Last updated: September 22, 2011 3:02 pm

Innovators don’t ignore customers

Customers don’t care about corporate structures, cash flows, technologies and growth ratings. They care about service
Pinn illustration

According to the business textbooks, Reed Hastings is a visionary and innovator. But thousands of his customers, and many of his investors, think the chief executive of Netflix is an idiot.

The DVD rental and online film service is “going to be held up as a gold standard of how to avoid being disrupted”, Clayton Christensen, the Harvard Business School professor and author of The Innovator’s Dilemma, tweeted this week. As he opined, Netflix shares were dropping rapidly and 25,000 of its customers were posting irate protests at having their service disrupted.

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John Gapper

I’m with them. Mr Hastings is the latest chief executive to blow up his company in response to changes sweeping the media and technology industries – Léo Apotheker was just as explosive at Hewlett-Packard last month. But no matter how solid the logic and brave the strategy, it has to carry people with it.

In practice, there was a vast gulf between what customers wanted – largely what they had already – and Mr Hastings’ vision of his company’s future. He rebranded its declining DVD rental operation Qwikster (yes, seriously), confined the Netflix name to its high-growth but immature online streaming service, and imposed a 60 per cent price increase on subscribers to both.

He did not help matters with his online apology – “I messed up. I owe everyone an explanation” – in which he claimed that the problem was that Netflix “lacked respect and humility” in how it had explained the price rise, rather than the rise itself. He antagonised his audience further with the rebranding.

The fall in the shares – 13 per cent on Monday and Tuesday and by more than half in two months – does not matter so much. They had risen sixfold in three years on hopes that Netflix was seamlessly adapting to the digital era, and even if Mr Hastings had not clumsily made that error clear, they would have adjusted eventually. But the customer revolt has long-term consequences.

Mr Hastings is not alone in struggling with upheaval. Many technology and media companies – from Microsoft to Time Warner and News Corp – now own businesses that produce plenty of cash but grow slowly, if at all, alongside promising digital operations.

Such divergence of activities under one roof is nothing new. The Boston Consulting Group came up with its famous matrix dividing businesses into cash cows, question marks, stars and dogs (now politely renamed “pets”) in 1968. On that matrix, Netflix has a cash cow in Qwikster and a star with trailing question marks in streaming.

The traditional prescription was for businesses to reinvest the proceeds of cash cows into stars, which is what Netflix did until now. It launched a free streaming service in 2007 and later bundled it with its monthly DVD subscriptions for $2 extra a month. In July, however, it abruptly abandoned bundling and forced those who wanted both services to pay twice.

Mr Hastings was influenced by Prof Christensen’s work which has rightly become a set text in Silicon Valley. As Prof Christensen noted in 1996, well-managed companies can fall prey to new technologies that are “simpler, cheaper and more convenient” than their own.

He recommended that those faced with the dilemma of whether to stick with incremental improvement of products, or act radically by cannibalising their business before someone else did, should choose the latter. Companies often lost their way “precisely because they listened to their [existing] customers”.

Mr Hastings added this week: “Most companies that are great at something – like AOL dial-up or Borders book stores – do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business ... Companies rarely die from moving too fast and they frequently die from moving too slowly.”

Leaving aside the fallacy in the last sentence (many companies die from making things that too few people yet want; that’s how markets work) his missive felt squarely aimed at the wrong audience – business strategists, professors and managers, rather than customers.

Customers don’t care about corporate structures, cash flows, technologies and growth ratings. They care about whether the familiar envelope containing a DVD arrives on time and whether they can stream a good selection of films at a decent price without their television screens freezing. They were not holding Netflix back from streaming – they were adopting it.

Netflix has been extremely good at providing its service, which is why it flourished while competitors fell away. Its disruption of the Blockbuster business model of charging high fees for late returns of DVDs to stores is one of the biggest reasons why that company filed for bankruptcy last year.

Now Mr Hastings faces new challenges – the rising costs of leasing films, new competition from Apple, Amazon and others, and a fading DVD business which Netflix last year predicted would keep growing until 2013. His response has been to leap into the chasm.

But Netflix subscribers liked both DVDs and streaming and saw them as complementary – they wanted both the traditional product and the disruptive one. Even if it made sense to split the two in financial reports and even to separate them into business divisions, there was no need to force Netflix customers to snap to the organisation chart.

From a business strategy perspective, I admire Mr Hastings’ quest to revolutionise his company. From a customer’s perspective, however, I cancelled my Netflix subscription on Tuesday. I suspect the second matters more.

john.gapper@ft.com

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