Seeing Around Corners

by Rita McGrath

  So, by 2000, there was widespread agreement about the eventual transition to streaming of video on demand. And yet, it took the better part of the following decade for companies like Netflix to make this a reality. This again illustrates the “gradually, then suddenly” principle of inflection points. As Jeff Bezos has observed, it isn’t usually all that difficult to identify key trends. The hard part is knowing when to move and bringing the organization with you when you decide to take action.

  Before we get into the streaming wars, however, let’s have a look at how Netflix established its powerful position in people’s homes by capitalizing on a different business model than the one Blockbuster had put forth.

  Capitalizing on Negative Attributes of an Incumbent’s Offering

  At the time Netflix was launched, its competitor Blockbuster occupied a strong position in the everyday lives of consumers. It had millions of customers and thousands of store locations, incredible brand recognition, and, at its peak in 2004, revenue of more than $6 billion. But the dirty little secret behind Blockbuster’s business model was that customer-irritating late fees accounted for a significant percentage of its profits. According to one source, in 2000 the company earned $800 million in such fees, or 16 percent of its revenue.

  In other words, the most significant factor contributing to the company’s success was the penalties imposed on its customers. That is what I would call a “tolerable” attribute, a concept that was introduced in the previous chapter. This is a basic feature that customers view negatively. As the word implies, customers will tolerate negative features as long as they do not feel they have viable alternatives. Once something comes along that allows them to capture the benefits they seek but eliminates the “tolerable” feature, that attribute becomes a “dissatisfier” and eventually an “enrager.” Netflix took advantage of this DVD inflection point to introduce an entirely different model for its customers, one that eliminated the enrager of excessive fees.

  Now, the folks over at Blockbuster were not blind to this. Observers report that CEO John Antioco started to take action on the threat that Netflix (and other nascent streaming services) represented around 2004. (Recall, that was the peak for Blockbuster in revenue terms.) He led a move to discontinue late fees and launch a subscription service. On top of that, he had the idea of leveraging Blockbuster’s considerable brick-and-mortar presence to offer something Netflix couldn’t at the time—immediate gratification. Done watching your movie? Want to get another one right away? No problem—head over to your local Blockbuster, hand in the one that you’re done with, and pick up a new one immediately. The new initiative was called Total Access.

  At the time, it was widely hailed as a strategic breakthrough. One breathless observer noted, “All of a sudden, all of that expensive real-estate and infrastructure is no longer a liability for Blockbuster—it is an enormous advantage that Netflix simply can’t match.”

  Antioco’s initiatives, however, were going to cost the firm serious money, and also depress short-term profitability, as is often the case when a business needs to go through a strategic inflection point. Carl Icahn, an activist investor, entered the fray, putting members of his own preference on the board and eventually easing Antioco out. Under his successor, Jim Keyes, Antioco’s changes were reversed, and Blockbuster stubbornly tried to hold off the inflection point. The company went bankrupt in 2010.

  The Blockbuster versus Netflix story illustrates why inflection points can open up areas of real opportunity. Many incumbent providers of all kinds of services accumulate negatives in their offerings over time, as Blockbuster did with its late fees. When an inflection point opens up the possibility to escape the negative, customers often depart, transferring their resources and relationship to a more accommodating provider. In other words, customers “escape” the incumbent and start doing business with the new provider. It is hard work for an incumbent to apply that kind of reinvention to itself. This is why the story of how Netflix transitioned its business model is such an interesting one.

  Seeing an Inflection Point Coming, but Moving Faster Than Its Customers Could Accept

  Consider a rare misstep by Netflix. Its original success stemmed from doing the job of providing customers with movie rentals in a convenient, affordable way. In its original model, customers paid a monthly subscription fee to receive mail-ordered DVDs of movies. They could create a “queue” of movies they wanted to see. When they returned a DVD to Netflix, the next one in the queue was sent to them.

  As mentioned earlier, predictions that video on demand would shift to a streaming format had been made since the late 1990s. The real challenge for leaders is to identify the point at which it makes sense to take action with respect to such a pending inflection point. With the spreading availability of high-speed Internet connections, Reed Hastings and his team at Netflix began a modest experiment to see whether the time might be right for at least some of their users to try the new format. Given what was possible at the time, the quality of streamed movies was going to be far inferior to that of those seen on DVDs or Blu-ray discs, but the movies would be available immediately.

  Netflix launched its Watch Now service in January of 2007. It offered about a thousand titles in that format, ranging from classics such as Casablanca to cult movies, foreign films, and miniseries. The goal at that point was to offer something for everyone from the Netflix archives. At the time, users paid $5.99 per month for the plan, which got them six hours of streaming per month.

