Why is big business so inept at harnessing the power of new technology? I was reading Mark Cuban’s blog and I just found myself wondering if the Underpants Gnomes from an episode of South Park were more in tune with business decisions than these media companies. Linked below is a clip from SouthPark featuring the Underpants Gnomes obviously strong language will be featured in the clip.

http://www.southparkstudios.com/clips/151040

The Good

Books
I’m not sure how its possible but one of the oldest forms of medium has made the transition to the digital age the most gracefully. Both by offering eBooks as well as capitalizing off bloggers willingness to pitch books to their audiences publishing companies are really doing a great job of staying relevant in the digital age.

Add to that the fact they’ve not seen the huge problems with piracy the other industries are seeing and it looks like the next few years will be quite good for these publishers.

The Bad

Movies
On the plus side bandwidth limitations have mitigated a lot of the potential damage piracy could cause; it just takes too long to download multiple feature length films. Additional benefits movies are enjoying is the inability to recreate the theater experience, and movie subscription services like Netflix.

It’s not all a bed of roses for the movie companies, as torrents have become increasingly popular as bandwidth continues to rise. At the same time because of a reluctance to abandon the first run model on television and sell into online content aggregators like Netflix the film industry is not reaping any of the profits of deals that their own customers brokered instead.

Television
Its hard to imagine something that was freely available (broadcast) or has the depth of content that people feel compelled to spend upwards of $50 a month for would become threatened so fast. They had some good ideas with projects like Hulu, but it seems that even in success they start thinking about how best to fail.

While I’m a big fan of intellectual property management and am a huge proponent of enforcing rights against outfits like YouTube, I still think you have to offer the content up or risk piracy that dilutes the product.

Seeing lawsuits against YouTube for $1 billion I had hoped that would force the content holders to establish the value of the product by promoting it on their own web properties. Whether its pulling content or trying to divert a successful business model away from what made it a solid option for consumers.

The Ugly

Music Industry
Early on Napster had been looking for an exit strategy from the illegal download model to a subscription based model. Unfortunately the music industry was either not capable of understanding the business opportunity of converting music pirates into real customers, or was too spiteful towards the business that built their customer base upon it.

Instead the music industry shut down Napster allowing Kazaa, torrents, and Limewire to become the new medium of illegal file sharing.
Even now the music industry still hasn’t recovered from the wasteland that piracy has brought them. They’ve still yet to establish a lasting revenue stream which replaces the inflated prices of the CD days. They still haven’t fully adopted a subscription model that could bring them a substantial annuity, and while their work with iTunes and Amazon has yielded some solid revenues it has been pennies on the dollar of what it was before.

Newspapers
How it is there are so many bloggers out there making big time bucks and yet newspapers can’t unlock this equation to save themselves from the downward spiral that is the end of the circulation business? I’ve seen bloggers who do nothing but talk about how much money they make and yet they somehow manage to continue to sell advertising.

I don’t see any future for the majority of newspapers as they’re struggling to even figure out how to get online. There’s been a lot of talk about bringing the medium to the iPhone or Kindle but it’s yet to be seen how this will work, and how many papers will adopt this model.

Conclusion
Most of these companies haven’t done a great job of figuring out a solid business model, and it may be because they’re used to having a monopoly. The problem is copyrights don’t mean a heck of a lot on the internet, if one person gets cut off another 20 will upload the infringing work.

These companies should start focusing on the reality that they’re now competing against free, and if they want to engage the audience they better be somewhat more accommodating than they’ve been in the past. It’s not enough to stamp your foot on the ground and expect the justice system to protect you, that doesn’t get your shareholders the earnings they want.

Out of last week’s discussion centered on Sony’s battery issues and the impact it could have on branding and customer relationships came a very interesting question from Mike a frequent commenter:

“In your opinion, do you feel these quality issues have anything to do with globalization of the workforce?”

My Take
Globalization and outsourcing absolutely has an impact on performance and reliability of a product. That’s not to say that a product cannot be a quality product when you introduce these factors just that the potential for issues goes up dramatically.

Some risks that globalization and outsourcing bring in:

Disparate systems: And I’m not just talking metric to the standard system conversion. We’re talking the back-end systems that each branch is utilizing, different production methods, quality control etc.

Methodologies: I’ve done enough training in my life to see the difficulty in introducing new methodologies to groups that haven’t been properly introduced to it (bought in). They may nod their heads, and get the right answers in the classroom environment but once back on the job all knowledge gleaned is quickly discarded. Different management styles also create additional barriers to change as well.

Cultural differences and values: This might just be the biggest issue that you’ll face. In the book Outliers Malcolm Gladwell shows how cultural differences increase the expectancy of an airplane crash exponentially, this is a lesson for any industry. How people treat authority, view their own autonomy, think critically, and address issues; are all directly impacted by their society and its social norms.

