by Adam Hartung | Jul 19, 2021 | Entertainment, Entrepreneurship, Innovation, Strategy, Trends
Netflix Redefines The Pivot
Last week Netflix announced it was going to enter gaming . Interestingly, the analyst reaction was, at best, mixed. Most didn’t think it was a great idea. My favorite is this quote in AdAge came from a pair of Bernstein analysts.
“Bernstein analysts Todd Juenger and Gini Zhang said in a note that they were “tepid” about Netflix getting into gaming, partly because it would mean a lesser focus on the core business. They worry about creating a distraction.”
These untalented analysts went on to say:
“It’s hard not to imagine that if Netflix were to launch its own video games, the majority of the company’s energy would be focused on the success of that new, different, exciting thing (even among employees who aren’t involved in it),” according to the note. It’s also unclear how the company can capitalize on the video-game content without raising prices—and potentially turning away some users unwilling to pay extra, they said.”
A History of Pivoting to Meet Customer Needs
Wow, I’ve heard that before. Remember how Netflix started? Back when we all went to Blockbuster or another video store to rent a tape or dvd overnight, Netflix offered to send them to our house. And let us keep them as long as we wanted. This convenience was so powerful Netflix drove Blockbuster, Family Video and all other traditional video rental stores bankrupt.
After this big win analysts thought that Netflix should take on Amazon in general merchandise e-commerce. After all, Netflix was the largest customer of UPS, USPS and Fedex at the time. Most analysts thought Netflix had the infrastructure to ship things, so they wanted to build on that infrastructure. But Netflix didn’t to that at all. Keeping its eyes on its Value Proposition of “Delivering Entertainment” Netflix instead went headlong into video streaming. And the stock tumbled dramatically as analysts said streaming wasn’t the “core” of Netflix. Netflix wasn’t a tech company, or a telecom or cable company and streaming would be a huge distraction for people lacking proper skills. Netflix’ Value Delivery System was dominated by logistics expertise, and the analysts were focused on milking more out of the Value Delivery System.
Of course Netflix knew its value was in keeping customers happy, not milking its invested assets. Netflix’ “core” was in knowing entertainment, so it had to develop the skills in streaming, or its customers would drift away. Further, Netflix knew it had nowhere near the savvy of Amazon for general merchandise marketing and sales. If it followed Amazon it would fritter away its Value Proposition, and probably never make any money chasing Amazon by trying to devote more energy to its logistics Value Delivery System.
Of course, Netflix was right. Leadership jettisoned the physical distribution Value Delivery System and built a new one around streaming technology. Just as the Bernstein analysts feared, Netflix had to raise prices. Which it did on physical distribution in order to raise the money to invest in streaming, which turned out to be the shot allowing Netflix to dominate globally, not just in the USA. It was enormous win for gaining customers, selling more stuff, and making more money.
About 5 years ago, Netflix realized it yet again had to change its Value Delivery System if it was to maintain its customer Value Proposition. So it scaled back investing in streaming, as that technology was becoming available to everyone. And it invested heavily in content production. Even though it had long distributed other people’s content, Netflix saw that to be a leader in “Delivering Entertainment” it had to create its own. So the money was shifted into making “House of Cards,” which was a huge hit, and “Orange is the New Black.” Now Netflix is the most prolific video content creator in North America. So much good content Netflix has jeopardized the future of TV networks, major movie studios and even entire theatre chains.
Where once the big employment center, and resource hog, in Netflix was logistics, Netflix leadership pivoted its Value Delivery System into streaming technology. Then it pivoted again into content creation. And now, as gaming has become “the next big thing” Netflix is once again pivoting its resources — into fast growing gaming.
Given this is the third pivot, and 4th Value Delivery System, in Netflix, would you bet against CEO Reed Hastings and his leadership team? The negative analysts are as dead wrong now as they were before. Netflix has demonstrated a keen understanding of their Value Proposition, and demonstrated the skill set to adapt their Value Delivery System to meeting emerging customer needs. I believe it is almost a certainty Netflix will find its way in on-line gaming as the trend keeps growing exponentially. And like all the other pivots, they’ll attract even more customers, and sell more product, and make more money.
Are you adaptable to new Value Delivery Systems as technology makes them available?
Do you clearly know your Value Proposition, and are you focused on it — or are you focused on running your Value Delivery System. Are you trying to maximize your old business, or are you seeing how emerging trends are creating new opportunities to grow by entering new businesses, with new Value Delivery Systems? Netflix has demonstrated how to grow very large, very fast. Are your eyes open to Trends and Market Shifts – and are you adaptable to take advantage of emerging market needs? Now is a good time to learn from Netflix.
