Blockbuster's CFIT

Tonight in the undergraduate strategy class, we discussed the sad story of Blockbuster Video, the video rental store that consolidated the fragmented industry, made Wayne Huizenga even richer, and somehow managed to botch decades of multi-billion-dollar cash flows into Chapter 11 last week.

The 2000s were not kind to Blockbuster: it lost money four of the past five years (all but 2006), and entered 2010 with a negative shareholder's equity. Although its traditional rivals (notably Hollywood Video) fared even worse than it did, it faced a bevy of daunting substitutes.

Still, all but one of these substitutes was obvious a decade ago. The only new wrinkle under the sun is Redbox and the video kiosk, which has commoditized video rentals to the consternation of both studios and the video chains. And even kiosks were not a secret forever. In 2004, USA Today reported:

Even McDonald's (MCD) is thinking about getting into the act. It's testing kiosks in its Denver stores where customers can rent and return videos for about $1 a day.

So clearly Blockbuster had a lot of time to come up with a response to its major challenges, particularly Netflix, video downloads and kiosks.

Blockbuster started a video-by-mail service, several download services, and licensed its name to NCR to create Blockbuster Express (which survives its Chapter 11 filing.) Despite foolish optimism by some analysts, none of them caught on.

So my question: couldn’t they see these problems coming a decade ago? And why didn’t they do anything about it? Is this another example of controlled flight into terrain (CFIT).

There could be some problems specific to Blockbuster. It was milked as a cash cow by Viacom/CBS for decades, and since 2005 has had to cope with Carl Icahn as its major shareholder and micromanager.

More generally, it’s not a tech company, and so it never had the genes of a Netflix or Amazon or other company that “gets it.” However, Barnes & Noble has made a credible showing against Amazon — even if its website and e-books never quite catch on, they certainly have done everything we would expect out of a follower.

But perhaps there’s also the general problem of hubris. In my research, teaching and consulting, it’s been quite clear that overconfidence is an endemic problem for market leaders. Companies that dominate their industry or segment believe their own PR and assume that ongoing dominance is their God-given right.

Or it could just be that — as Richard Foster, Clay Christensen and others have observed — cannibalization is really hard to do. You see where you need to go, but the short-term incentives prevent you from doing what needs to be done long-term — like competing with the retail storefronts, eliminating late fees, or whatever Blockbuster needed to do.

I don’t know that there’s a happy ending for Blockbuster, but there’s certainly no shortage of object lessons. I have a class full of students who’ve learned from their mistakes, and I know there will be others in the years to come.

Favorite quote of the month

Oct. 11 will bring news of the latest winner of the Sveriges Riksbank Prize, endowed by the Bank of Sweden but branded as the “Nobel” prize in Economics Sciences.

As with previous years, there is betting on who will be this year’s winner. To me there is no obvious front-runner as there was last year with Oliver Williamson and his long-overdue prize.

Harvard Economist Greg Mankiw notes two places to find your pool of candidates: a list of top-cited academics (in all the Nobel fields) from Thomson-Reuters, and the REPEC ranking of most cited economists.

However, my favorite quote on the topic (and in fact on any topic this month) comes from Mizzou economist Peter Klein:

It is said that when the Nobel Prize in economics was first established, prizes were given for using economics to teach people things they didn’t already know, e.g., that economic growth might increase inequality, that depressions are caused by central banks, that macroeconomic stabilization policy doesn’t work, etc. Now, prizes are given to economists who teach other economists things that regular people already know — politicians are self-interested, you shouldn’t put all your eggs in one basket, institutions matter, different people know different things, etc.

Ouch. How do you top that for cutting to the heart of the matter?

Metro leapfrogs 3G to LTE

Cross posted from the San Diego Telecom blog.

Dow Jones, PC Mag and others report that CDMA discount carrier MetroPCS is the first US carrier to offer LTE. (That effectively means 2nd for 4G, after Sprint’s WiMax, and ahead of Verizon’s planned LTE launch before the end of the year.)

It launched the service in Las Vegas, but plans 3 other cities by the end of the year.

