Thoughts from 10 Years Ago: Disruptive Innovation in the Evolution of Moving Pictures

[This was written a few years before I joined Netflix, and before they launched streaming]

Lets look at the history of movies. The initial technology to capture and replay moving pictures was developed around 100 years ago, and the initial competition between inventors went through its first transition when movie theaters became established and began to settle on a standard form of projector. The inventors who had alternative camera/recording/projector technology died out. Consumers wanted to go see movies and the movie industry formed to provide content for that market.

The next innovation was to be able to watch movies at home on film, then there were movies on TV. The movie theaters had far bigger screens, better sound and color but the technology at home gradually caught up in features and reduced in cost, and a market transition to home viewing occurred. The total market size for equipment bought to watch movies at home is huge. Its important to note that the primary vendors in each phase of the market are different. The movie theater business is very different to the home video equipment supplier business. The early battles in the home were over the standard formats, famously Betamax failed to win over VHS for video tape, and there are continuing battles over DVD formats, but Sony is a dominant brand name in a crowded market for home video equipment.

The next innovation was video rental, and Blockbuster ended up as a major player in this market, with presence on every high street. However, that presence became unnecessary as Netflix shipped DVD’s directly to consumers and took over a large share of the market.

Finally, video is available directly over the internet , its being viewed on PC’s rather than TV sets, anyone can create and upload it, and YouTube is this year’s hot market leading name in this space for all kinds of short videos. Its also trivially easy to take a full length movie or TV program and share it using one of the many BitTorrent services, and a growing proportion of movies are being watched for free, to the consternation of the movie industry.

The PirateBay site in Sweden was shut down and charged with copyright violation, but it appears that a significant proportion of the population of Sweden were users and they got upset as they had got used to exchanging content for free. After three days the site came back up, hosted in Holland, and with even more users due to the publicity.

Unlike YouTube, BitTorrent sites such as PirateBay don’t host the actual content, they just connect individual users who exchange content, they don’t need to provide storage or bandwidth, just a searchable database of small index files that configure the BitTorrent transfer between a large number of seeders that have some or all of the file already, and leechers who want to get the file, and who can in turn become seeders.

The publicity gained as a side effect of trying to shut down the PirateBay site may even have the opposite effect of cementing the PirateBay brand as a market leader and accelerating growth in this space.

Every step in this history involves a disruptive innovation. There is a fundamental reduction in cost, offset by a large increase in unit volume, which has often increased the overall revenue using a new way to monetize the market for moving pictures. Each time the previous market leader is left behind (often kicking and screaming) as the new larger market emerges. Each time a new brand captures the attention span and trust of the consumer, and dominates the market.

[The cost of bandwidth eventually dropped far enough that Netflix was able to emerge as the leader in subscription streaming services.]

Here I’ll take a more abstract view of a maturing market as each phase evolves, and refer to the development of in-home movie watching as an example.

  1. An emerging market is characterized by competition on the basis of technology. Early adopters like to play with new technology and are able to cope with its issues. Many different products are competing for market share on the basis of “my features are better”. Think of the early days of the VCR, with VHS vs. Betamax. In a mature market, few people worry about features, most VCR or DVD players have the same feature set and very good picture quality at a very low price. If you want to be sure you get a good one, you are most likely to buy using brand name (e.g. Sony) rather than poring over detailed specifications. Margins are low, but volume is high and margins can be better if you won the brand battle.
  2. The next phase in the market is characterized by competition on the basis of service. Think of the video rental store as a service. You visit the store and pay rental according to how much you use the service. As an emerging service, anyone could setup to rent videos and DVDs. As the market matured, larger stores with a bigger selection and more centralized buying power provided a better service, and video rental chains such as Blockbuster took over the market. Again, the power of a dominant brand became the primary differentiator as the service market matured.
  3. The third phase in the market is the evolution of a service into a utility. A utility provides a more centralized set of resources, and a regular subscription or monthly bill. It can provide similar services, but in a more automated manner. Netflix is my example of a utility based DVD provider service. You pay a monthly fee which encourages steady consumption, and Netflix have automated the recommendation system, which replaces asking the counter clerk in a video rental store for advice. The recommendations are the result of many peoples opinions, so are likely to be less biased and better informed, but the most important difference in the utility approach is that it doesn’t need people to provide the service directly to the customer. This makes it fundamentally cheaper. Many traditional services were transformed into utilities by the arrival of the Internet, which allows consumers to access information based utilities in a generic and efficient manner. The network effect benefit of having a large user base also causes dominant brand names to emerge. Netflix leads mindshare in this space, despite attempts by Blockbuster to copy their business model, Netflix can grow faster with fewer people as a pure utility.
  4. The final phase in the evolution of a market occurs as the cost of replication and distribution of the product approaches zero. For digital content the end customer already has a computer and an Internet connection. There is no additional cost to use it to download a movie. A central utility such as YouTube can use a mixture of advertising and premium services (for a minority of power users) to offset their own costs. Peer to peer systems distribute the load so that there is no central site and no incremental cost in the system. The only service that is needed is some kind of search, so that peers can find each other’s content to exchange it. PirateBay is primarily a search engine, and search engines become dominant when the brand gets well known, and they find what you are looking for because they have a comprehensive index.

So the evolution of a marketplace goes from competing on the basis of technology, to competing on service, to competing as a utility, to competing for free. In each step of the evolution, competitors shake out over time and a dominant brand emerges.

To use this as a maturity model, take a market and figure out whether the primary competition is on the basis of technology, service, utility or search, and consider whether a dominant brand has emerged in that phase. The model should then indicate what the next step is likely to be, so you can try to find the right disruptive innovation to get you there. Good luck!

Originally published at .

Work: Amazon Sustainability (ex AWS, Battery Ventures, Netflix, eBay, Sun Microsystems, CCL)