Specialization: Compartmentalization is not without risks, it breeds an environment where very few people have a clear view of the entire process. On top of that people who work on the smallest widget may not have a clear idea of how it will be implemented into the final good. This robs the entire system of the ability to leverage the human capital of those working throughout the entire chain of supply.

Distance and Logistics: The more barriers you put between a manager and their subordinants the worse the impact on the product. Management is all about communication and visibility into the work flow. No matter how good of a manager you are, without seeing the conditions of the plants and staying on top of those you delegate work to will cause an impact on the finished good.

Incentives: While the end goal may be to produce XYZ product outsourcing production leads to a variety of different goals and incentives for each player. All it takes is one link in the chain to prioritize a different way than the customer company is expecting and problems could result.

Conclusion
Go in with open eyes outsourcing is a risk to your brand. Anything from quality of materials, to working conditions, or even illegal activities from your partners can become a black mark against your brand. The reality is most companies that manufacture goods don’t have an option but to outsource, but through rigorous planning and management of your product as it flows through all stages of production will minimize the damage that could be done.

Being a Product Manager I see in many companies a predisposition to focus myopically on their product and ignore customer concerns. The concept of “user error” or of the never satisfied customer ends up propping up an unrealistic valuation of their products. I see articles like this one linked every so often, while humorous the conviction that some of the people have who send such articles is disturbing.

Anyone in business should value and appreciate their customers as this is the lifeblood of the business. While of course there are exceptions to any rule, there is something to be said for the phrase “the customer is always right”.

The Great Sony Exploding Battery Experiment
I’m picking on Sony a little bit here, as there was more at play than just ignoring/not listening to the customer; this was however a substantial contribution to their painful lesson.

In August of 2006 it became apparent that Dell had a serious safety issue with their laptops, they had found that an unacceptable number of them had a tendency to over-heat and possibly explode. Dell had purchased these batteries from Sony who was a leading manufacturer of Lithium-Ion batteries. Dell proceeded to contact Sony about the problem, being a concerned customer. The answer coming back from Sony bordered on arrogance and completely ignored the seriousness of Dell’s inquiry:

“It is the configuration. We use the same batteries in our Vaios, and have our own safeguards against potential overheating. Other manufacturers which use the same cells haven’t come forward with any issues. On rare occasions, a short circuit can occur, but this is affected by systems configurations found in different laptops,” the representative said.

It’s unimaginable to think this was Sony’s reaction, knowing now what we do about Sony’s continued problems with batteries. Eventually the evidence began to build that this was a far reaching problem that impacted nearly every customer of Sony’s including: Lenovo, IBM, Fujitsu, Dell, Apple, and yes even Sony itself.

At some point it would come down to a full public apology from the executives to try and rebuild a troubled brand, but even here Sony took a tone that seemed to diminish the real and legitimate concerns of their customers. Here are some great examples of quotes that were coming from the company:

“The company should have investigated the cause of the battery problem more quickly,” he (Sony president Ryoji Chubachi) said. “The worries over the batteries spread as a result.” In the interview

“This is not a safety issue,” said Naofumi Hara, a Sony spokesman. “This is about addressing people’s concerns which have become a social problem, and we made the managerial decision that the recall was necessary.”

“maintained that the short-circuiting happens only very rarely and only in certain ways that the battery is connected in a system with laptop models, or if the laptop is used improperly and gets bumped around.” AP via Engadget 

Final Tally
Sony ended up having to offer a recall on 9.6 million batteries, with an estimated cost of $427 million which dramatically reduced their earnings for the year. In addition to the cost the damage to Sony’s credibility, and brand image was unimaginable.

 
Conclusion
The example that is shown by Sony is a worst case scenario type of situation that can happen when you ignore your customers. Even some of the responses such as claiming that a laptop is only at risk if it’s used improperly or getting bumped around are absurd. Laptops are mobile computers that a reasonable person could expect to get jostled, or moved around during operation. Additionally, even if something is somewhat absurd such as sticking a powered on laptop in a bag these are the types of things you should be testing your product for.

 Not every decision will have this level of consequences, but every decision you reach should be done with your customer in mind. If your customer has any problems with your product, they are your problems too. Addressing problems directly and thoughtfully will garner goodwill and grow your brand.

Willingness to Pay and Customer Segmentation

The value of utilizing Economics in a business to define and understand the factors that create predictable outcomes is immense. Much like Sociology or Psychology the roots of Economics are in understanding what moves human beings to act, especially when incentives are introduced to move the point of equilibrium.

There is a theory in economics called “willingness to pay” which is derived from how much 1 individual is willing to pay for a good or service. When we take this concept and apply it on a broader level and look at a group of individuals it will theoretically create a distribution of purchase preferences that we can then use to make a decision on pricing as a business.

Additionally identifying any sub-groups that may exist and attempting to address them through building incentives can be referred to as a customer segmentation strategy.

