I spoke about innovation at the Conference on Intellectual Property Law and Business Strategy on Monday. Thanks to Adbul Basit for organizing, and to the University of Miami for hosting us.
I tell the story of how Netflix beat Blockbuster in 2010 — but didn’t stop there! They proceeded to entirely revamp their business model within a few short years. I also provide a framework you can use to evolve your own business.
Here’s the video:
And here’s the transcript:
This slide looks the same — but I promise it’s different because we can go to the next slide!
Netflix was actually founded a long time ago, 20 years ago and they originally shipped DVDs in those little red envelopes that we all remember. They became very very good at shipping those DVDs. That was at a time when that when you could walk down the street and go to Hollywood Video or a Blockbuster. These were physical stores you could walk into and you could physically take the DVDs home with you. And blockbuster was kind of the king at that point. They had stores everywhere. They were making a ton of money and Blockbuster had the chance to buy Netflix in 2000 — three years after they launched — for 50 million dollars and said “no thank you.”
So 10 years later, in 2010, Blockbuster declared bankruptcy primarily because Netflix had destroyed their business. Netflix came to market without stores so their costs were much lower. And really the way blockbuster made money was on the late fees. You would check out the DVD, not return it, and they would charge you money. That was a big chunk of Blockbuster’s revenue and Netflix just got rid of it. They came out with a pricing model that didn’t have any late fees. You just didn’t get another video until you sent the one back. So they basically knocked the knees out from under Blockbuster’s business model.
So that meant Netflix’s business models was validated, right?
Here’s the thing: that was 2010 and Netflix had just started just started streaming, but they were primarily shipping DVDs in little red envelopes. Actually it was funny, I was at Christmas, I was with my wife’s parents and my father-in-law still gets those little envelopes. So there’s still a business there. But most of us in this room are streaming and are used to watching on a computer or an iPad or whatever. So in a few short years Netflix entirely shifted the business model.
They’d been experimenting with streaming starting in 2007. But it really started to take off and they were streaming other people’s content and by 2015 they were responsible for a big chunk of Internet traffic.
In 2013 they released their first original series — House of Cards — and now a few years later they’re winning all kinds Emmys, they did 30 original programs this years, and they’re expecting to double that this year. They’re spending six billion on content this year. They’ve become a destination and it’s turned out to be a better business model for them. It’s a complete shift from from shipping DVDs.
Their CEO, Reed Hastings, has this to say: “We don’t really know where we’ll be another five years.” He said this in 2016 and about five years before they were primarily shipping DVDs. “We are figuring out every year how to use the Internet to make a great consumer experience. Every year is an experiment.” The concept that I want to talk about is this constant evolution. Following the customer, doing experiments, figuring out where the market is going, and making sure that you’re following along. This is exactly what blockbuster didn’t do right. Blockbuster said, “We have stores, we make money on the late fees, and we’re just going to keep doing that.” Netflix would be in the same position as blockbuster right now if they had kept shipping DVDs. They had to change in order to survive and they’re doing a great job.
So if we’re going to experiment, the question is, “How do we do that?” For any business, any entrepreneurs, this is what we talk about. I talk about this when I work with entrepreneurs. Everything is an assumption. You create your assumptions and that might look like a business plan, or a pitch deck, or it might look like a minimum viable product. In Netflix’s case it was actually a working business model that put someone else out of business — but even that was still an experiment. It turns out that mailing DVDs wasn’t the ultimate answer. It was just the right answer at that time. So it’s always an assumption. “You know, the best way of tackling things is mailing these DVDs. Well, maybe we should do some experiments with streaming and original content and see how that goes.” And so you go out into the world and you validate your assumptions, and then you come back and adjust your assumptions based on what you’ve learned. Companies that build this into their DNA are the ones that stay current and the ones that win. The ones who don’t — like the Blockbusters of the world — end up getting crushed.
This has some significant ramifications, which I’ll talk about in a minute. There’s a guy named Steve Blank who wrote a book called “The Four Steps to the Epiphany.” One of the points he makes — that other people have made — is that the companies that win are the ones that do this really well. The ones that make the decisions quickly, get into motion, and then learn as they’re going.
And they treat everything is an assumption, even things that are working.
And thus everything becomes an experiment that they can learn from and evolve based on.
