Lessons on Transformation
The year is 1997 and a little-known start-up is about to revolutionize the way we devour entertainment. The story of Netflix, in my view, is a revealing look at transformation and offers at least some insight that’s relevant outside the entertainment industry.
Recall that the original Netflix service involved renting DVD’s – we hardly know what those are any more – and exchanging them by mail for a monthly subscription. In its early days, Netflix partnered with the US Postal service so that once an envelope was scanned at a local facility, it triggered the shipment of the next DVD in your queue. This was an example of focusing rigorously on improving the known.
In 2007, Netflix began offering streaming service as an add-on to its DVD mail business. In 2009, they offered a streaming only plan for the first time in history. Keep in mind, in 2007 Netflix posted a 7.61% operating margin off $1.2B in revenue. At the time, they were experiencing 9.03% year over year quarterly growth. Their financial health looked rosy in fact, though they sensed trouble on the horizon from the likes of Amazon, Apple and Walmart who were each making forays into direct to consumer video rental digital downloads.
Netflix leadership understood that their core model – plastic discs mailed by the US Postal Service – couldn’t scale. They understood that digital was the future of the content distribution business. While Netflix’s DVD rental business thrived in large part because of the company’s superior logistics and partnership with the Postal Service, leaders recognized that this competitive edge would not mean much in the world of digital distribution. Importantly, they knew developing a digital platform that was desirable would take years. (In fact, their leadership recognized this nearly from Day 1. The company has always been called NET – FLIX after all…not QUICK FLIX).
In 2007, Netflix invested $40MM in server capacity and for licensing titles it didn’t own, much to the chagrin of Wall Street. It was a big bet, though a necessary one to position them for the future.
In 2010, Netflix begin its international expansion, moving into 200 countries within six years. Global expansion was made possible only because of their eye toward scale in transformation. At year end 2016, Netflix posted $8.83B in revenue, ~75% of which derived from their streaming service. Importantly though, it took Netflix nearly 5 years from the time streaming was introduced for their digital only service to constitute 50% of their revenue.
And of course, the story doesn’t stop there. In Netflix third act, with the introduction of House of Cards in 2013, they began their foray into the production of original content. Their server upgrade to make the leap to digital streaming in 2007 – that $40MM investment – was table scraps by comparison to the move into content – in 2017, the company allocated $6B to content alone.
Not only did they fundamentally change the way we consume television – in the form of binge watching – they also demonstrated how the use of sophisticated consumer data on use and preference could help mitigate the risk of producing shows and distributing content anywhere in the world. Netflix knows, for example, the exact countries where Adam Sandler movies are most popular.
Netflix went into the original content generation game largely to fend off established studios who could easily cut off their distribution channel. But make no mistake, this was a years long journey for Netflix to move to a place where the majority of their available streaming content was original.
So what do we learn about transformation from the Netflix example?
Improving the known is necessary but not sufficient to transform. We often start with what we know best, which is how to improve the widget that exists.
It takes courage, vision and persistence to transform in the face of success. Netflix could have easily soared on the wave of its initial product offering. But it understood the inherent problems with its product and core business – like scalability and insufficient convenience – and sought to correct those inadequacies. Using a product mentality, Netflix understood that it would need to retire elements of its core business in order to make the leap. DVD’s as a format would not allow for global expansion, which Netflix understood was required to make significant leaps in growing its platform.
It is necessary to start the transformation journey early because it takes time. A long time. The journey from the development of the on-demand digital platform to a time when 50% of the company’s core business was streaming took nearly 9-years. Which leads to the next critical observation….
Most measures of success are too short term to reward the investment in transformation. Quarterly earnings reports and even annual financial measures may be too blunt of instruments to reward the kinds of successes that can come from investing in transformation. This suggests to me that we need to learn to balance a rigor and discipline of improving operations – the known — with the rigor and discipline of inventing the new.
Transformation, when done right, is a powerful engine for growth and differentiation. Today, Netflix is a $50B juggernaut, with 325+ million subscribers globally, that is revolutionizing the traditional movie and television industries. Their platform has altered human behavior.
