September 2019 - Beyond the Crucible by Warwick Fairfax

One of the most cautionary tales in recent corporate history is how Netflix embraced change and Blockbuster didn’t. As of 2018, Netflix, barely 20 years old, had a stock market value of nearly $165B, with 130 million subscribers in 200 countries. Blockbuster was out of business by then, having filed for bankruptcy in 2010 after incurring more than $1B in losses the previous year.

How did this happen — Netflix’s stunning success and Blockbuster’s equally stunning fall? Netflix embraced change. Blockbuster didn’t.

When Netflix launched in 1997, Blockbuster had for years been the undisputed champion of the video rental industry. Between 1985 and 1992, Blockbuster grew from one location in Dallas to more than 2,800 rental stores worldwide. Netflix competing against Blockbuster seemed like a David vs. Goliath scenario. Hopeless.

But through a series of disruptions and changes to the video/home entertainment industry, the tables turned. In 1997, when VHS video was the industry standard, Reed Hastings, the CEO and founder of Netflix, saw an opportunity to introduce a monthly DVD subscription service by mail. Unlike Blockbuster, there would be no late fees. When customers were finished with their DVD, they would simply return it to Netflix and get another one. Blockbuster initially did not embrace the subscription service model, charging customers per video rental, including late fees. Blockbuster was wedded to its brick-and-mortar retail outlet business model.

In 2007, Netflix transitioned from DVD shipments to online programming. Faster bandwidth and greater download speeds made this new service feasible. But Netflix didn’t stop there. It continued to innovate, creating its own programming, including the highly successful House of Cards TV series. In 2018, Netflix spent $8B annually on new programing to keep its customers bingeing online. In 2019, Netflix received 14 Oscar nominations, winning four. This put Netflix on par with the other major studios for Academy Award wins. Netflix was now a significant player in movie and TV production.

The legacy of Blockbuster, on the other hand, is one of stubbornness and missed opportunities. In 2000, Hastings, head of the still small Netflix, came to Blockbuster, proposing a partnership. Netflix would run Blockbuster’s brand online, while Blockbuster would promote Netflix in its stores. Blockbuster, then the king of the video rental industry, turned Netflix down. Eventually, Blockbuster saw Netflix as a threat. But it was too little, too late. In 2004, John Antioco, then CEO of Blockbuster, proposed eliminating late fees and launching Blockbuster Online. These two initiatives would cost a proposed $200M each. But the Board lost confidence in Antioco. Eliminating late fees would damage profitability. Antioco was fired in 2005. His successor as Blockbuster’s CEO dropped Antioco’s initiatives, which were designed to help Blockbuster compete with Netflix. Five years later in 2010, Blockbuster filed for bankruptcy.

What are the key lessons we can learn from the Blockbuster vs. Netflix saga?

1. Embrace Change

Netflix saw a technological and marketing opportunity to compete with Blockbuster with a subscription by mail DVD service. The company — each step of the way from a DVD subscription service to online video streaming, to online streaming content creation — was continually willing to innovate. Blockbuster saw itself as the video rental king, with locations all over the world. They fell in love with their business model more than they did with satisfying customer needs. Their business model of charging their customers with late fees, while very profitable, was in part based on causing their customers pain.

2. Don’t be Afraid to Fail

Netflix has constantly been willing to try new things. Many have worked out — such as their DVD subscription rental service, online streaming, and online streaming content creation. But some initiatives have not worked out, at least not initially. Netflix made an unsuccessful attempt in the mid-2000s to enter the film-making business, long before it had a large enough audience to make this a financially viable strategy. In 2011, critics ridiculed Netflix for its plans to split steaming and DVD rentals into two services. Hundreds of thousands of customers cancelled their subscriptions in the following months. Blockbuster, on the other hand, was unwilling to take risks. When Blockbuster did decide in 2004 to enter the online video rental business and eliminate late fees, not only was it late to do this, but ownership soon reversed these moves.

3. Be Willing to Disrupt Yourself

While Blockbuster clung to its business model of being a video rental company, Netflix constantly disrupted itself. Netflix went from being a DVD subscription rental service, to a streaming of movies and TV series model, to being a creator of content. Netflix would always try to stay on the cutting edge of innovation, even if it meant disrupting its existing businesses.

4. Corporate Culture is the Key to Being able to Innovate

The key to embracing change, being able to innovate, and seeing disruption as an opportunity is corporate culture. In 2009, Reed Hastings delivered a PowerPoint presentation internally within Netflix about the company’s culture and HR policies. This presentation has been downloaded more than 18 million times. Sheryl Sandberg, the COO of Facebook, says this document might be the most important one ever to come out of Silicon Valley (where Netflix’s headquarters is located). The title of Reed Hastings’ presentation was “Freedom and Responsibility.” In short, Netflix finds brilliant people, pays them well, and gives them freedom to take responsibility for their own work. Hastings said, “Responsible people thrive on freedom and are worthy of freedom.”