And so Facebook calls this “move fast and break things.” Get something up, figure out how to measure it, watch how people use it, and then adjust. It’s interesting: when you look at the evolution of Netflix, pretty much the only thing that’s the same is that they provide video entertainment. The way in which they do that, the actual video entertainment that they provide, all of that has changed. But really the core is the vision of providing video entertainment in a format that consumers want.
The next question is, “How do we run these experiments?” This is obviously a deep topic so I’m just going to cover the surface here. One key to doing an experiment is time-boxing it. You might measure something for two weeks, three weeks, or six months, but you want to set a time limit before you start the experiment. And you want to make a prediction about what’s going to happen. So, “We’re going to do this for two weeks and at the end of it we expect this.” You don’t predict in order to be right. You predict in order to improve your ability to predict. You want to make the prediction and see how close you came — and then understand why you predicted close or not so close, and what those facts were. You learn to predict better over time, and you get smarter about your experiments. And third you want to take little bets. If you’re in a situation where you’re having to bet the entire company on an experiment…you may have waited too long to start experimenting! It’s much better if you can run little bets constantly, and then double down on the winters and stop doing the things that don’t work. And you see companies doing this like Amazon. Amazon Web Services has become a huge business for them and it’s not about retail. It’s an experiment they did that eventually turned into something, and they kept doubling down on it and now it’s this giant business. And you also see it with Google with their Google X Labs. Some of their experiments they’ve carved out into their own companies. They’re doubling down the ones that are working and closing the ones that aren’t.
This is my diagram of awesomeness. There are three pieces to it. The first is the vision. Famous visionaries like Steve jobs — or Netflix has this vision of providing video entertainment. A lot of times people talk about the next piece being execution, and I prefer to think of it in terms of customers. So it’s the vision blended with what people actually want. This is where I see a lot of companies stumble. Because the vision is clear, but they don’t really understand how customers use the product, and so the experience falls flat and people move on. This is part of what happened with Blockbuster. They didn’t stay up with customers who wanted things to come in the mail, or wanted things to stream, and didn’t want to have to go down to the store physically and pay the late fees anymore. The third piece is this legacy piece. As we become successful things become ingrained: “This is the way we do things at this company. This is the way we’ve always done them. This is the way we need to keep doing them.” Success is great and we’re all looking for success. But the trick is balancing that with this need to keep evolving and moving forward. And when you get these three things right you end up with awesomeness! Right in the middle with a gold star.
So let’s talk about the goal.
Literally let’s talk about the book “The Goal” by Eliyahu Goldratt. It’s a book all about assembly lines. Who wants to talk about assembly lines this morning? Anyone?
There are a bunch of good points in this book and I’m sure many of you, if you have an MBA, you’ve probably read this book. It turns out that there are a bunch of lessons to be learned from assembly lines. One of which is, if you have stages in your assembly line — which is what an assembly line is — and there are slight variances in each of those stages, meaning a little bit of error, so most of the things come out correct from that stage but there are a few errors. What happens by the end of the chain is those errors have multiplied and you end up with a 1 in 10 defect rate or something crazy. So you have to be really careful when constructing and managing an assembly line. So how does this apply to our businesses? Everything we build is essentially on a foundation of someone else’s assembly line, and I’ll explain that in a second. The sands are always shifting underneath us and so we’re forced to evolve whether or not we make a conscious decision to do it. So my point is: you’re better off making the conscious decision and embracing the fact that you’re going to have to change. I’ll walk you through some examples.
So everything is changing. Products are changing all the time. The foundation that the products are built on is changing all the time. Markets are changing all the time, and customers’ tastes and what’s happening is changing all the time. And IP (intellectual property) is changing all the time. For example with Netflix, the features that made them successful enough to put Blockbuster out of business, are no longer important to the company. Yes, my father-in-law still receives those red envelopes in the mail, but that’s not where the bulk of the revenues are coming from. So all that work and all that success doesn’t matter in today’s version of Netflix. You see some other stuff with IP. For example, data has become really important and sometimes it’s even more important than the actual product. Because this isn’t about features, and the data survives longer than the individual features do for the product.
