Netflix announced new subscriber numbers last week – and it exceeded expectations. Netflix now has over 130 million worldwide subscribers. This is up 480% in just the last 6 years – from under 30 million. Yes, the USA has grown substantially, more than doubling during this timeframe. But international growth has been spectacular, growing from almost nothing to 57% of total revenues. International growth the last year was 70%, and the contribution margin on international revenues has transitioned from negative in 2016 to over 15% – double the 4th quarter of 2017.
Accomplishing this is a remarkable story. Most companies grow by doing more of the same. Think of Walmart that kept adding stores. Then adding spin-off store brand Sam’s Club. Then adding groceries to the stores. Walmart never changed its strategy, leaders just did “more” with the old strategy. That’s how most people grow, by figuring out ways to make the Value Delivery System (in their case retail stores, warehouses and trucks) do more, better, faster, cheaper. Walmart never changed its strategy.
But Netflix is a very different story. The company started out distributing VHS tapes, and later DVDs, to homes via USPS, UPS and Fedex. It was competing with Blockbuster, Hollywood Video, Family Video and other traditional video stores. It won that battle, driving all of them to bankruptcy. But then to grow more Netflix invested far outside its “core” distribution skills and pioneered video streaming, competing with companies like DirecTV and Comcast. Eventually Netflix leaders raised prices on physical video distribution, cannibalizing that business, to raise money for investing in streaming technology. Streaming technology, however, was not enough to keep growing subscribers. Netflix leadership turned to creating its own content, competing with moviemakers, television and documentary producers, and broadcast television. The company now spends over $6B annually on content.
Think about those decisions. Netflix “pivoted” its strategy 3 times in one decade. Its “core” skill for growth changed from physical product distribution to network technology to content creation. From a “skills” perspective none of these have anything in common.
Could you do that? Would you do that?
How did Netflix do that? By focusing on its Value Proposition. By realizing that it’s Value Proposition was “delivering entertainment” Netflix realized it had to change its skill set 3 times to compete with market shifts. Had Netflix not done so, its physical distribution would have declined due to the emergence of Amazon.com, and eventually disappeared along with tapes and DVDs. Netflix would have followed Blockbuster into history. And as bandwidth expanded, and global networks grew, and dozens of providers emerged streaming purchased content profits would have become a bloodbath. Broadcasters who had vast libraries of content would sell to the cheapest streaming company, stripping Netflix of its growth. To continue growing, Netflix had to look at where markets were headed and redirect the company’s investments into its own content.
This is not how most companies do strategy. Most try to figure out one thing they are good at, then optimize it. They examine their Value Delivery System, focus all their attention on it, and entirely lose track of their Value Proposition. They keep optimizing the old Value Delivery System long after the market has shifted. For example, Walmart was the “low cost retailer.” But e-commerce allows competitors like Amazon.com to compete without stores, without advertising and frequently without inventory (using digital storefronts to other people’s inventory.) Walmart leaders were so focused on optimizing the Value Delivery System, and denying the potential impact of e-commerce, that they did not see how a different Value Delivery System could better fulfill the initial Walmart Value Proposition of “low cost.” The Walmart strategy never took a pivot – and now they are far, far behind the leader, and rapidly becoming obsolete.
Do you know your Value Proposition? Is it clear – written on the wall somewhere? Or long ago did you stop thinking about your Value Proposition in order to focus your intention on optimizing your Value Delivery System?
That fundamental strategy flaw is killing companies right and left – Radio Shack, Toys-R-Us and dozens of other retailers. Who needs maps when you have smartphone navigation? Smartphones put an end to Rand McNally. Who needs an expensive watch when your phone has time and so much more? Apple Watch sales in 2017 exceeded the entire Swiss watch industry. Who needs CDs when you can stream music? Sony sales and profits were gutted when iPods and iPhones changed the personal entertainment industry. (Anyone remember “boom boxes” and “Walkman”?)
I’ve been a huge fan of Netflix. In 2010, I predicted it was the next Apple or Google. When the company shifted strategy from delivering physical entertainment to streaming in 2011, and the stock tanked, I made the case for buying the stock. In 2015 when the company let investors know it was dumping billions into programming I again said it was strategically right, and recommended Netflix as a good investment. And I redoubled my praise for leadership when the “double pivot” to programming was picking up steam in 2016. You don’t have to be mystical to recognize a winner like Netflix, you just have to realize the company is using its strategy to deliver on its Value Proposition, and is willing to change its Value Delivery System because “core strength” isn’t important when its time to change in order to meet new market needs.
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.)
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.
Poke’Mon Go is a new sensation. Just launched on July 6, the app is already the #1 app in the world – and it isn’t even available in most countries. In less than 2 weeks, from a standing start, Nintendo’s new app is more popular than both Facebook and Snapchat. Based on this success, Nintendo’s equity valuation has jumped 90% in this same short time period.
Some think this is just a fad, after all it is just 2 weeks old. Candy Crush came along and it seemed really popular. But after initial growth its user base stalled and the valuation fell by about 50% as growth in users, time on app and income all fell short of expectations. And, isn’t the world of gaming dominated by the likes of Sony and Microsoft?