  When launching Watch Now, Hastings said, “We named our company Netflix in 1998 because we believed Internet-based movie rental represented the future, first as a means of improving service and selection, and then as a means of movie delivery. While mainstream consumer adoption of online movie watching will take a number of years due to content and technology hurdles, the time is right for Netflix to take the first step.”

  The streaming business was economically attractive for the company, eliminating the need for the cumbersome activities involved in mailing DVDs around. Netflix was so confident in the anticipated growth of the streaming service that they circulated a widely viewed chart in 2010 projecting that the DVD business would peak in 2013 and that streaming would almost entirely replace it in the subsequent years. As they said at the time in an investor presentation, “The goal is to have content so broad, engaging and affordable that everyone subscribes to Netflix.”

  The framework presented in the previous chapter can be used to evaluate the advent of economically viable streaming. As always, it’s smart to begin with the limiting pot of resources for which an organization is contesting. In this case, that pot is household spending on entertainment. Given that, the situation (who, what, where) might well evolve from predominantly the living room at home to anywhere people would like to consume content, especially in light of the advent of greater mobility and faster cellular service.

  The job to be done likewise might expand beyond just watching a movie on a weeknight to the popular distraction of binge-watching entire series. The consumption chain would change dramatically—from queues, mailboxes, and the iconic red envelope with a DVD inside, to simply and conveniently clicking on an app on a smart device and watching on demand.

  And the capabilities also would change—from a business with heavy physical dimensions that creates, stores, and mails DVDs to one that offers an entirely digital experience. All the key metrics used to manage the DVD business would change should streaming become the platform of choice.

  Hastings felt that it would be foolhardy to keep the two businesses together. Aside from the Netflix brand and its well-developed relationship with content providers, there were few commonalities, as the metrics, investments, and drivers of success would all be different. Even the attributes used to watch on a streaming platform would be different. Netflix envisioned a purely digital consumption experience without the negatives associated with DVDs (needing a separate player, having to physically insert the DVD, having a limited nu
mber of physical places where they could be viewed).

  Given this belief, Hastings made a fateful choice in July of 2011. Since he felt strongly that the future was going to be streaming and the DVD business was going to decline, he decided to separate the streaming business from the DVD mail-order business. The DVD business would be transferred to a subsidiary called Qwikster. Customers would pay separately for the DVD service and the streaming service. Pricing would change from an all-inclusive subscription of $9.99 per month for both DVD mailing and streaming to $7.99 per month for either the instant streaming plan or the DVD plan alone. In effect, customers who wanted to retain both services would now have to pay $15.98 per month.

  Customers mutinied. They perceived the price change not as an offering to provide them with greater choice, but rather as a massive price hike for a service they had been receiving for $9.99 per month. Plus, the content available via streaming was more limited than that available on DVDs, leading many customers to declare that they would drop the streaming part of their subscriptions. Even more infuriating for customers who subscribed to both services, they would have to establish two queues for the two services. The fallout was so severe that by October of that year, reports with headlines such as “Netflix Facing a Fight Against Obsolescence” began to appear. Some 800,000 customers defected from the service.

  The Qwikster concept was quickly dropped, and Netflix returned to a bundled price.

  You can think of this as a case of moving too quickly in anticipation of an inflection point. Yes, streaming was likely to be an important and essential way in which the job of accessing entertainment and content on demand would be met in the future. But trying to force customers to give up convenience, flexibility, and an affordable price to do it generated nothing but anger on their part.

  What to Do About the Looming Inflection?

  This nonetheless left Hastings and his team with an unsolved problem: the future might well be streaming, but the profits of today were delivered by DVD. The solution was to quietly implement what the original split was intended to accomplish: create a separate business with its own URL (DVD.com), its own business structure, and its own operations. The URL was purchased in March of 2012, and at that time Netflix said it was for “defensive” reasons.

  The streaming side of the business would focus on growing its customer base around the world, while the DVD side would focus on increasing efficiency and maintaining profits even as subscriber numbers dwindled. The two groups have separate management teams, are located in headquarters some distance apart, use different metrics, and incentivize their people differently. By 2018, the streaming business reported 118 million subscribers worldwide. The DVD division reported 3.4 million subscribers, down from around 20 million at its peak in 2010. Hank Breeggemann, a longtime Netflix leader, was put in charge of the DVD business, freeing up Hastings to focus on the next big inflection point in the entertainment world—the creation of original content.

  The move into original content reflected a change on the part of incumbent content owners. While for years they had been happy to license their reruns and past shows to Netflix, often for considerable amounts of cash, once the company began to show consumers how pleasant a streaming, ad-free environment could be, and for a very reasonable price, loyalty to the vaunted cable bundle began to erode. To preserve the status quo, content owners began to reverse course on letting Netflix show their programs. This was probably too little, too late for the incumbents because, as one reporter noted, “every minute, another six people will cut the cord.”

