And the Winner Is – Netflix!!

by | Jan 29, 2013 | Current Affairs, Disruptions, In the Rapids, Innovation, Leadership, Television, Web/Tech

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.

Adopt Market Shifts – Television, Telephone, Apple’s new products

by | Sep 2, 2010 | Current Affairs, Defend & Extend, In the Rapids, Television, Web/Tech


Summary:

  • Market shifts create losers, and winners
  • Demand doesn’t decline, it just changes form – and usually grows!
  • We want more entertainment and communcation – but not the old fashioned way
  • Losers keep trying to sell what they have, and know
  • Winners supply solutions aligned with market needs regardless of old competencies

How would you react if your customers said your product really wasn’t something they needed?  Would you work hard to convince them they are wrong?  Maybe try to add some features hoping it would regain their attention?  Or would you start looking for what they really do need/want?

Pew Research Center, at PewSocialTrends.org headlines “The Fading Glory of the Television and Telephone” describing how quickly people are walking away from what were very recently considered absolute necessities. As a “boomer” and member of the “TV generation” I was surprised to read that only 42% of Americans now think a television is a necessity!  This has been a rapid, dramatic decline from 52% last year and 64% in 2006!  1 in 5 Americans have changed their point of view about television as a necessity in just 4 years!  And TV as a necessity is in an accelerating decline!  I can remember when my generation went from 1 TV in the house to 1 in every room!  This trend does not bode well for broadcast television networks, affiliates, advertisers, traditional production companies, television newscasters, manufacturers of TV sets and TV equipment – or many other businesses linked to TV as we know it.

Simultaneously, demand for a land line telephone  has declined.  Again, my generation remembers the days with one phone in the house – in some areas on a shared “party” line where multiple families shared a single phone line.  The phone was in a central area so it could be shared.  In the 1970s we saw things change as telephones were added to every room!  Now, according to Pew, folks who consider a land-line phone a necessity has declined to only 62%, a 10% decline from just last year (68 to 62) and barely 3 in 5 Americans!  Wow! 

Of course, for every decline there’s a winner.  47% see the cell phone as a necessity – that’s 5 percentage points greater than the TV score, indicating mobile phones are seen as more of a necessity than television by the general population.  And 34% see high speed internet as a necessity – only 9 percentage points fewer than the TV number – and more than half who see the need for a land-line phone. 

Demand for entertainment and communication have not declined!  If you are in television or land lines you might think so.  Rather, that demand is accelerating.  But it is just shifting to a different solution.  Instead of the old technology, and supplier industry, people are changing to something new.  First with video cassetttes, then digital video recorders (DVRs), then the plethora of available cable channels and on-demand TV, and now with on-line entertainment from YouTube to Hulu people have been changing the way they consume entertainment.  Demand has gone up, but not from traditional consumption of TV, especially as viewing has switched from the TV to the computer monitor – or the hand held device.

Clearly, access to the internet (facebook, twitter, et.al.), texting and anytime/anywhere calling has increased both our access and use of one-way (such as reading web pages) and two way communication.  Communication is continuing to grow, but it will be in a different way.  No longer do we need a “dial tone” to communicate – and in most instances people are finding a preference to asynchronous rather than real-time communication.

These are the kind of industry transitions that threaten so many businesses.  What Clayton Christensen calls “The Innovator’s Dilemma” as new solutions increase demand while making old solutions obsolete.  The tendency is for the supplier of traditional solutions to say “my market is in decline.”  But really, the market is growing!  Just like Kodak said the demand for film was declining, when demand for photography – now in digital format – was (and is) escalating!  When market shifts happen, incumbents have to resist the temptation to try “keeping” the “old customers” by undertaking Defend & Extend efforts – like adding features and functionality, while cutting price.  This inevitably leads to disaster!  Instead, they have to understand the shift is only going to accelerate, and develop an approach to entering the new market.

As this research comes out, Apple launched a series of new products to augment its set-top box and iPod/iTouch product lines. (San Francisco Chronicle, SFGate.com “Steve JobsUnveils Upgraded Apple TV, New iPods“)  by doing so Apple recognizes that people still want entertainment – but they are a whole lot less likely to accept sitting in front of a communal television, serially deploying programming at them.  They want their entertainment to be on-demand, and personalized.  Why should we all watch the same thing?  And why watch what some programmer at CBS, HBO or TMC wants to deliver? 

Apple is bringing out products that align with the direction the market is now heading. Ping is designed to help people share program information and identify the entertainment you would like to receive.  iTunes is upgrading to bring you in bite-size chunks exactly the entertainment you want, as you want it, aurally or visually.  These are products which will grow because they are aligned with what the market says it wants — even more entertainment.  Those who are hidebound to the old supply mechanism will simply find themselves fighting for declining revenue as demand shifts – and grows – in the new solutions