Hi guys, welcome back to Entrepreneurial Strategic Management. We are in module five, this is part three. We are discussing an approach to strategy to business success and business performance, that attempts to predict the future to some degree. And we've made an argument that Clayton Christensen's model or approach to innovation and strategy can help us understand business success in all sectors, whether it be a technology based firm or a non-technology based company. And we've introduced you to this model, which we hope has made sense. What we want to do to try to help add further foundation to this model is to give you a case, a case study. And we're going to look at the company Netflix in order to try to understand how disruption can incur in a market or an industry. And I want you to think in your own country, and different places are at different progress points, with respect to technological adoption. So I understand that your country might be at a different point, perhaps more advanced than what I will refer to, or perhaps still catching up to some degree. So Netflix is a technology that exists to allow you to view movies and other media content such as TV shows, television shows, on your computer or on your TV using high-speed Internet connections. But that's not how they got started. Let's go back to the 1990's, and I'm referring to the United States market. Again, your market may be experiencing a different pace of progress. And some of you may say that it's not progress, but that's another story. But in the 1990's, most people around the world who consumed movies in their home did so on a VCR, a video cassette recorder player. And most people rented videotapes that had recordings of movies on them in order to enjoy these films at home. And during the 1990's, there was a lot of consolidation in the United States market where you could rent movies. During the 1980's, there was a lot of fragmentation or decentralization of the market. There were a lot of what we call in English, mom and pop shops, local companies that rented videos. And in the 1990's, several major competitors, Blockbuster Video and Hollywood Video in the United States, established themselves by acquiring many of these local and regional video stores as the major competitors in the sector industry. And I want you to think for a couple of minutes, and this is important to understand this model, how it is that, that process was undertaken to rent a video. And I want you to think about the model that the business was undertaking to make money. First, let's talk about the experience for you and for me as a consumer. Well, it was wonderful to us that we got to go rent a movie and watch it in our home. Prior to that, watching a movie involved going to a theater. You had to schedule a time and it was more expensive, and that model still exists. But once the movie stopped being displayed in the movie theater, it was difficult to enjoy it later, unless you happened to subscribe to a cable channel that showed the movie. And so that was a wonderful innovation to the market, to have video stores that would rent you a movie. And the approach was that you would join the video store as a member and that you would have a card. You would use it to check out movies. Think about for a minute or so as we discuss this, how it is that you selected or chose the movie that you would watch. Who told you which movie to go see, and which movies were you interested in watching at the time? There probably are a lot of answers to that question. You probably got recommendations for movies from friends. You probably watched repeated times movies that you enjoyed. You probably waited to rent movies that you had seen already in the theater or that you knew had been released in a theater, but you hadn't had a chance to see. And so the video stores had a tendency to stock or to have an inventory, a large number of copies, and they needed a physical copy of the movie in the store. And so when you went there, the majority of the inventory seemed to be, or the highest percentage of the inventory seemed to be in newer movies, the newest releases. They also had an inventory of older movies. The inventory though was limited to the physical space of the store. And physical space is expensive, so it was not an unlimited ability to store movies. And so you might go there, and if you didn't know what you wanted to watch, if you'd already seen everything that was new that you wanted to see, you might spend some time walking around wondering what to watch. And you might even ask an employee of the store what they recommended. You might notice what other people were watching. So you got the video, maybe you decided beforehand that you were going to watch a movie that night. Maybe as you were driving home, you stopped at the store, or as you were walking down the street, if you live in a large metropolitan area, and you rented the movie. And then once you rented it, you viewed it and there was a period of time by which you needed to return the movie, which involved another trip to the video store. Now, this might seem tedious to go through these steps, but it's very important to understand that process, the consumption process, to understand Dr. Christensen's model. Because if you read one of his books, you'll see that he makes the argument that we are all hiring products or services to solve a problem, or to fulfill a job or task that we need accomplished in our lives. With renting a movie we probably were attempting to solve the problem of boredom, not having anything to do. We solved the problem of needing some excitement or an escape in our life, right? We enjoy movies for that. We want to participate in art, and many movies are part of that sector of the market. So there are a lot of reasons that we are hiring a movie to fulfill a task or job for us in our lives. And the major video store chains, which became international companies, international businesses, played a role in that solution to our lives, and did very well for a long time. What we're going to look at in the next part is how the video rental market began to be disrupted. And we're going to point out some very important factors to try to understand this model from this case. So that took longer than I thought. This is why I think I'll probably end up going halfway into six today. But we'll see. Or maybe this'll be super long, but I don't know. Okay, I'll pick it right back up. So, you might remember that we've been discussing Blockbuster Video, and Hollywood Video, and the movie rental business that was very popular and was very