  Netflix was not the first to venture into the production of original content, but relative to others, it had one enormous advantage: fifteen years of incredibly rich data on what customers enjoyed watching. With the decision to enter the world of creating original content, Netflix managed to pull off an amazing feat—content so desirable that reportedly 75 percent of all US households now subscribe to the streaming service. The company’s mission today reads as follows:

  We strive to win more of our members’ “moments of truth.” Those decision points are, say, at 7:15 pm when a member wants to relax, enjoy a shared experience with friends and family, or is bored. The member could choose Netflix, or a multitude of other options.

  How Easing Customer Frustration Can Change an Arena

  In the previous chapter, we reviewed some hypotheses about how an inflection point might change a business and potentially open up new opportunities. We examined how a change in decision-making around teen spending (the available resources in the arena’s context) created an inflection point as spending on communications and the Internet squeezed out spending on apparel. As we saw, this shift hurt many traditional retailers, but it benefited others that were prepared—whether by fortune or by strategy—to respond to the advent of fast fashion.

  So far in this chapter, we have studied how Netflix took advantage of an opportunity to do the job of providing rented entertainment better than Blockbuster, which had loaded this job with one big negative (late fees). We’ve also examined how challenging it was for Netflix to go through the next transition, from DVD to streaming, and from there to becoming a streaming-centered creator of original content, while still preserving its existing core business profitably.

  Three analytical lenses intersect in this example. The first is the consumption chain, which reflects the journey customers go through as they interact with an organization. Reed Hastings famously ignored a friend’s advice that he would not want to manage two queues for entertainment content, failing to understand that this was a less desirable customer experience than the one they already had. The second lens is the attribute map, which highlights how customers react to the features of an offering at various points in the chain. In this case, customers were enraged at what they perceived to be a price hike for a lower-quality service. The third is the job to be done, or what customers are trying to achieve, which motivates their behavior at any given link in the chain.

  When you identify a barrier to achieving a job to be done, you have identified a vital point at which an inflection might change the arena. You need to understand the barriers, obstacles, and frictions that get in the way of customers and other key stakeholders getting what they want out of a given situation. And you can’t rely on asking them. Even when a situation may be poorly designed or may frustrate them, they may not be aware of this. You may see them unconsciously engage in workarounds, simply put up with the inconvenience, or—worst case—do without an offering altogether because it doesn’t do the job well.

  The Next Inflection for Netflix?

  Despite its success, it is clear that the next round of competition for Netflix will be different from the last. Rather than simply being a conduit for content, it is now going directly into competition with original content providers by creating its own shows. And not just low-budget, cheap and cheerful shows either. In 2018, Netflix released three original movies directly into theaters—before offering them on its streaming platform. The company decided to do this so that the films would qualify for coveted Academy Awards, for work both in front of the camera and behind it. The team at Netflix clearly feels that original content is essential to maintaining subscriber loyalty and that top on-screen talent is key to the quality of that content.

  This comes in the wake of some content providers, surprised perhaps at how effectively Netflix has grown its subscriber base (and reduced the attractiveness of bundled cable programming), parting ways with the company. Disney Studios has announced that it intends to remove its content from Netflix and introduce a competing streaming service, Disney+. AT&T, which now owns Warner Media, another major content producer, is also likely to part ways with Netflix and launch its own streaming service. Many of the large cable companies, such as Comcast, already offer streaming bundled in with their cable fees, On Demand movies and programming, and Pay-Per-View, for which they charge.

  Interestingly, Hastings and his team seem prepared for the reactions of competi
tors. This is perhaps because they are thinking in terms of arenas, not in terms of the standard or conventional television industry. Netflix has very deliberately not defined its arena in terms of traditional television. Instead, it has framed its challenge in terms of increasing the percentage of their leisure time its members spend on the service. As their investor messaging says:

  We compete with all the activities that consumers have at their disposal in their leisure time. This includes watching content on other streaming services, linear TV, DVD or TVOD but also reading a book, surfing YouTube, playing video games, socializing on Facebook, going out to dinner with friends or enjoying a glass of wine with their partner, just to name a few. We earn a tiny fraction of consumers’ time and money, and have lots of opportunity to win more share of leisure time, if we can keep improving.

  Imagine—a network large enough to rival Facebook’s, for which subscribers actually pay, without the data collection that could eventually run afoul of regulators and members themselves. This may well represent the next inflection point for the streaming entertainment business.

  Why Cell Phones Get the Job Done Better Than Traditional Cameras

  Remember, a useful way to think about potential customers is to consider the jobs they are trying to get done in their own lives and how a shift in constraints can have an effect on how those jobs get done. A powerful source of inspiration with respect to the next inflection point is to consider what gets in the way of customers achieving their goals. This means that paying attention to the situations potential customers are in, what they are trying to achieve, and what outcomes they seek is key.