft fans, and the share price has moved distinctly higher, it is smart to look at other market leaders who obtained investor favorability, only to quickly lose it.

Blackberry was known as RIM (Research in Motion) in June, 2007 when the iPhone was launched.  RIM was the market leader, a near monopoly in smart phones, and its stock was riding high at $70.  In August, 2007, on the back of its dominant status, the stock split – and moved on to a split adjusted $140 by end of 2008.  But by 2010, as competition with iOS and Android took its toll RIM was back to $80 (and below.)  Today the rechristened company trades for $8.

Sears was once the country’s largest and most successful retailer.  By 2004 much of the luster was coming off when KMart purchased the company and took its name, trading at only $20/share.  Following great enthusiasm for a new CEO (Ed Lampert) investors flocked to the stock, sure it would take advantage of historical brands such as DieHard, Kenmore and Craftsman, plus leverage its substantial real estate asset base.  By 2007 the stock had risen to $180 (a 9x gain.) But competition was taking its toll on Sears, despite its great legacy, and sales/store started to decline, total sales started declining and profits turned to losses which began to stretch into 20 straight quarters of negative numbers.  Meanwhile, demand for retail space declined, and prices declined, cutting the value of those historical assets. By 2009 the stock had dropped back to $40, and still trades around that value today — as some wonder if Sears can avoid bankruptcy.

Best Buy was a tremendous success in its early years, grew quickly and built a loyal customer base as the #1 retail electronics purveyor.  But streaming video and music decimated CD and DVD sales.  On-line retailers took a huge bite out of consumer electronic sales.  By January, 2013 the stock traded at $13.  A change of CEO, and promises of new formats and store revitalization propped up optimism amongst investors and by November, 2014 the stock was at $44.  However, market trends – which had been in place for several years – did not change and as store sales lagged the stock dropped, today trading at only $25.

Microsoft has a great legacy.  It’s products were market leaders.  But the market has shifted – substantially.  So far new management has only shown incremental efforts to defend its historical business with product extensions – which are up against tremendous competition that in these new markets have a tremendous lead.  Microsoft so far is still losing money in on-line and gaming (xBox) where it has lost almost all its top leadership since 2014 began and has been forced to re-organize.   Nadella has yet to show any new products that will create new markets in order to “turn the tide” of sales and profits that are under threat of eventual extinction by ever-more-capable mobile products.

While optimism springs eternal long-term investors would be smart to be skeptical about this recent improvement in the stock price.  Things could easily go from mediocre to worse in these extremely competitive global tech markets, leaving Microsoft optimists with broken dreams, broken hearts and broken portfolios.

Update: On April 2 Microsoft announced it is providing Windows for free to all manufacturers with a 9″ or smaller display.  This is an action to help keep Microsoft competitive in the mobile marketplace – but it does little for Microsoft profitability.  Android from Google may be free, but Google’s business is built on ad sales – not software sales – and that’s dramatically different from Microsoft that relies almost entirely on Windows and Office for its profitability

Update: April 3 CRN (Computer Reseller News) reviewed Office products for iOS – “We predict that once the novelty of “Office for iPad” wears off, companies will go back to relying on the humble, hard-working third parties building apps that are as stable, as handsome and far more capable than those of Redmond. It’s not that hard to do.”

 

 

And the Winner Is – Netflix!!

Last week's earning's announcements gave us some big news.  Looking around the tech industry, a number of companies reported about as expected, and their stocks didn't move a lot.  Apple had robust sales and earnings, but missed analyst targets and fell out of bed!  But without a doubt, the big winner was Netflix, which beat expectations and had an enormous ~50% jump in valuation!

My what a difference 18 months makes (see chart.)  For anyone who thinks the stock market is efficient the value of Netflix should make one wonder.  In July, 2011 the stock ended a meteoric run-up to $300/share, only to fall 80% to $60/share by year's end.  After whipsawing between $50 and $130, but spending most of 2012 near the lower number, the stock is now up 3-fold to $160!  Nothing scares investors more than volatility – and this kind of volatility would scare away almost anyone but a day trader!

Yet, through all of this I have been – and I remain – bullish on Netflix.  During its run-up in 2010 I wrote "Why You Should Love Netflix," then when the stock crashed in late 2011 I wrote "The Case for Buying Netflix" and last January I predicted Netflix to be "the turnaround story of 2012."  It would be logical to ask why I would remain bullish through all the ups and downs of this cycle – especially since Netflix is still only about half of its value at its high-point.

Simply put, Netflix has 2 things going for it that portend a successful future:

  1. Netflix is in a very, very fast growing market.  Streaming entertainment.  People have what appears to be an insatiable desire for entertainment, and the market not only has grown at a breathtaking rate, but it will continue to grow extremely fast for several more quarters.  It is unclear where the growth rate may tap out for content delivery – putting Netflix in a market that offers enormous growth for all participants.
  2. Netflix leadership has shown a penchant for having the right strategy to remain a market leader – even when harshly criticized for taking fast action to deal with market shifts.  Specifically, choosing to rapidly cannibalize its own DVD business by aggressively promoting streaming – even at lower margins – meant Netflix chose growth over defensiveness.

