Author: Eddie Yoon

Netflix reported another great quarter last month, with big subscriber and stock growth. It’s hard to believe it was just two years ago that the company and its CEO were widely ridiculed — and even subject to a Saturday Night Live parody.

Certainly much credit is due to adding new tricks to its tool kit by creating new content like House of Cards, a programming success that’s highlighted how it is using its analytic power to find news ways to satisfy customers.

I’ve written three HBR posts on Netflix since its difficult 2011. All were bullish on its future. I had many left-brain reasons why to be bullish — the quantified upside of digital streaming, its leadership, distribution and analytics advantages, etc. But I think there was emotional ‘data’ that I’ve acquired as a 10 year subscriber that stitches all the rational reasons together and amplifies them.

Put simply, Netflix is a generous company. And generosity can be a highly effective growth strategy.

Most business is viewed as zero sum when it comes to competition — and too often when it comes to consumers. But Nordstrom’s generous return policy and customer service has been highly effective. Costco is well known for its veritable free lunch buffet with its samples. Gillette gives away free razors to teenagers for their first shave. How about even “discount brands” like Southwest and its bags-fly-free campaign?

Here’s the singular theme that is common across these brands. They are all great products and experiences. And they know that giving you a little taste of something great will have you coming back for a lot more — at full price.

A more left brain way of articulating this is Value = Benefits/Price. When consumers see benefits exceed price for something they want, they sign up. The trick is to find Benefits people want and deliver them in a way that Costs less than the Price you charge. Said another way, generosity can help you grow when Value = Benefits > Price > Costs

There are several ways to make benefits > price > costs and profitably grow.

• Offering things that make consumers feel great with low cost. Commerce Bank (now TD Bank) found free coin changing machines drove new accounts. Consumers felt it meant the bank wouldn’t nickel and dime them.
• Seeing giveaways as high impact, low cost marketing. A sampling study from Knowledge Networks PDI noted that sampling programs (the kind used at Costco) drove a 475% sales lift on the day of the event.
• Offering benefits in exchange for strategic information. Most free warranty programs are there to gather detailed consumer information for customer relationship management purposes.
• Betting on life time value. A single transaction might be a loss leader, but generosity has a big impact on loyalty and lifetime value. It’s why Gillette samples at the age of 18 and not 38.

All of these generosity strategies are at play in Netflix’s strategy and execution with House of Cards.

• Releasing all 13 episodes at once didn’t increase the total production cost, but made Netflix binge viewers very happy.
• This generated a ton of positive PR buzz and goodwill among consumers. As CEO Reed Hastings noted, the big bang of releasing all 13 episodes at once “reinforced our brand attribute of giving customers complete control over how and when they enjoy entertainment.”
• It was a great way to to quantify the emerging demand of binge watching — something that Netflix’s competition on regular TV can’t easily accommodate.
• It drove far more new subscribers with lots of goodwill vs. people trying to cheat the system. Netflix has always offered consumers a free one-month trial of its service, and one of the main concerns of Wall Street was people would take advantage of the free trial month, watch all 13 episodes of House of Cards, then quit. Netflix said that fewer than 8,000 actually did this, or about 0.6% out of the 1.3 million people who signed on for the free trial in January. Consumers tend to respond in kind when they are treated generously and with respect for something they value.

But it’s not just tactics, but also how generosity flows throughout the Netflix brand and business model. Last quarter Netflix said that its subscribers watched 4 billion hours of TV across a total subscriber base of 36 million. Per Nielsen, the average person watches 34 hours of TV per week. That means Netflix subscribers watch about 15 billion hours in a quarter. The latest numbers suggest Netflix accounted for approximately one quarter of total TV viewing for its subscribers. But at $7.99 per month, Netflix only charges 10% of the cost of the average cable bill, which is around $80.

If some skepticism remains about generosity as a growth strategy, then consider the alternative…stinginess as a growth strategy. Does that ever work in the long-run? How does it work in the social era, where singular acts of generosity or stinginess spread like a virus? If Twitter is the TMZ for corporate behavior — good and bad — might generosity be the only viable choice in a digitally connected world?

The etymological root of generosity is the same as genesis, genius, and generate. Generous companies appear to be proud of what they make. Panera is another example of a generous company. Panera knows that putting their great food in people’s mouths–and letting those same people talk it up to others–is the best marketing for them. That’s why Panera’s donations-only café are breaking even on average. Panera estimates ~60% of customers pay the suggested donation, 20% pay less (or nothing) and 20% pay more. And Panera knows that generosity is highly empowering for employees, and leads to wonderful stories (and PR).

Reed Hastings recently expressed it this way in the New York Times, as he realized the 2011 was a mistake from the thousands of emails that poured in from angry customers. “I realized, if our business is about making people happy, which it is, then I had made a mistake. The public shame didn’t bother me. It was the private shame of having made a big mistake and hurt people’s real love for Netflix that felt awful.”

Most CEOs don’t talk about love very often. But by giving consumers benefits that feel generous, Netflix and other companies are creating an effective way to grow.

One of the hardest places to get capital to commercialize a great growth idea is within corporate america. Startups can tap the venture capital market. Corporations can go to the general capital markets by issuing stocks or bonds. But let’s say you are a general manager or director/VP level of a business unit or brand within a corporation. Your options for funding a corporate idea are very narrow — basically, you have to go through the often bureaucratic and political process of getting a budget from the managers above you. Many great commercial ideas never blossom because they get choked out by internal politics, risk avoidance, shorter payback horizons, or perceived lack of capabilities.