Let’s talk about the product assembly line. I’m going to use this software example here — an app developer example — but this is just as true of physical products. Whatever your building is actually at the end of an assembly line, and there are other pieces in the chain. So in this example of an app, you have the hardware. So I have an iPhone. And that iPhone changes every year. There’s a new version of the iPhone. The specs change, the screen changes, the hardware is changing out from underneath my app. There’s an operating system that runs on that hardware. I could also be running a dell computer or Mac computer. All of those things have operating systems and those also are changing all the time. And then there’s a Web browser, or whatever my app is running on top of, and that’s changing all the time. Only then do we get to the actual product that I’m building here. Each stage in that assembly line introduces error. These errors can sneak up on you because today my code’s working, and tomorrow Apple releases an update and my code stops working. So the sands are shifting underneath us, and this is just as true of physical products. If you look at a company like Tesla, they’re taking physical input of materials and components and putting those things together, and those things can change. Also the way those things are manufactured can change. And so there’s change happening constantly in the product.
There’s also change constantly happening in the market. First of all the culture is changing. Right now, iPhones are incredibly popular and Tesla cars are incredibly popular. There are reasons for that, and those reasons are under constant change or threat of change. The technology landscape is changing all the time. Pricing is changing all the time. Blockbuster won with the pricing model of late fees. Netflix came to market with a pricing model that did away with those late fees. Google has famously made a ton of money providing free products, because they can monetize the data and that data actually makes their paid products better. So they can undercut Microsoft on price for office software, for example. And the competition that you’re up against, or any alternatives that people can use instead of your product, are changing all the same. The same is true of IP and the legal landscape. For example, I was working with an entrepreneur who’s raising a fund to do real estate investing in the cannabis industry, which is weird right now because globally at the UN level it’s illegal, it’s a schedule 1 narcotic. Nationally at the US federal level it’s illegal, it’s a schedule one narcotic. But individual states have made it legal, and the Obama administration has looked the other way, and now you have an administration coming in that may not be cannabis friendly. It remains to be seen how that will play out. That landscape is constantly shifting, regardless of what this guy’s is doing, his individual fund. He’s building on a foundation that is changing all the time, and changing pretty radically on a regular basis. So regardless of what we do, change is coming and the companies that embrace that — and use that to evolve — are the ones that are going to win.
Here are four quick strategies to accomplish this evolution.
The first strategy is to measure everything. Everyone is familiar with this. We hear about analytics all the time. People are constantly measuring what people do.
I like digital examples but this works for anyone. This is simply sales funnel. In this case this is a conversion funnel. So if I’m running a website, five percent of people who come to my website may download the whitepaper. Of those people, thirty percent come back to the website for more information. Of those people, two percent make a purchase that turns into money at the end of my funnel. That’s essentially an assembly line, right? At the end of my assembly line I end up with dollars. What breaking this down does is allow me to see where is the luckiest bucket, and then I can target that. What I would want to see in my conversion funnel is my numbers getting bigger all the time, so that two percent is where I want to target first. Why aren’t more people who come back to my website purchasing from me? How do I fix that? I’ve worked with an entrepreneur for the past couple months where they had a long application process on the site, but weren’t recording email addresses and were only recording if people filled out the entire application. They had an 80% drop-off rate. By breaking the application into sections — and the first section captures the email address — they were able to a) build one of these models, b) figure out where the leaky bucket was, and c) capture the email address right in the beginning so they can reach out to people and say, “Hey, I noticed you didn’t finish your application. Can we help?” This a) gives you more conversion and b) gets you into the mind of your customer. You could maybe ask some people — even if they didn’t buy from you — you can understand why, because they’ll tell you why they didn’t fill out the application.
That brings us to the second strategy which is: analytics tell you what — so I can look at the assembly line and see where the leaky bucket is — but the analytics don’t tell me why. They don’t put me inside the minds of people. Analytics are a great tool, but they leave me in the position of guessing. This is where you see people doing things like changing the color of a button from red to blue because the blue button converts better. Or they change an image, or they change a headline. And they find better conversion rates — but it’s a guessing game. And again, if we’re doing experiments we might be doing two-week, three-week, four-week experiments. If the experiment doesn’t go well we may have lost that time. So it’s this constant guessing game where we’re trying to read people’s minds.
So strategy number two is to actually listen to your customers. Go out and talk to them.
There’s a great book that came out last year, written by a couple of guys from Google Ventures called “Sprint.” They introduced this concept of the design sprint. Their subtitle is, “Solve Big Problems and Test New Ideas in Just Five Days.” The idea is you do this sprint, this very quick sit-down with your customers, and you put something in their hands — whether you have an existing product or you need to mock something up — and you get them to tell you what’s going through their heads. Really you’re doing a couple of things. One, this helps you understand very quickly what people think when they look at your product — which the analytics won’t tell you. Two, it lets you see if people understand the value of what you’re providing. A lot of applications and products, both physical and digital, trip over the fact that people don’t know what they’re for or why they’re supposed to use them. So is your messaging clear? Three, can people get to that value? I may think this is the most useful thing in the world, but if I can’t get it to work then I’m going to move on to something else.
