How Netflix Upended an Industry
What counter-positioning and scale economies look like in business
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Netflix has long been championed for seeing in DVDs what Blockbuster didn’t—the future. Their DVD-by-mail business was akin to what Jeff Bezos did to retail book stores when he created Amazon. Bezos transformed a capital-intense business model, requiring high capital expenditures and physical stores capable of offering a few thousand books, into a distribution network capable of delivering nigh on every book ever published. Netflix also had the self-awareness to look towards the horizon, and where the future was heading—digital streaming. Reed Hasting say’s in the foreward to 7 Powers:
“The existential threat from Blockbuster was behind us, and we were on track to reach almost $1.7 billion in sales. These were hard-won advances, but even so our strategy challenges were no less daunting. The clock was ticking on our red envelope business, as DVDs by mail was clearly a transitional technology. And looming was the prospect of facing off against huge competitors with resources far beyond ours: Google, Amazon, Time Warner and Apple to name several.”
DVD-by-mail, and digital streaming are two separate industries with their own economics, and the prospects of entering the digital streaming industry didn’t look all that appealing: IT costs were getting cheaper by the year; cloud storage was expanding and with it costs plummeting. The barrier for entry seemed to be getting lower—not higher, and so too was the prospect of Power: that which creates durable differential returns.
But, Reed Hastings and his team at Netflix were strategists. They knew it was only a matter of time that digital streaming would do to them, what they did to Blockbuster. They decided that if they were going to be killed anyway—they’d do it on their terms.
“Any strategy framework, to be broadly useful to a business person, must address all key strategy issues within the organisation.”
In 2007 Netflix tentatively entered the digital streaming industry by partnering with a dizzying array of electronic hardware specialists. But they didn’t bet the house and go all-in. They did the leg-work, allowed themself exposure to this emerging market, and gained the much needed experience before making any big moves. While smart, these tactics aren’t a strategy and any potential for Netflix to gain Power in this industry was at the very best muddy.
The way streaming worked back then was streaming platforms like Netflix negotiated for streaming rights of content with film studios. But, the film studios were astute and strategic custodians of their properties, and would split them up by geography, regions, release dates, contract length and so on in ways that benefitted them, not Netflix. It’s the equivalent of wanting to get a new iPhone where the contract provider determines the amount of minutes, text and data you get as well as the price and duration of the contract.
Netflix fought for scraps for 4 years, until in 2011 where they finally made their move. Ted Sarandos, Netflix’s Chief Content Officer, believed it vital that Netflix secure exclusive streaming rights to certain properties. It was exactly this type of thinking that would allow Netflix the potential to finally gain Power over the film studios: they were going to start creating originals. This shift—from being controlled by the film studios—to creating their own content was not only expensive, but risky. However, this move was as bold as it was ingenious.
This was a brazen attempt at counter-positioning and upending the status quo. Reed Hasting:
“Throughout my business career I have often observed powerful incumbents, once lauded for their business acumen, failing to adjust to a new competitive reality. The result is always a stunning fall from grace. A superficial thinker might pin this on lack of vision and leadership. Not Hamilton. By inventing the concept of Counter-Positioning, he was able to peel back the layers to peer into the deeper reality of these situations. Rather than lacking vision, Hamilton established, these incumbents are in fact acting in an entirely predictable and economically rational way. Our earlier battle with Blockbuster bore out this notion.”
The film studios could have copied Netflix into launching their own streaming platforms, but that would have meant cannibalising their already lucrative legacy business models (cinema releases, cable syndication, and DVD sales). The incumbents rational self-interest was Netflix’s moat. The collateral damage to their existing revenue stream made the net present value of copying Netflix at the time an unattractive prospect.
By taking this route, Netflix was now playing a different game. A game of one. Creating originals, such as the hit House of Cards (with that infamous Kevin Spacey look), and gaining exclusive rights to content, would mean that other streaming platforms would have to up their fixed-costs to compete with Netflix or remain beholden to the whims of the film studios. If House of Cards cost Netflix $100m and they had 30 million subscribers then the cost per customer was just over $3. If a competitor had only one million subscribers then the cost per customer to make the original would be $100. They created a 10m-high barrier where none was there before and told those who wanted to compete they’d have to pay up to do so. This radical shift in industry economics allowed Netflix to move away from the value-destroying commodity rat race they found themselves in, and created the path for another of Helmer’s Powers: Scale Economies.
The benefit for people using Netflix was clear: exclusive premium content, on demand, for a low subscription fee that can be cancelled at anytime. The more people that subscribed to Netflix, the more fixed costs they had to create original content.
If Netflix hadn’t made their move in 2011 who knows where they would be today, if anywhere at all. Disney, Amazon and Apple would all eventually all follow suit and create their own streaming platforms but it is Netflix who is still the clear market leader. They have over 325 million subscribers compared to their nearest competitor Amazon Prime Video’s 200m. Disney+ has 131m and Apple+ 45m.
Ultimately, Netflix’s transition from DVD-by-mail to digital streaming is a masterclass in structural strategy and the deliberate construction of Power. They recognised that simply participating in a market dictated by film studios was a tactical manoeuvre, not a strategy for enduring success. By boldly pivoting to original content, Netflix fundamentally altered the industry’s barrier conditions. They leveraged Counter-Positioning to paralyse incumbents—whose rational self-interest prevented them from cannibalising their own legacy models—buying Netflix the crucial runway needed to build insurmountable scale economies
Today’s subscriber numbers are more than just a testament to popular shows; they are the mathematical proof of a moat built on high fixed-costs and massive scale. Netflix proved that to escape a value-destroying commodity rat race, a company cannot just play the game better—it must possess the strategic foresight to rewrite the rules entirely.