The Business Model Innovation Factory

How to Stay Relevant When The World is Changing

Saul Kaplan

• Publisher: Wiley
• Year: 2012
• ISBN:
  9781118239148
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: F&D

Business model innovation is the new strategic imperative for all leaders

Blockbuster's executives saw Netflix coming. Yet they stuck with their bricks and mortar business model, losing billions in shareholder value. They were "netflixed." Business models don't last as long as they used to. Historically CEO's have managed a single business model over their entire careers. Today, all organizations must be capable of designing, prototyping, and experimenting with new business models. The Business Model Innovation Factory provides leaders with the survival skills to create a pipeline of new business models in the face of disruptive markets and competition.

Avoid being netflixed. Your organization must be a business model innovator to stay competitive in today's turbulent world.

• Author Saul Kaplan is the founder and chief catalyst of the Business Innovation Factory (BIF), a real world laboratory for exploring and testing new business models and social systems. BIF has attracted a global community of over five thousand innovators and organizes the internationally renowned BIF Collaborative Innovation Summit

I

What You Have Always Done Isn't Working Anymore

Chapter 1

Don't Get Netflixed: Your Current Business Model Isn't Going to Last Much Longer

The nuclear industry measures how long a radioactive material will retain its potency by its half-life, which is the time it takes for the material to lose half of its radioactivity. For instance, the half-life of Uranium-235 is 700 million years. No wonder nuclear proliferation is so feared! During the industrial era the half-life of a business model has been measured in generations. Business models have always lasted a long time. Business models rarely changed and were handed down from generation to generation. Most business leaders have never had to change their business model. Most CEOs have led a single business model throughout their entire career. They never learned how to change a business model in business school or from their peers, who also have never had to change their business models.

During the industrial era once the basic rules for how a company creates, delivers, and captures value were established they became etched in stone, fortified by functional silos, and sustained by reinforcing company cultures. All of a company's DNA, energy, and resources were focused on scaling the business model and beating back competition attempting to do a better job executing the same business model. Companies with nearly identical business models slugged it out for market share within well-defined industry sectors. There was a mad rush to copy so-called best practices in order to not be left behind by industry leaders.

It should be no surprise that if you ask executives and corporate employees to define the term business model and to share their company's business model story you tend to get a lot of blank stares and very different stories from across the organization. For most, their business model has probably been in place since the business was started—before most employees joined the company. It hasn't changed. It is implicit. No one talks about it. No one shares business model stories because they are taken for granted.

Industry definitions are also taken for granted. As if industries were clubs with exclusive admission criteria and secret handshakes only revealed to companies that agree to play by understood rules. The industrial era has been defined by clearly delineated industries, making it easy to identify which sector every company is competing in. It was all so gentlemanly, as if competition was governed like boxing by a code of generally accepted Marquess of Queensberry rules. Companies were all conveniently assigned a numerical Standard Industrial Classification (SIC) code (now North American Industry Classification System, or NAICS) identifying which industry sector they fit into. Within each industry sector companies all migrated toward an identical business model competing for market share within the sector. Business models rarely changed.

Those days are over. The industrial era is not coming back. The half-life of a business model is declining. Business models just don't last as long as they used to. In the twenty-first century business leaders are unlikely to manage a single business model for an entire career. Business leaders are unlikely to hand down their businesses to the next generation of leaders with the same business model they inherited from the generation before. Leaders are either going to learn how to change their business models while pedaling the bicycle of the current one or they are going to be netflixed. The challenge in the twenty-first century for all leaders is how to avoid being netflixed.