Matinees a Model of Applied Customer Segmentation

Movie Theatres had a problem there was a finite market segment at the attractive price point, and a fixed capacity of their theatres; additionally the preferred method of movie consumption was usually directly before or after dinner. All these factors led to crowding during peak times and waste during sub-optimal show-times.

 Let’s take a look at the problem they are facing and see if we can show identify the missed market opportunity.

Assumptions:
The 4pm showing is only 20% full
The 6pm and 8pm sell out capacity.
Theatre holds 200 seats.
Movie cost is fixed.
Preferred movie time by customers is after 5pm.

Audience characteristics

Now as we see from the data we’ve gathered there are only a total of 440 people total that are willing to pay $9, but a total of 600 people who would pay at least $5. There is only capacity to address 200 people per show so our pricing strategy must account for that.

Pricing Option 1: All tickets cost $9
4PM showing: 20% x 200 (40 people) x $9 = $360
6PM showing: 200 x $9 = $1800
8pm showing: 200 x $9 = $1800
Total collections: $3960

Pricing Option 2: All tickets cost $5
4PM showing: 200 x $5 = $1000
6PM showing: 200 x $5 = $1000
8pm showing: 200 x $5 = $1000
Total collections: $3000

Pricing Option 3: $5 matinees and $9 for prime viewing times
4pm Showing 200x $5 = $1000
6pm Showing 200 x$9 = $1800
8pm Showing 200 x$9 = $1800
Total collections: $4600

Looking at our 3 options we see that the current solution while creating some waste is preferred over the price reduction across the board to meet the $5 customer demand.

Looking at option 3 though with the appropriate licensing considerations we can create a strong enough incentive to drive additional consumption beyond what we’re currently experiencing.

Conclusion
While my example is overly simplified and there are some additional factors I left out to keep it simple, this is a time tested method to increase profits. Most products can likewise benefit from careful licensing or merchandising to unlock additional profits beyond what their current pricing model allows for.

Read a great article from Wired.com on Netflix’s success. In the face of so many mounting business pressures in the early 2000’s who could have anticipated that they would achieve this level of success.
 

My Prognostication Failed

Five years ago I had a friend who was sitting with Netflix stock which had increased in value by 500% when he came to me and asked for some advice: Should he sell? My response was yes based on the following criteria.

Strong Competition- Blockbuster had recently entered the fray; they had a strong competitive strength with their local stores and had plenty of money to target Netflix. I figured even if Netflix did win the costs associated with acquiring and retaining subscriptions in a competitive atmosphere would erode substantial earnings.

Digital Transition- At the time 5 years ago many were predicting a strong push to web based content delivery. It made a lot of sense and would have an impact on Netflix. Expectations were that strong players like Microsoft, Google, Sony, and Apple would crowd out Netflix.

Content Acquisition- With the digital transition I expected consumers to transition to watching web video. As such, companies interested in this market would need to negotiate new deals with the film companies. The Netflix model is somewhat disruptive and they lacked strong relationships with the film companies. This would require a hurdle that Netflix would have to overcome, which introduced substantial risk.

Increasing costs of doing business- Netflix’s primary model was based upon delivery by mail, the more customers used the service the more expensive it would become. Additionally the US Postal Service had shown an interest in continuing to increase the cost of shipping.

Business Transition- Netflix was looking to radically change their business model from mail delivery to digital delivery. It was unclear they had the Intellectual Property, or business assets to smoothly make this transition.

While these were all valid concerns at the time, Netflix has been validated. My friend sold Netflix around $10, and it’s now hovering near $45 (yes up another 500% from where he had it).

How’d They Do It?

Where did this run-away success come from? Here are some of the keys I’ve noticed:

Great Business Model- Netflix had a great business model, understood the finances of the subscription based service and capitalized off Blockbuster’s blunders. Eventually Blockbuster went bankrupt which just forced more subscriptions back to Netflix

Differentiated Service- They doubled down on their key piece of intellectual property the recommendation engine and movie queuing. When you’re providing a service, the worst case scenario is someone not utilizing it, growing disenchanted with it, and cancelling. The recommendation engine is the key to Netflix’s captive audience, and they’ve invested in it appropriately.

Innovative Content Deals- Netflix knew they were in trouble when it came to securing rights for streaming; the reason is that Film Studios typically get paid big bucks for “First Run” rights from HBO, ShowTime, and Starz. With a little ingenuity Netflix turned the source of their frustration into the enabler for their business by signing a deal with Starz that enabled them access to the content without having to negotiate directly with a film studio.

Netflix App. On multiple devices- By leveraging platforms such as the Xbox360, Media Center Extenders, and Set-Top-Boxes Netflix is one of the few digital content provider setup to push from the PC to the living-room

Conclusion

Netflix will face more challenges in the coming years but with the strength in leadership and ingenuity they’ve shown they are well positioned to tackle them.