My calls on Netflix have historically been quite good. Check out these links to previous articles:
How Netflix became the King of Strategic Pivots, 4/2018
Predicting Netflix Would Dominate Entertainment Content, 4/2016
Explaining Why and How Netflix content creation would be good for investors, 3/2015
Explaining why investors should buy Netflix stock when it crashed after announcing its move into streaming, 10/2011
Explaining why you should buy Netflix, predicting it would be the next Apple or Google, 11/2010
Netflix ended last week at $530/share. Had you bought it when I recommended in 11/2010 the stock was $25. You would have had a 25X gain. Had you added to your position in October, 2011 the stock was $16.75. You would have a gain of 31.6X. Had you added in 3/2015 when I recommended higher valuation for investors from content you would have bought at $62, for a gain of 8.5X in 6 years.
Did you see the trends, and were you expecting the changes that would happen to your demand? It IS possible to use trends to make good forecasts, and prepare for big market shifts. If you don’t have time to do it, perhaps you should contact us, Spark Partners. We track hundreds of trends, and are experts at developing scenarios applied to your business to help you make better decisions.
TRENDS MATTER. If you align with trends your business can do GREAT! Are you aligned with trends? What are the threats and opportunities in your strategy and markets? Do you need an outsider to assess what you don’t know you don’t know? You’ll be surprised how valuable an inexpensive assessment can be for your future business. Click for Assessment info. Or, to keep up on trends, subscribe to our weekly podcasts and posts on trends and how they will affect the world of business at www.SparkPartners.com
Give us a call or send an email. Adam@sparkpartners.com 847-726-8465.
by Adam Hartung | Mar 9, 2015 | Current Affairs, In the Rapids, Leadership, Television
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 Cards” may 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.
But 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.
by Adam Hartung | 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:
- 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.
- 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:
- 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.
- 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!!
- 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.
- 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.
- 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.
- 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.
by Adam Hartung | Oct 4, 2011 | Current Affairs, Defend & Extend, Film, In the Rapids, Innovation, Leadership, Television, Transparency, Web/Tech
Reed Hastings, the CEO of Netflix, has long been considered a pretty good CEO. In January, 2009 his approval ranking, from Glassdoor, was an astounding 93%. In January, 2010 he was still on the top 25 list, with a 75% approval rating. And it's not surprising, given that he had happy employees, happy customers, and with Netflix's successful trashing of Blockbuster the company's stock had risen dramaticall,y leading to very happy investors.
But that was before Mr. Hastings made a series of changes in July and September. First Netflix raised the price on DVD rentals, and on packages that had DVD rentals and streaming download, by about $$6/month. Not a big increase in dollar terms, but it was a 60% jump, and it caught a lot of media attention (New York Times article). Many customers were seriously upset, and in September Netflix let investors know it had lost about 4% of its streaming subscribers, and possibly as many as 5% of its DVD subscribers (Daily Mail).
No investor wants that kind of customer news from a growth company, and the stock price went into a nosedive. The decline was augmented when the CEO announced Netflix was splitting into 2 companies. Netflix would focus on streaming video, and Quikster would focus on DVDs. Nobody understood the price changes – or why the company split – and investors quickly concluded Netflix was a company out of control and likely to flame out, ruined by its own tactics in competition with Amazon, et.al.
(Source: Yahoo Finance 3 October, 2011)
This has to be about the worst company communication disaster by a market leader in a very, very long time. TVWeek.com said Netflix, and Reed Hastings, exhibited the most self-destructive behavior in 2011 – beyond even the Charlie Sheen fiasco! With everything going its way, why, oh why, did the company raise prices and split? Not even the vaunted New York Times could figure it out.
But let's take a moment to compare Netflix with another company having recent valuation troubles – Kodak.
Kodak invented home photography, leading it to tremendous wealth as amature film sales soared for seveal decades. But last week Kodak announced it was about out of cash, and was reaching into its revolving credit line for some $160million to pay bills. This latest financial machination reinforced to investors that film sales aren't what they used to be, and Kodak is in big trouble – possibly facing bankruptcy. Kodak's stock is down some 80% this year, from $6 to $1 – and quite a decline from the near $80 price it had in the late 1990s.
(Source: Yahoo Finance 10-3-2011)
Why Kodak declined was well described in Forbes. Despite its cash flow and company strengths, Kodak never succeeded beyond its original camera film business. Heck, Kodak invented digital photography, but licensed the technology to others as it rabidly pursued defending film sales. Because Kodak couldn't adapt to the market shift, it now is probably going to fail.
