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.
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.
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.
Video retailer Blockbuster (and competitor Hollywood Video) are now bankrupt
Video rentals/sales are at an all time high – but via digital downloads not DVDs
Nokia, once the cell phone industry leader, is in deep trouble and risk of failure
Yet mobile use (calls, texts, internet access, email) is at an all time high
These companies are victims of locking-in to old business models, and missing a market shift
Commitment to defending your old business can cause failure, even when participating in high growth markets, if you don’t anticipate, embrace and participate in market shifts
Lock-in is deadly. It can cause you to ignore a market shift.
According to YahooNews, “Blockbuster Video to File Chapter 11.” In February, Movie Gallery – the owner of primary in-kind competitor Hollywood Video – filed for bankruptcy. It’s now decided to liquidate.
The cause is market shift. Netflix made it possible to rent DVDs without the cost of a store – as has the kiosk competitor Red Box. But everyone knows that is just a stopgap, because Netflix and Hulu are leading us all toward a future where there is no physical product at all. We’ll download the things we want to watch. The market is shifting from physical items – video cassettes then DVDs – to downloads. And both Blockbuster and Hollywood Video missed the shift.
Blockbuster (or Hollywood) could have gotten into on-line renting, or kiosks, like its competition. It even could have used profits to be an early developer of downloadable movies. Nothing stopped Blockbuster from investing in YouTube. Except it’s commitment to its Success Formula – as a brick-and-mortar retailer that rented or sold physically reproduced entertainment. Lock-in. And for that commitment to its historical Success Formula the investors now will get a great big goose egg – and employees will get to be laid off – and the thousands of landlords will be left in the lurch, unprepared.
As predictable as Blockbuster was, we can be equally sure about the future of former powerhouse Nokia. Details are provided in the BusinessWeek.com article “How Nokia Fell from Grace.” As the cell phone business exploded in the 1990s Nokia was a big winner. Revenues grew fivefold between 1996 and 2001 as people around the globe gobbled up the new devices. Another example of the fact that when you enter a high growth market you don’t have to be good – just in the right market at the right time.
But the cell phone business has become the mobile device business. And Nokia didn’t anticipate, prepare for or participate in the market shift. From market dominance, it has become an also-ran. The article author blames the failure, and decline, on complacent management. Weak explanation. You can be sure the leadership and management at Nokia was doing all it possibly could to Defend & Extend its cell phone business. The problem is that D&E management doesn’t work when customers simply walk away to a new technology. It may take a few years, and government subsidies may extend Nokia’s life even longer, but Nokia has about as much chance of surviving its market shift as Blockbuster did.
When companies stumble management sees the problems. They know results are faltering. But for decades management has been trained to think that the proper response is to “knuckle down, cut costs, defend the current business at all cost.” Yet, there are more movies rented now than ever – and Blockbuster is failing despite enormous market growth. There are more mobile telephony minutes, text messages, remote emails and mobile internet searches than ever in history – yet Nokia is doing remarkably poorly. It’s not a market problem, it’s a problem of Lock-in to a solution that is now outdated. When the old supplier didn’t give the market what it wanted, the customers went elsewhere. And unwillingness to go with them has left these companies in tatters.
These markets are growing, yet the purveyors of old solutions are failing primarily because they stuck to defending their old business too long. They did not embrace the market shift, and cannibalize historical product sales to enter the new, higher growth markets. Because they chose to protect their “core,” they failed. New victims of Lock-in.
Businesses usually try defending an old solution in the face of an emerging new solution
Status Quo Police use “cannibalization” concerns to stop the organization from moving to new solutions and new markets
If you don’t move early, you end up with a dying business – like newspapers – as new competitors take over the customer relationship – like Apple is doing with news subscriptions
You can adapt to shifting markets, profitably growing
You must disrupt your lock-ins to the old success formula, including stopping the Status Quo Police from using the cannibalization threat
You should set up White Space teams early to embrace the new solutions and figure out how to profitably grow in the new market space
When Sony saw MP3 technology emerging it worked hard to defend sales of CDs and CD Players. It didn’t want to see a decline in the pricing, or revenue, for its existing business. As a result, it was really late to MP3 technology, and Apple took the lead. This is the classic “Innovator’s Dilemma” as described by Professor Clayton Christenson of Harvard. Existing market leaders get so hung up on defending and extending the current business, they fear new solutions, until they become obsolete.
In the 1980s Pizza Hut could see the emergence of Domino’s Pizza. But Pizza Hut felt that delivered pizza would cannibalize the eat-in pizza market management sought to dominate. As a result Pizza Hut barely participated in what became a multi-biliion dollar market for Domino’s and other delivery chains.
The Status Quo Police drag out their favorite word to fight any move into new markets. Cannibalization. They say over and over that if the company moves to the new market solution it will cannibalize existing sales – usually at a lower margin. Sure, there may someday be a future time to compete, but today (and this goes on forever) management should keep close to the existing business model, and protect it.