strong in the 1990's. You'll probably remember, or know that in the 2000's, DVDs became popular, they were a technology that many people began to utilize. And they had some advantages over the videotape, and the major rental companies, like Blockbuster and Hollywood Video, adopted them. And so in the 2000's you began to see videotapes and DVDs, or digital video discs, being offered in the same stores. DVDs had an advantage that they were easier to copy, faster to copy, they were better quality than videotapes, there was more storage capability so extra features could be stored. Fast forwarding was much faster and they took up much less space. And so the DVD technology was one of the most widely adopted and the fastest adopted in history, faster than radio for sure. Also, the price of a DVD player dropped very, very quickly in the early 2000's. And so, DVD acceptance, or usage, by the average consumer happened very quickly. And so we're stating all this to set the stage, that Blockbuster and Hollywood took advantage of a sustaining innovation, which was the DVD, and that was definitely an improvement for the average customer. The overall experience didn't change. You still had to go to the store, you still had to get it from them. You still didn't know which movie to watch or had to find a recommendation of which movie to watch, or figure out ultimately, what to watch, and you still had to return it. And if you didn't return it on time, you still had to pay a late fee, and you still were limited by the movies in stock at the physical store that you frequented. So, and by the way, you often had to return it to the same store that you rented it from. By the mid to late 1990's, Netflix, now a major company as we sit here in 2015 discussing it, emerged on the scene. And what Netflix did as its first approach to business was to change completely the model for individuals who wanted to consume videos in their own homes or watch movies at home. What they did is they had much more in terms of diversity and variety in stock. Where a local store might have a few hundred titles, the Netflix catalog included you know, tens of thousands of movies. Foreign films of all languages, older films, obscure or very rare films. And their approach was much different. They offered to you for one flat fee, rather than per item, unlimited viewing of videos in your home. So as fast as you could watch them, if you returned them, you could get another and watch as many as you could in a month. What Netflix did is they charged you this flat fee, and they mailed you, using the United States Postal Service, digital copies, DVDs, of movies. So it's very important to understand that Netflix saw DVDs as a very important innovation. They were smaller and lighter, and therefore, could be easier and much less expensively mailed and quickly. And so that was their model, is you went on their website and you selected the movies you wanted to watch. It gave you recommendations, which was a huge innovation at the time. It used algorithms and big data to try to predict what movies, based on what you rented in the past, would like in the future. So that was a huge pro for the consumer. The added variety and the breadth of the catalog was also a huge advantage that they had over their competitors, such as Blockbuster. You also could keep it longer, so if it took you a week to watch it, you didn't have to pay a late fee. This was something that in the late 90's was making people very mad about Blockbuster. They would forget to watch a movie or even misplace it, and end up spending more than it would have cost to purchase it in late fees. And so people were beginning to get a little bit upset with Blockbuster. What Blockbuster and Hollywood had as an advantage at the time was convenience. They were physically located all around any given community, and so you could get there relatively quickly. The main disadvantage for Netflix when it started out was the fact that you had to wait two or three days to get the movie. So you had to plan ahead when you were going to want to watch it. You couldn't impulsively watch a movie like you might be able to with Blockbuster. Even though you had to drive to Blockbuster and rent it, you still could do it rather impulsively. With Netflix you had to plan. Secondly, you might have to wait for these titles to be available. They also had limited numbers of new releases, and so the top five movies that you wanted to see might not be in stock and so you might have to wait as well. You might even have to wait a longer period of time. And to return the video took longer, right? You had to send it back in the mail. That was part of the flat fee you paid was all the postage costs, but it still was a disadvantage compared to Blockbuster. What we're describing here, guys, is this green line. We're describing Netflix being much, or far below, this red line of the average benefits that the average customer would expect from a service or a product. Netflix wasn't good enough for the average customer in 1999. Many people didn't have high-speed Internet. Most people in the world didn't have access to a solid mailing system that was fast, so it was limited to the United States, for example. And it took more planning and more work, and more time to get the videos, even though you could see more exotic or rare films than you could otherwise. And so the point is, what you want to gain from this is, why is it that in 1999 or 2000 Blockbuster ignored Netflix? And that's the typical explanation that you probably have heard in the business press, is that the managers of Blockbuster were simply ignorant, or unintelligent, dumb, that they should have done what everybody could see coming, which was see the threat from Netflix. And more specifically, see the threat of people becoming frustrated with late fees and with not knowing which movie to watch, the lack of recommendation ability in the Blockbuster model. The truth is, guys, that they did see all those threats. The problem is that there were a million, and that's an exaggeration, I admit, there were a large number of other threats that occurred and no one knew in 2000 which one was the real threat. No one knew in 2000 if Netflix was going to last more than one year. Blockbuster did in fact offer competing services to many of the innovations that Netflix and other companies came out with. What we're going to see in the next part is what it was that Blockbuster was focused on that led them to not be able to respond to the threat of Netflix in the way that we with the value of hindsight think they should have.