And that is why it is worth revisiting Netflix. Although things were poorly explained, and certainly customers were not handled well, last quarter's events are the right move for investors in the shifting at-home video entertainment business:
- DVD sales are going the direction of CD's and audio cassettes. Meaning down. It is important Netflix reap the maximum value out of its strong DVD position in order to fund growth in new markets. For the market leader to raise prices in low growth markets in order to maximize value is a classic strategic step. Netflix should be lauded for taking action to maximize value, rather than trying to defend and extend a business that will most likely disappear faster than any of us anticipate – especially as smart TVs come along.
- It is in Netflix's best interest to promote customer transition to streaming. Netflix is the current leader in streaming, and the profits are better there. Raising DVD prices helps promote customer shifting to the new technology, and is good for Netflix as long as customers don't change to a competitor.
- Although Netflix is currently the leader in streaming it has serious competition from Hulu, Amazon, Apple and others. It needs to build up its customer base rapidly, before people go to competitors, and it needs to fund its streaming business in order to obtain more content. Not only to negotiate with more movie and TV suppliers, but to keep funding its exclusive content like the new Lillyhammer series (more at GigaOm.com). Content is critical to maintaining leadership, and that requires both customers and cash.
- Netflix cannot afford to muddy up its streaming strategy by trying to defend, and protect, its DVD business. Splitting the two businesses allows leaders of each to undertake strategies to maximize sales and profits. Quikster will be able to fight Wal-Mart and Redbox as hard as possible, and Netflix can focus attention on growing streaming. Again, this is a great strategic move to make sure Netflix transitions from its old DVD business into streaming, and doesn't end up like an accelerated Kodak story.
Historically, companies that don't shift with markets end up in big trouble. AB Dick and Multigraphics owned small offset printing, but were crushed when Xerox brought out xerography. Then, afater inventing desktop publishing at Xerox PARC, Xerox was crushed by the market shift from copiers to desktop printers – a shift Xerox created. Pan Am, now receiving attention due to the much hyped TV series launch, failed when it could not make the shift to deregulation. Digital Equipment could not make the shift to PCs. Kodak missed the shift from film to digital. Most failed companies are the result of management's inability to transition with a market shift. Trying to defend and extend the old marketplace is guaranteed to fail.
Today markets shift incredibly fast. The actions at Netflix were explained poorly, and perhaps taken so fast and early that leadership's intentions were hard for anyone to understand. The resulting market cap decline is an unmitigated disaster, and the CEO should be ashamed of his performance. Yet, the actions taken were necessary – and probably the smartest moves Netflix could take to position itself for long-term success.
Perhaps Netflix will fall further. Short-term price predictions are a suckers game. But for long-term investors, now that the value has cratered, give Netflix strong consideration. It is still the leader in DVD and streaming. It has an enormous customer base, and looks like the exodus has stopped. It is now well organized to compete effectively, and seek maximum future growth and value. With a better PR firm, good advertising and ongoing content enhancements Netflix has the opportunity to pull out of this communication nightmare and produce stellar returns.
by Adam Hartung | Nov 29, 2010 | Current Affairs, Disruptions, In the Rapids, Innovation, Leadership, Lifecycle, Openness, Television, Web/Tech
Summary:
- Most leaders optimize their core business
- This does not prepare the business for market shifts
- Motorola was a leader with Razr, but was killed when competitors matched their features and the market shifted to smart phones
- Netflix's leader is moving Netflix to capture the next big market (video downloads)
- Reed Hastings is doing a great job, and should be emulated
- Netflix is a great growth story, and a stock worth adding to your portfolio
"Reed Hastings: Leader of the Pack" is how Fortune magazine headlined its article making the Netflix CEO its BusinessPerson of the Year for 2010. At least part of Fortune's exuberance is tied to Netflix's dramatic valuation increase, up 200% in just the last year. Not bad for a stock called a "worthless piece of crap" in 2005 by a Wedbush Securities stock analyst. At the time, popular wisdom was that Blockbuster, WalMart and Amazon would drive Netflix into obscurity. One of these is now gone (Blockbuster) the other stalled (WalMart revenues unmoved in 2010) and the other well into digital delivery of books for its proprietary Kindle eReader.
But is this an honor, or a curse? It was 2004 when Ed Zander was given the same notice as the head of Motorola. After launching the Razr he was lauded as Motorola's stock jumped in price. But it didn't take long for the bloom to fall off that rose. Razr profits went negative as prices were cut to drive share increases, and a lack of new products drove Motorola into competitive obscurity. A joint venture with Apple to create Rokr gave Motorola no new sales, but opened Apple's eyes to the future of smartphone technology and paved the way for iPhone. Mr. Zander soon ran out of Chicago and back to Silicon Valley, unemployed, with his tale between his legs.
Netflix is a far different story from Motorola, and although its valuation is high looks like a company you should have in your portfolio.