That’s what the newspapers did. All of them could see the internet emerging as a route to disseminate news. They could see Monster.com, Vehix.com, eBay, CraigsList.com and other sites stealing away their classified ad customers. They could see Google not only moving their content to other sites, but placing ads with that content. Yet, all energy was expended trying to maintain very expensive print advertising, for fear that lower priced internet advertising would cannibalize existing revenues.
Now, bankrupt or nearly so, the newspapers are petrified. The San Jose Mercury News headlines “Apple to Announce Subscription Plan for Newspapers.” As months have passed the newspapers have watched subscriptions fall, and not built a viable internet distribution system. So Apple is taking over the subscription role – and will take a cool third of the subscription revenue to link readers to the iPad on-line newspaper. Absolute fear of cannibalization, and strong internal Status Quo Police, kept the newspapers from embracing the emerging solution. Now they will find themselves beholden to the device providers – Apple’s iPad, Amazon’s Kindle, or a Google Android device.
But it doesn’t have to be that way. Netflix built a profitable growth business delivering DVDs to subscribers. Streaming video clearly would cannibalize revenues, because the price is lower than DVDs. But Netflix chose to embrace streaming – to its great betterment! The Wrap headlines “Why Hollywood should be Afraid of Netfilx – Very Afraid.” As reported, Netflix is now growing even FASTER with its streaming video – and at a good margin. The price per item may be lower – but the volume is sooooo much higher!
Had Netflix defended its old model it was at risk of obsolescence by Hulu.com, Google, YouTube or any of several other video providers. It could have tried to slow switching to streaming by working to defend its DVD “core.” But by embracing the market shift Netflix is now in a leading position as a distributor of streaming content. This makes Netfilx a very powerful company when negotiating distribution rights with producers of movie or television content (thus the Hollywood fear.) By embracing the market shift, and the future solution, Netflix is expanding its business opportunity AND growing revenue profitably.
Don’t let fear of cannibalization, pushed by the Status Quo Police, stop your business from moving with market shifts. Such fear will make you like the proverbial deer, stuck on the road, staring at the headlights of an oncoming auto — and eventually dead. Embrace the market shift, Disrupt your Locked-in thoughts (like “we distribute DVDs”) and set up White Space teams to figure out how you can profitably grow in the new market!
Most people misunderstand evolution. They think that changes happen slowly. Imagine an animal with a 12 inch tail. Every generation or so it's imagined that the tail gets a little shorter, then a little shorter, then a little shorter until after some very long time it simply disappears. But that's not at all how evolution works.
Instead, most of the animals have a long tail. Some small number of animals are born each year with very short or no tails. For the most part, this matters little. If the tail is valuable – say for warding off parasites – those without tails may suffer and die off quickly. And that's the way things are, largely unchanged, for decades. But then, something happens in the environment. Perhaps the emergence of a predator able to catch these animals by the tail and hold them in place to let the pack kill it. Within one generation almost all of the tailed animals are killed by the predator, and only the no-tail animals survive. Some of these have developed an immunity to the parasite. So then this "evolved" animal becomes dominant. No-tail animals replace the tailed animals. That's how evolution really works. It happens fast, with drastic change (and this time of change is referred to as a punctuated equilibrium.)
Once we know how evolution really works, we can start to better understand business competition. A Success Formula works for a really long time, until something changes in the marketplace. Suddenly, the old Success Formula has far poorer results. And a replacement takes over.
Consider newspapers. They played a very important role in society for at least 100 years (maybe 200 or 300 hundred years.) But with the advent of the internet, their role is no longer viable. Printing and delivering a daily paper is too expensive for the value it can provide. So think of newspapers as the long-tail animal. And digital news delivery is a short-tail animal. The internet is the attack pack that kills the newspapers. And within short order, the world is a different place – in a new equilibrium. And everything about the surrounding environment is shifted. Regardless of how much you enjoyed newspapers, they simply cannot compete and new competitors are a better fit in the new marketplace.
Now consider Netflix. Netflix played a major influence in obsoleting traditional movie rental shops – like Blockbuster. Netflix was a winner. But markets – new attack packs – keep emerging. And the latest shift are products like the Kindle and Apple Tablet (as well as other tablet PCs.) These products make Hulu and YouTube a lot more viable. Suddenly, Netflix is the long-tail animal, and the short-tail animals are doing relatively better.
According to The Wall Street Journal, in "Apple Sees New Money in Old Media" Apple is close to a deal with several newspapers to deliver their content to readers via their internet device. They also are negotiating rights to deliver movies and television (small format) entertainment. Simultaneously, Amazon keeps marching forward as MediaPost.com reports in "Take That Apple: Kindle Introduces Apps." We see that there are a LOT of potential different versions of the short-tail animal. Tablets, phones, netbooks, etc. Which will be the biggest winners? Not clear. But what is clear is that the old long-tail competitors (newspapers, print magazines, network television, traditional PCs) are not going to flourish as they once did. The market has permanently shifted. Those competitors are in the back end of their lifecycle.