PC Mag says that the new Samsung Craft is “the world’s first LTE phone,” a dual 2G/4G phone. DJ notes that Samsung supplied the LTE infrastructure for Las Vegas, as well.
This is a rare example in the cellphone industry of “the last shall be first.” Metro skipped 3G altogether, saving a significant investment. Also, roaming for 3G in the US seems to be a lot less common than for 1G or 2G, so the company doesn’t lose anything by not having 3G hardware.

Normally, companies that are low-cost providers don’t lead technological innovation — it’s contradictory to their basis of competitive advantage.

In this case, MetroPCS hopes to gain cost savings by migrating voice off onto LTE-enabled VoIP.

Toyota, Target and Togo's

This week in undergraduate strategy was our discussion of generic business-level strategies — one of the most fundamental lessons of the entire course. This reminded me of two paradoxes of generic strategies, one big and one small.

In his 1985 book, Michael Porter argued there are two generic strategies

• low cost, which is the basis of competition under cases of commodization
• differentiation, which requires firms create unique products that are valued by buyers.

Porter originally argued it was impossible to do both simultaneously: increasing perceived value will increase costs, while cutting costs will cut perceived value. Geoff Moore makes a more nuanced version of the same point in Dealing with Darwin. Marketing experts also cite the potential for brand confusion (premium features for commodity products, cost cutting on premium products.)

This leads to the big paradox. Since Porter, other strategy researchers have claimed there are exceptions. Examples include JetBlue until 2008, Toyota until 2009.

Explaining (or dismissing) these exceptions is one of the dilemmas of teaching this material, or applying it to the real world. Given it failed in the long run for Toyota — relentless cost cutting led to declining quality and led to a public relations nightmare — perhaps this “big paradox” is really just a rare and temporary exception to an unavoidable strategic contradiction.

The small paradox seems more permanent and puzzling. Exhibit A is Target, which has nearly the cost cutting of Wal-Mart but with a much better shopping experience. (Both my wife and sister swear by Targét, but rarely if ever would be found in Wal-Mart.)

So how does Target maintain its price premium over Wal-Mart? Would it be better off going straight at Wal-Mart, or is this just a chance to segment a really big nationwide market? I continue to wrestle with this exemplar of the small paradox.

After class, one of my students talked about his experience at the early Togo’s, a sandwich shop founded by Tom Neumann and Gordon Reed. If Neumann and Reed are the McDonald brothers, the SJSU student Michael Cobler is the Ray Kroc of Togo’s who grew the business (before it was sold to Dunkin’ Brands in 1997.)

Togo’s was a cult favorite here in the Bay Area for many years. Today they charge a marked premium over Subway, but for the life of me I can’t understand why people pay it.

My student recalled fondly working for Cobler, who gave Togo’s a clear differentiation strategy until it was lost under its new corporate owners.

Like rivals, Cobler relentlessly cut costs to remain competitive. Unlike rivals, he would not cut costs if it would diminish his perceived quality edge: flavorful ingredients trumped cardboard at every opportunity. I haven’t seen the numbers, but I was told extra ingredient costs of 5% or less could be used to support the Togo’s price premium (which today is 20-30%).

So maybe a slight premium of costs can be used to sustain a larger premium of prices. It probably requires a large market (like fast food and department stores) to allow both a low cost and a slight premium vendor to co-exist.

Are there other examples? Continental managed post-911 cuts to match its bigger rivals, but remained at or near the top of customer satisfaction — in part by not cutting costs as badly as its rivals. Even this advantage appears to be temporary, because next month Continental is being acquired by United (one of the worst carriers).

Commodity companies, commodity budgets

The WSJ Wednesday posted an interesting article (and also snippets of video) from its interview with IBM CEO Sam Palmisano. The videotape

The article reported:

Palmisano said he doesn't worry about companies such as H-P that have slashed their investments in core technologies and need to make expensive acquisitions to keep up.

"H-P used to be a very inventive company," Mr. Palmisano said in an interview at a Wall Street Journal event on Tuesday. IBM would never have paid what H-P did to buy data-storage provider 3PAR Inc., he said. "[H-P] had no choice," said Mr. Palmisano. "Hurd cut out all the research and development."

Unfortunately, the WSJ doesn’t actually share the video of Palmisano making these points. However, in the opening part of the video clip, Palmisano says:

If you look at the core business of a Dell or HP, it’s an electronics distribution channel for Microsoft, Intel, and storage guys and everybody else. There's nothing wrong with that, we just don’t focus on it as much.