So the genius of this is that it’s only five days. On day one, you map out what you want this to do and who you want it to do it for. Then you book five slots, book five people to talk to on Friday, and find backup people. So if one of your people flakes out you have someone to step in. Then your deadline is set. You have it scheduled and it’s definitely going to happen. That’s the genius here! Set a deadline and things actually occur. And it’s short. So you sit down with your team, you sketch out what the interface might look like — or if you’re doing a physical product you might make something out of clay or Styrofoam or a 3d printer. You have a bake-off and decide what the best approach is. You prototype it. You mock it up. So if it’s a physical product, you get to something that you can put in people’s hands that by no means a finished product. If it’s digital, you don’t do any programming, you don’t do any development. You might put together a couple of screens in PowerPoint that look like something that people can click through. You just want to put something in people’s hands on Friday where you can sit there and have them walk you through what’s going on in their head and what they’re thinking. This has some pretty amazing consequences. I have seen some amazing results from this. You don’t need the type of scale you do with analytics. With analytics I need thousands of data points before I really have statistical significance. Here, in five one-hour conversations I know a lot. I can see some patterns pretty quickly.
I was working with an entrepreneur who’s successful, he’s been doing software for 10 years. He has a product that’s making millions of dollars. I asked him when the last time he sat down in front of customers was, and he said, “I don’t need to, I’m making all this money.” And I said, “This is a really good idea. You should sit down with customers.” And he said, “You do it.” So I went and did a little bit and saw some things people were tripping over. But I couldn’t get him to participate. Then finally a few weeks later I got this email from him saying that he had finally sat down with three people, and it had totally changed his understanding of how people saw and interacted with the software. Just three conversations. He reevaluated the interface and changed the order of the product roadmap and feature set. It really opened his eyes. There’s a saying in tech that, “You’ve got to get out of the building.” So you’ve got to talk to people. So that’s strategy two.
Strategy 3 is setting aggressive goals. There’s this concept of 10x goals that Google champions a lot. But any kind of aggressive goal will work.
The idea is that I’m here and I want to get to there. I want to grow from this year to next year. If I set a ten percent growth goal and I hit that, I get ten percent growth. If I miss it, maybe I get five percent growth. But if I set a more aggressive goal, like if I say to myself and my team, “What would we have to do to 10x our revenue in a year?” That forces us to reevaluate everything. So let’s sit here for 10 seconds and think about what you would have to do to 10x your revenue this year. Ready, go. You’d have to change everything, right? You have to change the product, the team, the marketing, everything you’re doing. But if you set that kind of goal and reevaluate and really try to get there, and get your team aligned on it, then even if you fail you may “only” get 2x or 3x times your revenue. So you fail much better if you set more aggressive goals. It’s scary because no one likes to change everything. But that’s how you can force yourself to evolve. The question that came up as I was preparing this in my head was what if Blockbuster had done this, right? You see the Netflix threat coming and you’re like, “Okay, what we need to do to 10x revenue next year?” Regardless of what Netflix is doing, what do we need to do? Maybe we need to ditch the physical stores. Maybe we need to have some other revenue stream besides the late fees. It really forces you to rebuild yourself from the ground up and push yourself beyond what you’re comfortable with.
Here’s my last strategy, and this always looks like low-hanging fruit to me: make it easier for people to buy from you.
This is really an interesting concept. So I have two circles here: people who want to buy from you and people who actually buy from you. The circle on the left is not people who come to your website, it’s not people who are interested, it’s not people who download the white paper — it’s people showing up who want to buy from you. They have cash in hand, they want to buy what you’re selling. There is actually a sales funnel there. Not all of those people succeed in buying from you. If you can figure out what’s happening there and make that part easier, you will raise revenue. That’s a way you can evolve. You’re thinking to yourself, “Wait it’s really easy to buy things, right?”
So here’s a really scary chart. This is the average retention curve for Android apps. So the best apps do better than this. But in general out of 5,000 apps what this says is: on day one, 75% of people stop using the app. I think we’ve all done this. We’ve downloaded something to our phone and then the sign up is too hard, or we don’t understand the features, or it’s not as useful as we thought it would be. Here we have three quarters of the population who are showing up ready to buy from us are giving up on day one! So there’s a lot of room for improvement there. So that’s the digital side.