It is easy to say, who would want to be Blockbuster over Netflix? But the path Netflix took requires courage and clarity. Know what business you are in (home entertainment, not brick and mortar video rental locations). Be willing to fail, which means hiring great people and encouraging them to take risks. Be willing to hurt your profitability in the short term to stay ahead of the technology and innovation curve. Reward your team, give them a clear mission, and then get out of their way. Very few leaders and companies are willing to do the above. Fear, caution, and pride usually take over.

Reflection

Are you willing to disrupt yourself, even if it hurts your profitability for a time, to stay ahead of the curve?
Are you willing to fail, and have your team experience failure, to ensure your organization continues to innovate?
Do you have the right people on board — people who are willing to take risks — and have you created a climate that both rewards and supports risk taking?

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Change is not easy, which is a major challenge for us because we live in a world that is forever changing. Technology is changing. The market is changing. The culture is changing. Not only is everything around us changing, but it seems that change is happening at an ever-increasing rate.

What makes change difficult for most of us is that human beings yearn for the familiar, so, in a sense, we yearn for things to stay the same. We are caught between a desire to grow and the fear of the disruption change will cause. For many of us, it leads us to stick our heads in the sand and try to let change pass us by while we cling to what we know.

One type of disruptive change is highlighted in Harvard Business School Professor Clayton Christensen’s book, The Innovator’s Dilemma, first published more than 20 years ago. Christensen highlights how smaller companies with fewer resources are able to successfully challenge incumbent businesses with more at their disposal. While incumbent businesses serve the needs of their existing profitable customers, the entrant companies target newer customer needs with different functionality, often at a lower price.

One classic example is Toyota. Toyota entered the U.S. market in the 1960s with a cheap car for people who could not afford the models the big three U.S. automakers (General Motors, Ford, and Chrysler) made. Initially, Toyota did not compete with the Big Three head on, but after building a following, it gradually made more expensive cars, including the upmarket brand Lexus.

Another great example is Kodak. In the late 1970s, Kodak owned around 90 percent of the photography market. But with the advent of digital photography around 2000, Kodak’s dominance slid until the company filed for bankruptcy in 2012. What is remarkable is that Kodak had patents for digital photography but did not utilize them. Why? While Kodak knew digital photography would one day have an impact, it was reluctant to sacrifice revenue it was enjoying in the present.

A business I grew up in, newspapers, is another example of the challenge of embracing change. For years there was talk of the threat and the opportunity of digital versions of newspapers. While most major newspapers currently have both print and online versions, they have largely lost their chief revenue stream. Newspaper revenues from advertising used to predominantly be from classifieds (real estate, automotive, employment). That is not the case today. In many instances, newspapers failed to launch robust online classified advertising, ceding the market to other companies.

The common thread in all these examples? It is hard to embrace change and sacrifice current profitability for future opportunity.

As a leader you have a choice. You can embrace change, or you can put your head in the sand and somehow hope to avoid the tidal wave that might be coming towards you.

The key to keep from winding up all wet when the wave inevitably hits is to change your perspective. Turn an impending challenge (or crisis) into an opportunity. Rather than being fearful or complacent, embrace the challenge. Change is inevitable, so why try to avoid it?

So, what are the keys to embracing change?

Don’t Put Your Head in the Sand – When you are faced with change, be it technological, market driven, cultural, or other types of change, address it head on. Don’t assume that the challenge to your organization will just go away if you do nothing. It won’t. If you are Kodak, recognize the threat and opportunity of digital photography. If you are a newspaper company, recognize the challenge and upside of online newspapers and online advertising.
Have Courage – Be willing to sacrifice some of your current profits to develop the new technology or new opportunity. Embrace the opportunity to disrupt and innovate. Take risks. Even if that means cannibalizing your own business. This is why people fail. They aren’t willing to take risks and possibly hurt themselves in the short term for massive long-term gains.
Innovate or Die – Continually experiment with new technology and new opportunities. See change as a good thing. Stay ahead of the curve so you won’t be left behind.

How do you do this, embrace change and be ahead of the curve?

Identify the Type of Change – Examine whether the change is technological, market driven, cultural, or another type of change. Then come up with a plan to address this change, examining how your organization can use this change to its advantage.
Get Your Team Onboard – Help your team understand that the mission of your organization has not changed, but how that mission will be expressed might change. It’s imperative to have employees who are risk takers and who understand the importance of having an innovative and disruptive culture. Kodak might still be in the business of capturing moments if it had entered digital photography.
Implement the Change – If it is a technological change like digital photography, you might need to set up a separate entity with people who are willing to experiment and lead the change. You will need to help your team realize that their goal is not just to survive amidst the turmoil but to thrive. Change should not be viewed as a threat, but as an opportunity.
Ensure Your Stakeholders Embrace the Change – It is essential that your leadership team and your board are willing to embrace the change. As the leader, it is your job to be the chief advocate and persuader, to ensure your team embraces the change. You have to let them know the real-world consequences to your organization of not embracing the change. Look at what happened to Kodak.

There is a fundamental law of business, and indeed life. You are either growing or declining. You are either adapting, or you are on your way to your organization going under. Don’t stick your head in the sand. Lead the charge. Embrace the change.