To his credit, reporter Spencer Ante quantifies the impact of HP’s brutal budget cuts as part of its shift from innovator to low-cost commodity player:

Mr. [Mark] Hurd cut H-P's research and development budget to $2.8 billion, or 2.5% of H-P's revenue, in its last fiscal year from $3.5 billion, or 4% of revenue, in 2005, when he took over as CEO. Under Mr. Palmisano, IBM has continued to invest about 6% of its revenue in R&D, including $5.8 billion last year.

Alas, the interview also retreads old ground as Palmisano calls PCs a dying industry. His comments are classic sour grapes: IBM dumped PCs because it proved itself unable to compete in that business, while HP has become the market leader. (Neither HP nor IBM has made a transition from PCs to smartphones or tablets, but unlike IBM HP has a plausible entree with its Palm acquisition.)
If the article is interesting and informative, the video snippets are neither. It’s painful to watch the actual news (i.e. comments by a leading tech exec) with insipid commentary by WSJ staffers.

If the WSJ is going to produce video clips, they need to learn PBS production values and hire some broadcasting professionals. Its AllThings D spinoff has done a great job packaging interviews from its annual conference, so perhaps it can provide the WSJ with necessary expertise.

Open standards at Stanford

Starting on Sept. 21, Ken Krechmer will be teaching a 6 week evening course in Stanford’s Continuing Studies program entitled “Interfaces: The Gateway to Controlling New Technology Markets” (Bus 209). To quote from the course description:

Interfaces are everywhere: user interfaces, software interfaces, protocols, and many more. Designing, developing, and deploying key interfaces are crucial to the long-term success of many products, product lines, and companies. And interface control is perhaps even more important. Controlling interfaces has reaped enormous rewards for some of the most successful companies on the planet, such as Intel, Microsoft, and Qualcomm.

These days, the web is full of market opportunities that might become long-term profit opportunities if key interfaces can be controlled. What will happen to social networking interfaces such as Google OpenSocial, Facebook Connect, and Twitter’s API over time? Or consider Apple APIs — several European governments are concerned that only Apple products can download music from Apple’s iTunes site.

This course analyzes the historic, legal, societal, political, and economic impact of controlled interfaces, and also suggests future directions: new ways of creating interfaces that sidestep the negative issues of control and yet still support commercial advantage.

Ken has spent much of his life focusing on standards. He was the founder/publisher Communications Standards Review, tracking the latest developments in communications standardization for many year until he was bought out by his arch-rival, Bell Labs. He also served on a variety of standards committees, including those sponsored by ITU, ETSI, TIA, IEEE and IETF.

I’ve known Ken since he sold CSR. He was the head of the program committee for the SIIT conference for many years, most recently at SIIT 2009 in Nagoya (and will be on the program committee for SIIT 2011 in Berlin in Sept 2011).

Today he is a lecturer at the U. Colorado telecommunications program. He is also doing research based on his deep knowledge of standards. I’m proud to say that his most quoted standards article — on the definition of open standards — was presented at a HICSS standards minitrack that I co-chaired and published in a special issue of JITSR that I co-edited.

Standards are obviously of crucial importance for the computers, communications and consumer electronics industries. In the US, it’s rare that standards are treated as a discipline or subject of academic instruction. When I teach my MBA tech strategy class, at most I get to spend one week on standards and can barely scratch the surface.

For those in the Bay Area who are interested in standards, it is hard to imagine a more in-depth education on their origins and implications.

Hurd mentality

Noting Dell’s problems with its commodity business model, on Aug 19 I wrote:

If they need a commodity IT turnaround specialist, I know just the guy: Mark Hurd. He’s turned around two companies already — NCR and HP — and now finds himself unexpectedly with time on his hands.

On Sunday night, the FT (and a herd of other news outlets) reported:

Oracle’s board will meet within days to vote on a deal to bring Mark Hurd to the company in a top role, marking a rapid corporate rehabilitation for the ousted Hewlett-Packard chief executive.

Mr Hurd is unlikely to win the title of chief executive, which has been held since 1977 by Larry Ellison, Oracle’s founder and chairman, who owns about a quarter of the database software giant. But almost any position would represent a coup for Mr Hurd after HP’s board forced him to quit the company he had led for five years.