Ed Zander simply took Motorola further out the cell phone curve that Motorola had once pioneered. He brought out the next version of something that had long been "core" to Motorola. It was easy for competitors to match the "features and functions" of Razr, and led to a price war. Mr. Zander failed because he did not recognize that launching smartphones would change the game, and while it would cannibalize existing cell phone sales it would pave the way for a much more profitable, and longer term greater growth, marketplace.
Looking at classic "S Curve" theory, Mr. Zander and Motorola kept pushing the wave of cell phones, but growth was plateauing as the technology was doing less to bring in new users (in the developed world):
Meanwhile, Research in Motion (RIM) was pioneering a new market for smartphones, which was growing at a faster clip. Apple, and later Google (with Android) added fuel to that market, causing it to explode. The "old" market for cell phones fell into a price war as the growth, and profits, moved to the newer technology and product sets:
The Motorola story is remarkably common. Companies develop leaders who understand one market, and have the skills to continue optimizing and exploiting that market. But these leaders rarely understand, prepare for and implement change created by a market shift. Inability to see these changes brought down Silicon Graphics and Sun Microsystems in 2010, and are pressuring Microsoft today as users are rapidly moving from laptops to mobile devices and cloud computing. It explains how Sony lost the top spot in music, which it dominated as a CD recording company and consumer electronics giant with Walkman, to Apple when the market moved people from physical CDs to MP3 files and Apple's iPod.
Which brings us back to what makes Netflix a great company, and Mr. Hastings a remarkable leader. Netflix pioneered the "ship to your home" DVD rental business. This helped eliminate the need for brick-and-mortar stores (along with other market trends such as the very inexpensive "Red Box" video kiosk and low-cost purchase options from the web.) Market shifts doomed Blockbuster, which remained locked-in to its traditional retail model, made obsolete by competitors that were cheaper and easier with which to do business.
But Netflix did not remain fixated on competing for DVD rentals and sales – on "protecting its core" business. Looking into the future, the organization could see that digital movie rentals are destined to be dramatically greater than physical DVDs. Although Hulu was a small competitor, and YouTube could be scoffed at as a Gen Y plaything, Netflix studied these "fringe" competitors and developed a superb solution that was the best of all worlds. Without abandoning its traditional business, Netflix calmly moved forward with its digital download business — which is cheaper than the traditional business and will not only cannibalize historical sales but make the traditional business completely obsolete!
Although text books talk about "jumping the curve" from one product line to another, it rarely happens. Devotion to the core business, and managing the processes which once led to success, keeps few companies from making the move. When it happens, like when IBM moved from mainframes to services, or Apple's more recent shift from Mac-centric to iPod/iPhone/iPad, we are fascinated. Or Google's move from search/ad placement company to software supplier. While any company can do it, few do. So it's no wonder that MediaPost.com headlines the Netflix transition story "Netflix Streams Its Way to Success."
Is Netflix worth its premium? Was Apple worth its premium earlier this decade? Was Google worth its premium during the first 3 years after its Initial Public Offering? Most investors fear the high valuations, and shy away. Reality is that when a company pioneers a growth business, the value is far higher than analysts estimate. Today, many traditionalists would say to stay with Comcast and set-top TV box makers like TiVo. But Comcast is trying to buy NBC in order to move beyond its shrinking subscriber base, and "TiVo Widens Loss, Misses Street" is the Reuters' headline. Both are clearly fighting the problems of "technology A" (above.)
What we've long accepted as the traditional modes of delivering entertainment are well into the plateau, while Netflix is taking the lead with "technology B." Buying into the traditionalists story is, well, like buying General Motors. Hard to see any growth there, only an ongoing, slow demise.
On the other hand, we know that increasingly young people are abandoning traditional programing for 100% entertainment selection by download. Modern televisions are computer monitors, capable of immediately viewing downloaded movies from a tablet or USB drive – and soon a built-in wifi connection. The growth of movie (and other video) watching is going to keep exploding – just as the volume of videos on YouTube has exploded. But it will be via new distribution. And nobody today appears close to having the future scenarios, delivery capability and solutions of Netflix. 24×7 Wall Street says Netflix will be one of "The Next 7 American Monopolies." The last time somebody used that kind of language was talking about Microsoft in the 1980s! So, what do you think that makes Netflix worth in 2012, or 2015?
Netflix is a great story. And likely a great investment as it takes on the market leadership for entertainment distribution. But the bigger story is how this could be applied to your company. Don't fear revenue cannibalization, or market shift. Instead, learn from, and behave like, Mr. Hastings. Develop scenarios of the future to which you can lead your company. Study fringe competitors for ways to offer new solutions. Be proactive about delivering what the market wants, and as the shift leader you can be remarkably well positioned to capture extremely high value.