In 2011 CEO Reed Hastings was given "CEO of the Year 2010" honors by Fortune magazine.  But in 2011, as he split Netflix into 2 businesses – DVD and streaming – and allowed them to price independently and compete with each other for customer business he was trounced as the "dunce" of tech CEOs

His actions led to a price increase of 60% for anyone who decided to buy both Netflix products, and many customers chose to drop one.  Analysts predicted this to be the end of Netflix. 

But in retrospect we can see the brilliance of this decision.  CEO Hastings actually did what textbooks tell us to do – he began milking the installed, but outdated, DVD business.  He did not kill it, but he began pulling profits and cash out of it to pay for building the faster growing, but lower margin, streaming business.  This allowed Netflix to actually grow revenue, and grow profits, while making the market transition from one platform (DVD) to another (streaming.)

Almost no company pulls off this kind of transition.  Most companies try to defend and extend the company's "core" product far too long, missing the market transition.  But now Netflix is adding around 2 million new streaming customers/quarter, while losing 400,000 DVD subscribers.  And with the price changes, this has allowed the company to add content and expand internationally — and increase profits!!

Marketwatch headlined that "Naysayers Must Feel Foolish."  But truthfully, they were just looking at the wrong numbers.  They were fixated on the shrinking installed base of DVD subscribers.  But by pushing these customers to make a fast decision, Netflix was able to convert most of them to its new streaming business before they went out and bought the service from a competitor. 

Aggressive cannibalization actually was the BEST strategy given how fast tablet and smartphone sales were growing and driving up demand for streaming entertainment.  Capturing the growth market was far, far more valuable than trying to defend the business destined for obsolescence. 

Netflix simply did its planning looking out the windshield, at what the market was going to look like in 3 years, rather than trying to protect what it saw in the rear view mirror.  The market was going to change – really fast.  Faster than most people expected.  Competitors like Hulu and Amazon and even Comcast wanted to grab those customers.  The Netflix goal had to be to go headlong into the cold, but fast moving, water of the new streaming market as aggressively as possible.  Or it would end up like Blockbuster that tried renting DVDs from its stores too long – and wound up in bankruptcy court.

There are people who still doubt that Netflix can compete against other streaming players.  And this has been the knock on Netflix since 2005.  That Amazon, Walmart or Comcast would crush the smaller company.  But what these analysts missed was that Amazon and Walmart are in a war for the future of retail – not entertainment – and their efforts in streaming were more to protect a flank in their retail strategy, not win in streaming entertainment.  Likewise, Comcast and its brethren are out to defend cable TV, not really win at anytime, anywhere streaming entertainment.  Their defensive behavior would never allow them to lead in a fast-growing new marketplace.  Thus the market was left for Netflix to capture – if it had the courage to rapidly cannibalize its base and commit to the new marketplace.

Hulu and Redbox are also competitors.  And they very likely will do very well for several years.  Because the market is growing very fast and can support multiple players.  But Netflix benefits from being first, and being biggest.  It has the most cash flow to invest in additional growth.  It has the largest subscriber base to attract content providers earlier, and offer them the most money.  By maintaining its #1 position – even by cannibalizing itself to do so – Netflix is able to keep the other competitors at bay; reinforcing its leadership position.

There are some good lessons here for everyone:

  1. Think long-term, not short-term.  A king can become a goat only to become a king again if he haa the right strategy.  You probably aren't as good as the press says when they like you, nor as bad as they say when hated.  Don't let yourself be goaded into giving up the long-term win for short-term benefits.
  2. Growth covers a multitude of sins!  The way Netflix launched its 2-division campaign in 2011 was a disaster.  But when a market is growing at 100%+ you can rapidly recover.  Netflix grew its streaming user base by more than 50% last year – and that fixes a lot of mistakes. Anytime you have a choice, go for the fast growing market!!
  3. Follow the trend!  Never fight the trend!  Tablet sales were growing at an amazing clip, while DVD players had no sales gains.  With tablet and smartphone sales eclipsing DVD player sales, the smart move was to go where the trend was headed.  Being first on the trend has high payoff.  Moving slowly is death.  Kodak failed to aggressively convert film camera customers to its own digital cameras, and it filed bankruptcy in 2012.
  4. Dont' forget to be profitable!  Even if it means raising prices on dated solutions that will eventually become obsolete – to customer howls.  You must maximize the profits of an outdated product line as fast as possible. Don't try to defend and extend it.  Those tactics use up cash and resources rather than contributing to future success.
  5. Cannibalizing your installed base is smart when markets shift.  Regardless the margin concerns.  Newspapers said they could not replace "print ad dollars" with "on-line ad dimes" so many went bankrupt defending the paper as the market shifted.  Move fast. Force the cannibalization early so you can convert existing customers to your solution, and keep them, before they go to an emerging competitor.
  6. When you need to move into a new market set up a new division to attack it.  And give them permission to do whatever it takes.  Even if their actions aggravate existing customers and industry participants.  Push them to learn fast, and grow fast – and even to attack old sacred cows (like bundled pricing.)

There were a lot of people who thought my call that Netflix would be the turnaround tech story of 2012 was simply bizarre.  But they didn't realize the implications of the massive trend to tablets and smartphones.  The impact is far-reaching – affecting not only computer companies but television, content delivery and content creation.  Netflix positioned itself to be a winner, and implemented the tactics to make that strategy work despite widespread skepticism. 

Hats off to Netflix leadership.  A rare breed.  That's why long-term investors should own the stock.