Owning The Onramp: What Netflix Gave Up When It Ditched The DVD

In January, when Netflix was riding high, I wrote that it was going to break my heart. While it offers an amazing service, its competitive advantage disappeared by its switching to online video streaming.

In the last three months, according to BusinessWeek, Netflix has lost a half-million subscribers and $79.5 million in market value. Some expect the company’s content cost—what it must pay the owners of movies and TV shows—will rise over 300% to $2 billion in 2012. Even at these prices, Netflix is losing content. Meanwhile, its competitors—DISH Network, Amazon, Hulu, etc.—are moving in for the kill.

On the way to the airport this evening, my taxi got stuck at the onramp to a freeway. That is when it occurred to me: Netflix is losing because it no longer owns the onramp.

The onramp is the point at which customers enter the game. The onramp is the position of power. If you can own the onramp, you can extract the value.

Netflix used to own the onramp. When customers wanted to watch a DVD, they had three choices: walk to Blockbuster, sort through the clumsy on-demand menu of their cable service, or pick out a red envelope that contained a DVD of a movie they knew they wanted to see because they had chosen it. The answer was clear. Get a movie you want with no hassle. Netflix owned the onramp.

When Netflix first moved into online video streaming, things looked promising because it was still the only service that offered online streamed movies—at least ones that you actually wanted to see—immediately. But its advantage became shaky. Whereas before it was the only game in town because no one else wanted to invest in the warehouses and delivery infrastructure replicating Netflix’s DVD subscription service would require, launching a movie-streaming business is relatively easy. Netflix’s "copying cost" decreased, so competitors copied.

Hulu, an online streaming service owned (for now) by News Corp., Walt Disney, and NBC, launched a compelling alternative. Amazon (which may buy Hulu) enhanced its digital streaming service through Amazon Prime, combined with its Fire tablet. And DISH Network has started assembling another powerful alternative: buying the Blockbuster brand, launching a Blockbuster-branded streaming service to DISH Network satellite customers, and acquiring more broadband providers who own wireless spectrum. This has put the company just a few moves away from offering a new onramp: a service that allows you to stream movies directly to your phone or tablet without having to go through your home Wi-Fi system. Meanwhile, movie producers and other content owners are finding they can distribute directly to consumers.

Netflix once owned the onramp. But by moving to a model that others can copy relatively easily, the company invited competitors to start diverting its traffic.

To create competitive advantage, you want to own the onramp. This does not necessarily mean having deep pockets. It simply means understanding what your customer entry point is and choosing an entry point that your competitors will not want to copy.

Consider, for example, CODY Systems, a family-owned public safety software vendor, located just outside Philadelphia. The company offers software that helps different police departments coordinate their efforts by sharing data. CODY was founded 30 years ago by a former Army intelligence officer, who, a couple years after returning stateside from Vietnam, recognized that law enforcement agencies had the same need to share data to mitigate crime as troops in a warzone did.

Like Netflix, CODY was one of the first to its game. Like Netflix (and most innovators), CODY found that larger competitors soon got attracted to its space. But unlike Netflix, CODY has chosen an onramp that is different from its competition.

I got a chance to interview David N. Heffner, vice president of CODY and son of its founder. I wanted to understand how this relatively small innovator contends with well-funded behemoth competitors who have been attracted post-9/11 by the heightened demand by first-responder agencies to share information. One would expect CODY to be crowded out by the big boys, yet its employee growth rate is 17% in the past two years and its agency growth rate (the number of police departments and other agencies it serves) is 29% over the same period.

The key insight Heffner shared with me was that CODY is laser-focused on one specific onramp. While its competitors focus on how agencies can respond to crises more effectively by sharing data, CODY is focused on protecting the police officer who has just made a traffic stop.

Imagine this. A police officer stops a car. Before he steps out of his police vehicle, he runs the car’s license plate through their system. His own town system comes up with nothing. But because his police department has implemented a CODY system, the officer’s search also checks the systems of neighboring police departments. Something comes up: The car was seen three hours ago speeding away from an armed robbery scene. The officer now knows the driver may have a gun. He calls for back-up. His life may be saved as a result.

CODY could seek out the onramps of its competitors. It could try to sell its software to larger state and federal agencies looking to improve their coordinated responses to major crises. But to do so would be to put itself into direct competition with better-funded enemies.

CODY knows to stick to its onramp. Netflix did not. Do you? 

[Image: Flickr user jbrownell]

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