If netflixed isn't a verb it should be.

netflix; netflixed

verb

1. to cause disruption or turmoil to an existing business model

2. to destroy a previously successful business model

3. to displace the way value is currently created, delivered, and captured

4. to be disrupted, destroyed, or displaced by a new business model

Blockbuster Gets Netflixed

Blockbuster started out with a compelling business model. Its value proposition was clear—enabling consumers to watch hit movies in the comfort of their homes. Blockbuster established an extensive value delivery network with stores conveniently located on every corner. Its first store opened in 1985 and it quickly grew to have over 5,000 retail outlets and 60,000 employees. It also had a smart financing model to capture value. It rented hit movies at a price consumers found attractive relative to the price of going out to the movies. Instead of paying a large upfront fee to buy videos from the studio (up to $65 per video) Blockbuster entered into a revenue-sharing model with the movie studios including little to no upfront costs per video, which gave them a huge advantage, and fueled explosive growth. Blockbuster started out on a roll. At its peak in 2002 Blockbuster's market cap rose to $5 billion. In 2010 it filed for bankruptcy. So what happened? Blockbuster was netflixed.

It wasn't as if Blockbuster didn't see Netflix coming. They were just so committed to their bricks and mortar business model they couldn't see or act beyond it. They were stuck in their business model. It became a straitjacket that eventually took the company down. You didn't have to be a fly on the wall of Blockbuster's headquarters during those years to imagine the management debate that took place on what to do about the emerging competitive upstart, Netflix.

As is often the case, the Blockbuster business model story starts and ends with technology playing a leading role. Initially, technology enabled and then ultimately disrupted Blockbuster's business model.

Early versions of the videocassette recorder (VCR) first appeared in the late 1950s and through the 1960s, but it wasn't until the late 1970s that they began to have any mass consumer market success. Who doesn't remember the great format war between Sony's Betamax and JVC's VHS competing videocassette standards? VHS won out due to a longer two-hour recording time with the ability to extend the recording time up to four hours. The last obstacle to broad consumer uptake of VCRs was overcoming the resistance of movie studios. Like any industry facing a business model threat, whether real or imagined, the movie industry fought hard to block the spread of VCR technology. Jack Valenti, head of the Motion Picture Association of America, implored Congress to protect the movie industry from the “savagery and the ravages of this machine.” In Congressional testimony Valenti said, “the VCR is to the American film producer and the American public as the Boston strangler is to the woman home alone.”¹ The case went all the way to the Supreme Court ruling in Sony Corp. of America v. Universal City Studios, Inc. that VCRs were allowable for private use. Ironically the movie industry ended up finding a significant new revenue source by distributing video recordings of their movies.

With consumer acceptance of VCRs expanding after the favorable Supreme Court ruling in 1984, Blockbuster opened its first store on October 1985 in Dallas, Texas, and never looked back, or over its shoulder, for that matter. Wayne Huizinga saw the potential to scale Blockbuster nationally, as he had previously done with garbage collection at Waste Management, and bought the company in 1987, starting with a few stores and quickly expanding through acquisitions and new store openings to become the largest retail video chain in the United States. In 1994 Huizinga sold Blockbuster to Viacom for $8.4 billion.

How smart was Huizinga, because in 1995 the DVD was invented. It was inevitable and easy to see. During the same period (in the late 1980s and early 1990s) that Blockbuster was capitalizing on consumer acceptance and demand for video recordings of hit movies, the demand for CD music recordings was also exploding. In 1982, Billy Joel's 52nd Street was the first record album released on CD in Japan, where Sony also launched its first CD player. In 1983 CD players were commercialized in the United States, along with 16 CDs released from CBS records. By 1988, 400 million CDs were manufactured in 50 plants around the world.

It was only a matter of time until the same optical disc storage technology enabling CDs to displace vinyl records would also displace videocassette recordings of movies. It happened in 1995 with the invention of DVDs, which had the storage capacity for an entire feature length movie. DVDs quickly gained consumer acceptance in the market over videocassettes. DVDs offered higher quality, more durability, and introduced an attractive interactivity feature allowing viewers to go directly to chosen scenes within a movie. As the price of DVD players quickly came down in the market, DVDs soon became the favored home movie format.

Blockbuster didn't see the emergence of DVD technology as a threat to their business model. They didn't see it as a disruptive technology. They saw DVDs as a sustaining technology to improve the performance of their current bricks and mortar business model. DVDs would sit alongside videocassettes and be just another product offering to their retail customers. Blockbuster didn't see DVD technology as a possible enabler of new business models or ways to change the way they created, delivered, and captured customer value. That all changed in 1997, when Reed Hastings got pissed off because he was charged a late fee by Blockbuster after failing to return the movie Apollo 13 within the due date. Turns out, Reed Hastings was not alone in hating to pay Blockbuster's late fees. While consumers had no convenient alternative to renting movies from Blockbuster, the company extracted over $500 million in late fees from customers like Hastings. Blockbuster was so focused on expanding its current business model it had no clue it was about to be netflixed.