Simultaneously, this market shift causes ripple effects through the environment. The market shift affects ALL players – not just the one most visibly being attacked. So, as SiliconBeat.com reports in "Looks Like Netflix is Dead, Again" this change suddenly imperils Netflix which has mostly counted on postal delivery rather than digital. And it provides a boost to short-tail players like Hulu and YouTube which could see much larger revenue given their digital-based delivery models.
And this affects you. What do you print, or say, that could be better handled on a mobile device? Could you deliver user instructions via an iPhone or Kindle app? If so, why aren't you doing it? Are you still working on traditional web pages, with embedded text in graphics that can't be seen by a mobile phone, when most people are likely to find you first on their mobile device? Are you busy working on your web site, while ignoring having a Linked-in or Facebook account? Are you advertising on television, or in newspapers, and ignoring Facebook ads – or YouTube links? Do you have a YouTube channel with short clips to instruct users on your product, or how to install an upgrade, or even why to buy? Are you still competing with a long tail, while the pack is rapidly killing off the long-tail species?
Market shifts are happening fast today. If you don't react, you just may find yourself deep into the pack with declining results. Or you can shift with the market to keep your business competitive.
If you try standing in the way of a market shift you are going to get treated like the poor cowboy who stands in front of a cattle stampede. The outcome isn't pretty. Yet, we still have lots of leaders trying to Defend & Extend their business with techniques that are detrimental to customers. And likely to have the same impact on customers as the cowpoke shooting a pistol over the head of the herd.
Book publishers have a lot to worry about. Honestly, when did you last read a book? Every year the demand for books declines as people switch reading habits to shorter formats. And book readership becomes more concentrated in the small percentage of folks that read a LOT of books. And those folks are moving faster and faster to Kindle type digital e-book devices. So the market shift is pretty clear.
Yet according to the Wall Street Journal Scribner (division of Simon & Schuster) is delaying the release of Stephen King's latest book in e-format ("Publisher Delays Stephen King eBook"). They want to sell more printed books, so they hope to force the market to buy more paper copies by delaying the ebook for 6 weeks. They think that people will want to give this book as a gift, so they'll buy the paper copy because the ebook won't be out until 12/24.
So what will happen? Kindle readers I know don't want a paper book. They wait. Giving them a paper copy would create a reaction like "Oh, you shouldn't have. I mean, really, you shouldn't have." So the idea that this gets more printed books to e-reader owners is faulty. That also means that the several thousand copies which would get sold for e-readers don't. So you end up with lots of paper inventory, and unsatisfactory sales of both formats. That's called "lose-lose." And that's the kind of outcome you can expect when trying to Defend & Extend an outdated Success Formula.
Simultaneously, as book sales become fewer and more concentrated a higher percent of volume falls onto fewer titles. And that is exactly where WalMart, Target and Amazon compete.High volume, and for 2 of the 3 companies, limited selection. This gives the reseller more negotiating clout against the publisher. So as the big retailers look for ways to get people in the store, they are willing to sell books at below cost – loss leaders.
So now publishers are joining with the American Booksellers Association to seek an anti-trust case against the big retailers according to the Wall Street Journal again in "Are Amazon, WalMart and Target acting like Predators?" . Publishers want to try Defending their old pricing models, and as that crumbles in the face of market shifts they try using lawyers to stop the shift. That will probably work just as well as the lawsuits music publishers tried using to stop the distribution of MP3 tunes. Those lawsuits ended up making no difference at all in the shift to digital music consumption and distribution.
"Movie Fans Might Have to Wait To Rent New DVD Releases" is the Los Angeles Times headline. The studios like 20th Century Fox, Universal and Warner Brothers want individuals to buy more DVDs. So their plan is to refuse to sell DVDs to rental outfits like Netflix, Redbox and Blockbuster. Just like Scribner with its Stephen King book, they are hoping that people won't wait for the rental opportunity and will feel forced to go buy a copy. Like that's the direction the market is heading – right?
If they wanted to make a lot of money, the studios would be working hard to find a way to deliver digital format movies as fast as possible to people's PCs – the equivalent of iTunes for movies – not trying to limit distribution! That the market is shifting away from DVD sales is just like the shift away from music CD sales, and will not be fixed by making it harder to rent movies. Although it might increase the amount of piracy – just like similar actions backfired on the music studios 8 years ago.
Defending & Extending a business only works when it is in the Rapids of market growth. When growth slows, the market is moving on. Trying to somehow stop that shift never works. Only an arrogant internally-focused manager would think that the company can keep markets from shifting in a globally connected digital world. Consumers will move fast to what they want, and if they see a block they just run right over it – or go where you least want them to go (like to pirates out of China or Korea.)
They only way to deal with market shifts is to get on board. "Skate to where the puck will be" is the over-used Wayne Gretzsky quote. Be first to get there, and you can create a new Success Formula that captures value of new growth markets. And that's a lot more fun than getting trampled under a herd of shifting customers that you simply cannot control.
