Monday, September 19, 2011

Netflix and the innovator's dilemma

This morning comes the news that Netflix' DVD rental business is to be called Qwikster and that Netflix itself will continue on as the streaming company only.

There's much hand wringing going on, but it seems to me that what's taking place is recognition of a classic innovator's dilemma. Netflix' DVD business was being disrupted by something new, "worse", and rapidly growing: streaming.

In the innovator's dilemma theory, companies have difficulty making good use of their innovations because they are locked into a 'value chain' that is optimized for their existing business. At the same time the new business may be targeting a different market segment which they are ill equipped to handle or the new innovation may be 'worse' (i.e. it's performance may appear to not be as good as the existing products; the classic example is smaller, but lower capacity, disk drives).

Netflix' streaming offering is 'worse' than it's DVD service because of selection. The company has a much smaller catalog of available titles and thus streaming, while providing immediacy, has trouble competing with DVD rentals. But streaming is destined to grow quickly.

Secondly, Netflix' value chain around DVD rentals is optimized for two things: the physical handling of DVDs and the contracts with Hollywood. It's not obvious that the contracts for physical DVD rental are going to be anything like those for streaming. Thus the streaming business has a totally different value chain from DVD rental.

If the two companies were one then there would be a problem of allocating revenue to different parts of the business. Does the DVD rental business get most of your subscription because it's larger? Or does the streaming business because it's going to grow quickly and needs the investment?

So, to me, the splitting of the company into two parts makes total sense. Totally different companies with different value chains can be built up, and, one day, one may buy the other.

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If you enjoyed this blog post, you might enjoy my travel book for people interested in science and technology: The Geek Atlas. Signed copies of The Geek Atlas are available.

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