Netflix Applies Disruptive Innovation to Itself

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Back in 2011, I wrote a post about Netflix’s fledgling efforts to disrupt itself. As Clayton Christensen has repeatedly reminded us, disruptive innovation is when a new entrant targets overlooked segments with a new offering (and often a new business model) that is more affordable, convenient or simpler than the existing offering. The new offering doesn’t match existing offerings on traditional performance criteria, but the ignored customers don’t care; they prefer the affordability and accessibility of the new offering. The new entrant gets a foothold and over time takes more and more of the existing market, eventually displacing the incumbent.

This is exactly what Netflix did to Blockbuster. Its original mail order service didn’t provide the instant gratification that Blockbuster did, but it was far simpler and less costly (no late fees). And as Netflix did to Blockbuster, the usual disruption model is a startup disrupting an established player. What we see far less often is a company disrupting itself. Doing so goes up against all the established instincts of the existing business.

But that’s what Netflix has done with its streaming business. Compared to DVD delivery, streaming underperformed on the predominant performance criteria for the business: availability of first run movies. But it was simpler, faster and less costly, attractive to new users or existing users who were overserved by the DVD business.

The question I raised back in 2011 was: would it be successful? It didn’t seem so clear back then. Reed Hastings, Netflix CEO and Co-founder,  had just separated the two businesses and was widely criticized for doing so (my personal viewpoint is that the move made total sense from a management standpoint—it’s much easier to disrupt oneself if the two businesses are more separate—but it wasn’t a good move from a customer service and PR standpoint).

The results since then demonstrate that Netflix is one of the rare companies that has successfully disrupted itself. In the third quarter of 2011, Netflix had 14M DVD subscribers. By the third quarter of 2015, that number was 5M. That looks like an incumbent being disrupted. But from 2011 to 2015, Netflix’s annual revenue rose from 3.2B to 6.7B. This growth demonstrates that it was successfully able to create the new market and disrupt itself without being displaced. But doing so has come at a cost. Netflix’s 2011 net income was $226M. In 2015 it was $122M. This doesn’t surprise me.

Do you believe Netflix has been successful?

Netflix is running two business models simultaneously (a costly endeavor) and is also fighting off a slew of competition (Hulu, Google, Amazon, etc.) in its new market. One might be tempted to look at the profitability numbers and say that Netflix hasn’t been successful in disrupting itself, but compared to the alternative—having its DVD business disrupted by one of these new entrants and then going bankrupt—it doesn’t seem so bad.

Innovation is hard. Disruptive innovation is even harder. And disrupting oneself is the hardest of all. But Netflix shows that its possible. The example should be an encouraging lesson. If you are a manufacturer starting down the tracks as the IoT locomotive, or you are a service company threatened by digital upstarts, take heart. It is possible to imagine and reach an exciting new future.

And if you’d like to talk about how to get there, we’d love to hear from you.

Dan Ostrower

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Dan Ostrower

CEO