Mail & Algorithms
In the 90's, watching a movie at home meant renting a video cassette from a local video rental store. There were companies like Blockbuster in the US that catered to customers with a large retail footprint. Netflix entered the video rental business but chose to follow a different business model. Instead of a retail footprint, it decided to have a mail-delivery service model where customers would log onto the Netflix website, choose a movie which would be mailed to them.
Instead of using video cassettes, the company opted to use DVD. While DVDs are easier to ship because they are lighter, the technology had not yet become the standard format at the time. Video cassettes and video players were still used by many as the preferred technology but Netflix chose to use a newer technology and the company was launched in 1997. As the company was started by a software entrepreneur Reed Hastings, Netflix set itself apart from the competition through the software on its website. Customers are asked to rate the films they watch and the company's proprietary software then recommends movies to watch based on their review patterns. The recommendations encouraged customers to watch new movies that they may not discovered on their own.
With a service built around on the premise of convenience, it was important to get the delivery system right. First, Netflix entered into revenue-sharing deals with major studios giving it access to film titles and creating a library that the company could access. The company also had to set up regional distribution centres - once the customer places an order, employees at the nearest distribution centre fill the order and send it to the customer. Inventory also had to be calibrated so that there were more copies for popular movies and fewer DVDs for smaller, niche films.
Paying for convenience
Netflix also had to find a pay model that was different from the industry. Initially, Netflix followed the video rental industry where customers pay for each movie they rent and additional charges could be levied if the video was returned past the due date. Netflix's implicit sales pitch was built on the convenience factor - customers didn't have to go to the video store physically to rent a movie. Since the pay model didn't reflect that convenience, they were initially unable to lure customers to rent from them. So Netflix followed the gym membership route where customers pay a flat subscription fee regardless of the number of movies they rent. This proved to be popular with customers as it fulfilled the convenience factor they were seeking.
With the initial glitches resolved, Netflix soon built an enviable subscriber base even while its competitors faltered. Others in the industry like the video rental chain Blockbuster didn't see the technological changes and missed jumping onto the train in time. Blockbuster tried to expand into the digital space and continue juggling its extensive retail presence but it proved to be a disastrous move as fewer customers preferred to shop physically at the stores. Blockbuster was later forced to file for bankruptcy.
Move up the value chain
As broadband connections gained more traction, customers found streaming movies an even more convenient option. Netflix's move into the streaming space did not come without hiccups. Their initial attempt in 2011 to raise the subscription fee by bundling the mail-delivery service and streaming angered and alienated some customers. Forced to retreat, Netflix had to find a better delivery and pay model for streaming. Content was also an issue. Getting licensing for television shows from major studios proved to be an uphill and expensive task and this was reflected in the balance sheets, but Netflix continued to march ahead with online streaming as it understood that this was where the market was now heading. The company understood that with the advent of broadband streaming, the convenience factor would no longer offer a sustainable competitive advantage. Its competitive advantage had become commoditized.
Netflix made a bold move to backward integrate - it decided to produce its own content for customers and created some shows exclusively aired online only for Netflix customers. This proved to be a good move as it gained customers and has steered Netflix into a new direction. Netflix had a customer base but was only providing the last mile connect for other people's products (movies, TV shows). As the last mile connect started getting commoditized, it moved wisely into content - to participate in the entire value chain from content creation to delivery. Netflix is growing its content swiftly to evolve into an online TV and movie channel, apart from continuing to distribute everybody else's content. There now continues to be good reason for Netflix customers to remain loyal to it - its not just convenience any longer but also some good exclusive content that's coming their way.
An idea for financial intermediaries
The vast majority of financial intermediaries in our market used to focus their attention on providing superior convenience as their key differentiator. As technology began to commoditize convenience, many moved up the value chain into advice. Now, as basic advice gets increasingly digitized through robo advisors, and direct plans offer lower cost alternatives, it might be time for you to think of how you can move up the value chain, like Netflix has done.
Can you take on some of the responsibility of delivering alpha into your investors' portfolios? Can you think of smart beta solutions? Can you get together with like minded professionals to set up innovative portfolio management services that offer bespoke solutions beyond what retail funds are capable of? If you have a growing customer base, can you think of working with independent niche money managers to create exclusive products for your clients? Its time to think of how you can move up the value chain to maintain a sustainable competitive advantage, just as Netflix is doing in its business.
Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.
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