Netflix and Sustaining a Disruptive Advantage (2024)

These interesting times in the media streaming sector are a great opportunity to examine the contrast between “disruption” with “sustainable disruption” (oxymoron intended!).

Credit where due, Netflix was absolutely a disruptive force in the 100+ year old industry, transforming the market with its innovative business model, to which media incumbents initially struggled to respond.

However, is the honeymoon period for Netflix now over? They face unprecedented competition from incumbents (eg Disney+, Warner Bros Discover with HBO Max, and others) and big tech (Apple, Amazon, YouTube), not to mention TikTok and others. Disney+ is quickly catching up, recently gaining 8m subscribers, over Netflix' 2m losses.

In this theory of Disruptive Innovation, the late Clayton Christensen’s big insight was that small disruptive entrants benefit from the inertia of big incumbents who ignore them. BUT disruptors must use this time to secure SUSTAINABLE advantage. When incumbents eventually start responding (and they usually will), sustaining the disruptive advantage only comes from being 10x good at:

1. things that matter to customers, AND
2. things that others - incumbents or other entrants - struggle to do well for structural, resource, cognitive, and other barriers.

Let us look at Netflix. The notion that Netflix is a “Tech” business has become less compelling when we consider what gives “tech businesses" competitive moats:

• Network effects: None more than any other streaming platform. Does having my friends on Netflix make it more valuable for me? Not really (well, password sharing aside).
• Data network effects and leverage: The notion that Netflix creates content entirely algorithmically has been widely debunked, reports indicate that while use of data and algorithms do play a role in content decisions (more so with recommendation engines) much of Netflix’s content strategy still relies on old-school creativity and throwing lots of money at production
• Adjacency leverage: Tech companies are very good at finding synergies between seemingly heterogeneous offerings. Arguably Netflix’s competitors have been much better at doing this, e.g. Disney (IP + Parks + Merchandise = $$), and Amazon (Prime as a loyalty program for eCommerce = $$).
• Leveraging digital channels: no differentiation, everyone can use the Internet, and many incumbents have shored up their digital capabilities
• Great customer experiences: Netflix has an advantage but the gap is quickly shrinking
• Customer loyalty/lock-in: Minimal - nothing to stop customers from unsubscribing, especially without real data network effects.
• Barriers to multi-homing: Minimal - customers can subscribe to multiple services (within limits)

Combine Disruptive and Old School Competencies

As competition streams into this space, this business comes down to the same old competencies from the past - making great content that people want to watch. Netflix stood out before as the only viable player, but in today’s world of competition, streaming fatigue, low switching, and multi-homing costs, streaming players have to fight hard for share of wallet.

This is where Netflix’s sustainable competitive advantage may flounder - producing great content is a function of not only data and digital competence, but IP, creative resources, and lots of financial capital to spend. However, here Netflix isn't necessarily 10x better then Disney, HBO, Discovery, etc, in fact arguably, this is where incumbents excel. Disney for example has great IP between Disney, Marvel, Star Wars, and other assets, a brand and legacy of storytelling, and is expected to spend $33bil on content in 2022.

Not to mention Netflix lost much advantage when prime library content was pulled (eg Disney and Marvel, HBO and Friends), and Netflix has recently struggled with the “nothing to watch” syndrome.

So what are Netflix’s options? Netflix’s challenge is that great content needs lots of $$ to play with. They might try to (1) grow customer base, (2) increase customer loyalty (lock-in), and (3) increase customer lifetime value.

(1) Is tough in Western markets, but they have an edge in other regions eg India, South East Asia by localization of content, and also bringing foreign content to other audiences, e.g. Squid Game.

However, much lower capability and willingness to pay in these markets will be a problem as Netflix needs $$ to produce good content.

(2) Increase customer loyalty - With minimal switching cost, customers increasingly weigh the value gained for their subscription $$. Here, Netflix can either offer lower fee options (see 3), or expand its offerings through synergistic leverage (e.g. gaming)

(3) Increase customer lifetime value - Intense competition will drive prices down, so their only option is to expand their offerings (e.g. gaming), orincrease CLV through ad-supported tiers. Ironically what they previously vehemently rejected, rumors indicate it is coming after all. This can help them with (1), and other services like HBO Max and Hulu have proven it works.

Take-aways

What lessons can we take away? It is important to distinguish between being “Disruptive” and being "Sustainably Disruptive”. All new disruptive business models combine elements of the new thing (e.g., digital streaming) and the old thing (e.g producing great content).

While disruptors often gain advantage from limited or poor incumbent responses, incumbent inertia is generally temporary - even more temporary nowadays with the persistence of the "disrupt-or-be-disrupted" meme. Thus, sustainable disruption only emerges if:

1. Incumbents persistently struggle to do the important new things well (e.g/ can they just buy their way in?)
2. Disruptors can do the important old things well

Netflix’s case fails this test:

1. Incumbents can do digital streaming quite well
2. Netflix can make decent content, but no better than others.

Netflix absolutely disrupted the industry, but disruption does not always lead to sustainable success.

Note 1: Netflix was much more successful at disrupting Blockbuster Video, where the headwinds against the incumbent were more pronounced, e.g. internal inertia, board politics, stranded assets eg 9,000+ stores, etc.

Note2: there are other real losers in this game, e.g. cinemas, but that's another story.