One fit is obvious. As the FT notes, Ellison himself stood up for Hurd after HP forced out its CEO on Aug. 6:

Mr Ellison is personally close to Mr Hurd and has supported him in public comments, calling his dismissal “the worst personnel decision since the idiots on the Apple board fired Steve Jobs many years ago”.

However, the more important fit is that Hurd revitalized a portfolio of mature, no-growth businesses by slashing costs, people and morale — executing on the imperfectly realized vision of Carly Fiorina.

If you want someone to find short-term efficiencies in a mature 21 tech firm, Hurd’s your man. (We have no evidence either way as to their effects on long-term competitiveness.)

Presumably Oracle poses less non-compete problems than Hurd would have faced going to Dell (not that Michael Dell was going to bring in another ego as big as his own.)

But this presumably would be a negative for Oracle employees, who have already faced considerable cuts after the acquisition of Sun Microsystems.

Update, Monday 9:30pm: Hurd has been named as one of two Oracle co-presidents — replacing Charles Phillips — and reporting to CEO Larry Ellison.

When anti-troll is anti-innovation

The Paul Allen/Interval Research patent lawsuit has occasioned much handwringing in the tech industry. Some of it recoils at the timing, nature and expansive claims of Interval. However, other is just reflexive antipathy to the idea of patents, particularly from the free software crowd.

Now one of the thought leaders (hate that term) of the open source crowd has weighed in with an expansive attack on all things patent. My friend Matt Asay of Canonical writes in The Register:

Businesses aren't built on ideas. They're built on execution. Google didn't win because it was the first to the search market. It won because it did search better than anyone else, and devised an ingenious way to monetize it.

This, more than anything else, is what makes the US patent system, overrun by patent trolls, so broken: it rewards ideas, not execution against them.

Anyone can think up a brilliant idea. The difficulty is in doing something with it.

Matt is clearly wrong here: I don’t know whether it’s his own bias (or vulnerability) as COO of an open source company, or just a overwrought reaction to the latest example of someone filling a silly suit (which may or may not make any progress in the courts).

While I understand the sentiment, ideas matter too. Things like the laser and the transistor and recombinant DNA got invented by real people who certainly deserved monetary rewards for their contribution to mankind — whether or not they create a company to bring those ideas to market.

My own test is “did this person cause this invention to benefit mankind sooner.” A patent troll goes to a market that’s already developed and says “pay me some money.” A legitimate nonpracticing entity says “I’ve invented something, I’ll help you commercialize it and we’ll share in the profits.”

As law school prof Frank Pasquale notes on the Madisonian, discounting the role of the specific inventor because “it would have happened anyway” is a slippery slope: Microsoft, Google, Facebook and Canonical would have happened too, but they got up one morning and decided to pursue the opportunity with the right strategy before someone else did.

If we don’t incentivize invention, we'll get less of it. This is particularly true today when “innovation benefactors” (to use Henry Chesbrough’s term) are becoming scarce due to budget cuts in basic research and higher education.

The patent system certainly needs incremental reform to fix its excesses, as Adam Jaffe and Josh Lerner showed in their book Innovation and its Discontents. These reforms involve preventing junk patents from being issued, and making it easier to challenge the bad ones who slip through

People in the patent office certainly know about these problems, and are taking steps to address them. One of the most knowledgeable on patent excesses is Stuart Graham, a PhD economist with a JD who was appointed chief economist of the USPTO in March. A study Graham co-authored earlier this year concluded in part:

• Technological innovation is linked to three-quarters of the nation’s post-WWII growth rate. …
• Highly innovative firms rely heavily on timely patents to attract venture capital—76 percent of startup managers report that venture capital investors consider patents when making funding decisions.
• Delay in the granting of rights has substantial costs.…
• The enhanced post-grant review—the process by which a patent’s validity may be challenged through an administrative appeal in front of the USPTO—offers a cost effective and speedier alternative to litigation. The cost of such proceedings is expected to be 50-100 times less expensive than litigation and could deliver $8 to $15 in consumer benefit for every $1 invested.

Patent reform — whether through USPTO administrative action, legislation or court rulings — will improve the odds that a given patent is applied appropriately. However, no system created or run by human being is ever perfect, or ever will be.