On the physical side, who in this room had gone to a Starbucks, seen that the line is too long, and walked away? And who’s done that multiple times in our lives? Again, this is me showing up to a Starbucks with money in my hand ready to buy from them, and I’m unable to buy from them because they can’t take my money and hand me a cup of coffee fast enough. How many millions of dollars in lost revenue is that when multiplied by all the Starbucks across the globe?
And Starbucks is working on this. This is a Starbucks I was at midtown Manhattan at morning rush-hour — at 8:45 in the morning in midtown Manhattan in December. Which is a crowded month in midtown. People are in town for the Christmas windows. They’ve done a couple things. You can see them experimenting. They have this app that lets you order ahead of time and skip the line. But clearly not enough people are using the app, because there’s always a line. The thing that they’ve done in this particular Starbucks that was working, was they added this woman with a register up ahead of the regular register and she was kind of front-running the line. What happened is at 8:45 in the morning — and I had already walked past another Starbucks that had a line that I was not willing to wait — and I came across this one and I was the third person in line, two blocks away. And the difference was this woman standing there. This is a place that companies can really stand to evolve. Just make it easier for people to buy from you! There’s some friction there. I encourage companies to look at that.
Those are the four strategies that I recommend for evolution: Measure everything, listen to customers, set 10x goals or at least aggressive goals, and make buying easier for your customers. The way to experiment is to treat everything like an assumption, go out into the world and validate it, and then bring it back and adjust your assumptions accordingly.
So that’s it. Thank You. Are there questions?
Question: I just had a question about Starbucks. What was she doing in the front? Was she just taking the orders before the other guys were going to pay?
Answer: Yes, exactly. So the order was already placed ahead of time, and then when you go up to the actual register your order was already being made. You paid and then the wait was like four minutes for a cup of coffee instead of 10 minutes for a cup of coffee and the line didn’t back up. And it was only at that one Starbucks. I kept looking for it at another Starbucks, but it wasn’t there. So hopefully they will learn from that experiment.
Question: But there’s a risk there because if a customer gives his order to the mobile order-taker and then he says, “To heck with this!” and walks away, they will have made a cup of coffee that they won’t have anyone to sell to. Unless they can resell it to somebody else and I’m not sure if they can do that.
Answer: Right. Or unless their margin on that cup of coffee is high, and at Starbucks you’ve got some pretty good margins to work with.
Question: So there’s a risk to all this.
Answer: Absolutely! You have to weigh you know how much business am I losing every day from people turning around and walking away versus how much do I stand to gain by shortening that line. And yes, you’re correct. There’s absolutely a balance.
Question: Lines are enticing as well. I mean it’s free advertising. You know, if you have a novel business that people aren’t familiar with and there’s no line then people assume it’s not good. So lines are valuable marketing.
Answer: Yes, and I think there are certain places where lines makes sense. I’m not convinced that Starbucks is that place at this point in their story arc. Yes, certainly in Florida — and on South Beach — we see a lot of lines being used to promote and sell. That’s how we know that things are interesting is the social proof.
Question: It’s like validating a novel idea while it’s still novel. This is how you get new customers.
Answer: And you see it with restaurants. Like with restaurants you do want to go to the crowded restaurant, right? Because that means it’s good and popular and the food’s fresh. Every case varies, and so each business has to think about it for themselves individually.
Question: I just had an experience in an Apple store. And I guess that Apple is currently using this line thing because I had to buy an IPhone and I still to wait in line. Because they they wanted so many people in the store but I still had to wait in the line. There were like five people in the store but then I had to wait in this line, then I had to go to another line. I was like, “What is going on? I Just need an iPhone. It’s that easy.” I think they’re using this line as a marketing thing. Just to let you know that it’s popular.
Answer: Yeah, which is annoying as a consumer when you know what you want but you can’t buy it. I have a pregnant wife. We’ve been outfitting the nursery this month. And the difference between Buy Buy Baby and Babies-r-us is Buy Buy Baby makes it really easy to buy. It’s right there in the name! Babies-r-us it’s a fight to buy things from. So we just go to Buy Buy Baby now, because it’s too hard to buy things at Babies-r-us. I don’t know why.
Any other questions, comments? Feel free to email me, or hit me up on Twitter, or I’ll be around. I look forward to hearing from the rest of the speakers and getting to know all of you throughout the morning. Thank you.