Netflix didn't invent any new technology. DVD optical disc storage technology had already been invented. What Netflix invented was a new business model. Netflix recognized that DVDs were small and light enough to mail using first-class postage. Netflix thought it could trump Blockbuster's value proposition, enabling consumers to watch hit movies in the comfort of their home by delivering movies directly to a customer's home by mail, allowing them to avoid a trip to the corner store. Initially, the rest of Netflix's business model was identical to Blockbuster's. In the beginning Netflix captured value in the same way as Blockbuster with a pay-per-rental pricing model. The only difference was the ability to order a movie online and have it delivered directly to your home by mail. The original Netflix business model even had the same late fee as Blockbuster for not returning the movie on time. Uptake was slow initially as people preferred the convenience of renting and watching a movie at the last minute without waiting for it to come by mail. Blockbuster initially saw Netflix as a niche mail order business that didn't represent a significant competitive threat.

That all changed when Netflix introduced its real business model innovation. In 1999 Netflix moved away from Blockbuster's pay-per-rental model and introduced a subscription model where customers paid a flat fee for unlimited rentals without due dates, late fees, or shipping and handling fees. Netflix's business model story was to enable consumers to watch as many movies as they wanted in the comfort of their home for a fixed monthly price. The new business model caught fire, with annual sales going from $1 million to $5 million in its first year. Within five years Netflix was a $500 million business and within eight years it had reached $1 billion in sales. In 2002 Netflix had 1 million subscribers, growing to over 5 million in 2006 and over 14 million in 2010. Hardly a niche business!

So did Blockbuster see Netflix coming? Did senior management see the opportunity to think beyond its bricks and mortar network expansion and store operations to deliver customer value in new ways? Did management see the disruptive potential of DVDs? Did they see Netflix coming and decide to stick with their bricks and mortar approach? Or did they just miss the opportunity because they were so busy pedaling the bicycle of their current business model they didn't think about and experiment with potential new ones?

I think the evidence is clear: Blockbuster saw Netflix coming and chose to ignore them at first and then reacted way too slowly. You may be surprised to learn that Blockbuster had the opportunity to partner with Netflix before the upstart really took off. John Antico, Blockbuster CEO, actually received a visit from Netflix founders Reed Hastings and Marc Randolf in 2000. The founders traveled to Blockboster's headquarters in Dallas to deliver an interesting offer to Antico. According to Barry McCarthy (Netflix CFO at the time), who joined Hastings and Randolf on the trip, the founders proposed that Netflix and Blockbuster collaborate. In an interview with The Unofficial Stanford Blog, McCarthy recounted the meeting saying, “Reed had the chutzpah to propose to them that we run their brand online and they run our brand in the stores and they just about laughed us out of their office. At least initially, they thought we were a very small niche business. Gradually over time, as we grew our market, his thinking evolved but initially they ignored us and that was much to our advantage.”²

Blockbuster made the mistake most companies make in underestimating the disruptive threat of new technologies and innovative business models until it is too late. Blockbuster remained stuck in their bricks and mortar business model, naively treating Netflix as a niche player that they could ignore. They underestimated Netflix at their own peril. They attempted to react, but it was too late. The constraints and pressures of their existing business model proved too great to overcome. Blockbuster was netflixed.

As Netflix took off and began to look like more than a niche competitor to Blockbuster CEO John Antico, he began to push very hard to respond to the threat with significant investment in an online platform and offering of Blockbuster's own called Total Access. The new platform, with direct attention from the CEO and resources to grow, gave Blockbuster a credible offering to counter Netflix. Antico's move was late but may have worked given Blockbuster's considerable resources, strategic relationships with movie producers, brand recognition, and substantial market share. But Antico ran directly into a conflict with ...