A bit of history
Nintendo launched the Wii in 2006 and it was a sensation. Gamers could do things not previously possible. Unit sales exceeded 20m units/year for 2006 through 2009. But Sony (PS4) and Microsoft (Xbox) both powered up their game consoles and started taking share from Nintendo. By 2011 Nintendo sale were down to 11.6m units, and in 2012 sales were off another 50%. The Wii console was losing relevance as competitors thrived.
Sony and Microsoft both invested heavily in their competition. Even though both were unprofitable at the business, neither was ready to concede the market. In fall, 2014 Microsoft raised the competitive ante, spending $2.5B to buy the maker of popular game Minecraft. Nintendo was becoming a market afterthought.
Meanwhile, back in 2009 Nintendo had 70% of the handheld gaming market with its 3DS product. But people started carrying the more versatile smartphones that could talk, text, email, execute endless apps and even had a lot of games – like Tetrus. The market for handheld games pretty much disappeared, dealing Nintendo another blow.
Competitor strategic errors
Fortunately, the bitter “fight to the death” war between Sony and Microsoft kept both focused on their historical game console business. Both kept investing in making the consoles more powerful, with more features, supporting more intense, lifelike games. Microsoft went so far as to implement in Windows 10 the capability for games to be played on Xbox and PCs, even though the PC gaming market had not grown in years. These massive investments were intended to defend their installed base of users, and extend the platform to attract new growth to the traditional, nearly 4 decade old market of game consoles that extends all the way back to Atari.
Both companies did little to address the growing market for mobile gaming. The limited power of mobile devices, and the small screens and poor sound systems made mobile seem like a poor platform for “serious gaming.” While game apps did come out, these were seen as extremely limited and poor quality, not at all competitive to the Sony or Microsoft products. Yes, theoretically Windows 10 would make gaming possible on a Microsoft phone. But the company was not putting investment there. Mobile gaming was simply not serious, and not of interest to the two Goliaths slugging it out for market share.
Building on trends makes all the difference
Back in 2014 I recognized that the console gladiator war was not good for either big company, and recommended Microsoft exit the market. Possibly seeing if Nintendo would take the business in order to remove the cash drain and distraction from Microsoft. Fortunately for Nintendo, that did not happen.
Nintendo observed the ongoing growth in mobile gaming. While Candy Crush may have been a game ignored by serious gamers, it nonetheless developed a big market of users who loved the product. Clearly this demonstrated there was an under-served market for mobile gaming. The mobile trend was real, and it’s gaming needs were unmet.
Simultaneously Nintendo recognized the trend to social. People wanted to play games with other people. And, if possible, the game could bring people together. Even people who don’t know each other. Rather than playing with unseen people located anywhere on the globe, in a pre-organized competition, as console games provided, why not combine the social media elements of connecting with those around you to play a game? Make it both mobile, and social. And the basics of Poke’Mon Go were born.
Then, build out the financial model. Don’t charge to play the game. But once people are in the game charge for in-game elements to help them be more successful. Just as Facebook did in its wildly successful social media game Farmville. The more people enjoyed meeting other people through the game, and the more they played, the more they would buy in-app, or in-game, elements. The social media aspect would keep them wanting to stay connected, and the game is the tool for remaining connected. So you use mobile to connect with vastly more people and draw them together, then social to keep them playing – and spending money.
The underserved market is vastly larger than the over-served market
Nintendo recognized that the under-served mobile gaming market is vastly larger than the overserved console market. Those console gamers have ever more powerful machines, but they are in some ways over-served by all that power. Games do so much that many people simply don’t want to take the time to learn the games, or invest in playing them sitting in a home or office. For many people who never became serious gaming hobbyists, the learning and intensity of serious gaming simply left them with little interest.
But almost everyone has a mobile phone. And almost everyone does some form of social media. And almost everyone enjoys a good game. Give them the right game, built on trends, to catch their attention and the number of potential customers is – literally – in the billions. And all they have to do is download the app. No expensive up-front cost, not much learning, and lots of fun. And thus in two weeks you have millions of new users. Some are traditional gamers. But many are people who would never be a serious gamer – they don’t want a new console or new complicated game. People of all ages and backgrounds could become immediate customers.
David can beat Goliath if you use trends
In the Biblical story, smallish David beat the giant Goliath by using a sling. His new technology allowed him to compete from far enough away that Goliath couldn’t reach David. And David’s tool allowed for delivering a fatal blow without ever touching the giant. The trend toward using tools for hunting and fighting allowed the younger, smaller competitor to beat the incumbent giant.
In business trends are just as important. Any competitor can study trends, see what people want, and then expand their thinking to discover a new way to compete. Nintendo lost the console war, and there was little value in spending vast sums to compete with Sony and Microsoft toe-to-toe. Nintendo saw the mobile game market disintegrate as smartphones emerged. It could have become a footnote in history.
But, instead Nintendo’s leaders built on trends to deliver a product that filled an unmet need – a game that was mobile and social. By meeting that need Nintendo has avoided direct competition, and found a way to dramatically grow its revenues. This is a story about how any competitor can succeed, if they learn how to leverage trends to bring out new products for under-served customers, and avoid costly gladiator competition trying to defend and extend past products.