Moreover, an effective innovation policy means more than just a patent policy: not all innovations are patentable, and patents are not always the best way to incentivize innovation.

Suzanne Scotchmer has talked about the historic role of prizes as a way to encourage innovations in her seminal book Innovation and Incentives. The idea of using prizes is catching on, with things like the X Prize and academic research on crowdsourcing. In some cases, the prize-winner even keeps the commercialization rights as an incentive to see it to market.

So while I certainly agree with Asay (and Chesbrough and many others) that we must reward those who bring goods and services to market, technological innovation is more than just execution: it’s also about technology. We need more than the MBAs and the salespeople and the bean counters and even the engineers who productize the technology; we also need the inventors who made it all possible.

Another sign Web 2.0 has peaked

The day of reckoning for Web 2.0 companies is approaching just as surely as it did for Web 1.0. We appear to be about a decade behind Web 1.0, which would suggest that the crash could start next spring.

Not all Web 2.0 companies will fail, just as not all Web 1.0 companies failed: Amazon and Google seem to be doing just fine, and the eventual Facebook IPO will graduate it into this camp as well.

But if the sign of a top is when everyone is pursuing a trend (or fad), then there’s not much upside left. Or as stockbrokers have long noted, when shoeshine boys are giving stock tips, it’s time to sell.

One sign is that — as with a decade ago — we’ve been subjected to years of hype about how Web 2.0 is the future and taking over the world. For example, this week‘s article that proclaims that future CEOs (unlike today) will be social media geniuses.

But what really got my attention was listening to a description of consulting projects that two accounting firms were pitching to our honors students. One of the firms was nationally known, one is a medium-sized regional player. Both wanted students to study how the accounting firms can use social media in their operations, e.g. for recruiting students.

True, some accounting and consulting firms are real IT opinion leaders: think Andersen Consulting. However, many are filled with bright people whose skills extend more to disentangling tons of tax code red tape than deploying cutting-edge technologies.

So how much more upside is there to Web 2.0? Yes, there is international growth in countries that use cellphones rather than PCs. And there may be some geezers who aren’t on Facebook that may adopt in the future — or perhaps these geezers will never adopt these technologies.

Either way, the adoption rate of Web 2.0 technologies in the US will be slowing down, and the rest of the developed world too. How many new entrants can be supported in a maturing market?

Sorry, Steve

Steve Jobs made a few announcements yesterday, and as usual, probably every man woman and child on the planet has heard the news about new and improved iPods etc. Heck, you can even find a few hundred articles that talk about his decision to ditch the mock turtleneck.

Most of it was the expected better, faster, cheaper. The Nano I bought last month (on a special promo) is now smaller and has a clip. The youngest member of our household is hoping that the iPod Touch will be drop-shipped from the North Pole in late December. (Steve finally admits that the iPT is just an iPhone Lite). The AppleTV is no longer a hackable Unix-based stripped-down Mac, but (if rumors about its use of iPhone OS are to be believed) an iPT without a screen.

However, I think the new iTunes movie policy is crazy: no sales, $1 for renting a TV episode, and $5 for renting a movie. Maybe he’s just greedy or not serious; I don’t know.

Maybe it’s because the studios are fighting him and demanding ridiculous royalties; certainly the decision of CBS and NBC to boycott the effort suggests the studios are not cooperating, although the NBC recalcitrance (even pre-Comcast) is déjà vu all over again.

Movie rentals are a commodity. Right now I rent my movies for $1 from a kiosk at my grocery store. In other cases, I pay $0 to rent movies or TV episodes from the library, or $0 to watch TV episodes on a website.

Meanwhile, Netflix will gladly rent me movies and some downloadable content for $9/month. That includes downloads to a Wii, PS3, Xbox360, iPad or AppleTV.

Why would I want to pay $5 for a single movie rental? If the studios conspire to embargo movies from the discounters for 60 days — and somehow avoid antitrust scrutiny — then it might be possible to charge a premium for hot new releases. Otherwise, it’s hard to see how anyone — save perhaps rich Silicon Valley elites who have more dollars than sense — would pay more than $2-3 for a download that’s available in so many other ways for a heck of a lot cheaper.