Companies need a different process for funding innovative projects. I call this idea “innovation capital markets,” and it’s a system that’s a hybrid of venture capital, general capital and corporate budgeting. Innovation capital markets would fund specific innovations vs. entire corporations. These might be innovations with a risk/reward profile that go beyond the typical corporate budgeting process. It might be growth platforms that are ‘orphans’ who don’t fall within a current business unit, like how Redbox was started with McDonald’s. It could be where a mid-level executive turns to after internal budget process has ended with a “No,” and which allows them to turn to pre-vetted, NDA-signed investors who have an appetite for a new kind of investment. The investment would have the upside of an entrepreneur but the assets of a large enterprise.

The inspiration for this idea came from the show Shark Tank. The first time I heard about Shark Tank, I thought it was just another reality TV show. When I tuned in, I was surprised to see that legitimate business was being conducted. By some measures, the Sharks have invested $20 million in over 100 companies. The average valuation for the companies is about $500,000, and entrepreneurs sold about 30-40% of their equity.

The notion of applying the Shark Tank model inside companies was created by one of my clients, a large consumer packaged goods player. It set up an offsite with their top executives and created an internal Shark Tank-like contest to pitch new business idea. For two days, three teams of executives worked into the night pouring over consumer, retailer, and financial data to come up with disruptive ideas to drive growth. On Day Three, each team presented to a panel of “sharks,” consisting of members of senior management, myself, and Mark Cuban, who they’d brought in for the event.

The event was a huge hit. Much of that was due to Mark Cuban, who was in full Shark Tank persona. Folks who were taking a while to take the stage were told to walk faster. Others with pre-ambles longer than 5 seconds were cut-off and reminded that this wasn’t a history class. Cuban acted as a human TiVo device for meetings, allowing us to fast forward or go back on the key parts of the meeting. Watching executives pitch to Cuban was an object lesson on the importance of the 30-second elevator speech.

He asked salient yet sharp questions and had everyone in stitches as he good-naturedly poked and prodded each presenter, bringing an entrepreneur’s lean mindset to the discussion. Those who asked for more money were asked what they spent now and why that wasn’t sufficient. “So you’re telling me you want another $20 million for smart marketing,” he’d ask, skeptically. “What does it say about the first $20 million you’ve already spent?”

Overall it was great watching an idea go through approval to funding at light speed vis-à-vis typical corporate America timing. Mark immediately came up with a cool cross-pollination idea to have the company participate on a future Shark Tank episode with an investment of his. The startup gets a connection with a multi-billion dollar company, while the company gets some earned media to show its entrepreneurial chops.

The Shark Tank event has had a lasting and meaningful impact on the company already. The winning team won largely because it embraced the classic HBR Marketing Myopia concept of building a growth strategy not on the products they sell, but rather the end benefit or job it provides. Those who were poked and prodded while presenting were given kudos by their peers for their courage, and set a great example that it is okay to endure a little embarrassment to push potential ideas with big economics. The company is working more collaboratively cross-functionally, at a faster, more urgent pace and with careful attention to cash flow.

Innovation capital markets are a huge category creation opportunity. Not just for entrepreneurs within Corporate America and investors, but for companies themselves. I have to believe that the overall innovation success rate (the paltry 10-15%) would have to go up once senior management saw which ideas were getting funding and which mid-level executives were generating them. Imagine a world where individual investors could get in involved. Couldn’t you imagine mom investors jumping on board the Swiffer investment? Or perhaps the fun Flip Video recorder (which I miss terribly) could have survived within Cisco? Wouldn’t M&A success rates also improve, as VCs and their portfolio of companies and strategic buyers within Corporate America collaborate more closely?

Just think if innovation capital markets existed decades ago for Xerox Parc within Xerox. Would we be buying xPods, xPhones and xPads at Xerox stores all over the country?

Netflix recently posted surprising US subscriber growth of 2 million in the last quarter, which has caused the stock to nearly double since the beginning of the year. It puts Netflix at 5-6 million subscribers since its infamous price increase.

The narrative appears to be simple — as Netflix successfully raised prices, it could afford to add more quality content, which in turn leads to subscriber growth. This can continue as long as untapped demand still exists. But how much growth is truly left? This confounding question is the reason why the Netflix stock has yo-yoed over the last 12 months.

On one hand, our previous media study suggested current demand for online streaming to be 40 million households. So there is still room to grow. But as they come closer to the potential 40 million, one expects life to get harder. Competition will increase as Redbox and Verizon enter streaming. Even HBO has acknowledged that a streaming-only option may need consideration. They’ll all spend money to fight over an increasingly smaller piece of the pie, driving acquisition costs per user very high. There is an opportunity for international growth, but life will still be difficult if the US market matures quickly.

On the other hand, if you look into the future 25 years, wouldn’t you be surprised if anyone did not have some kind of digital streaming service? The question to solve for is: is it 25 or 5 years from now?

This is the challenge of latent demand — unmet needs unarticulated by current consumers (pre-Starbucks, no one was asking to pay $4 for a cup of coffee). Or demand from an unexpected population of consumers (like Xbox drawing in women and kids via Kinect). By definition unmet, unarticulated needs from unexpected consumers is hard to measure.

It is possible to quantify latent demand, but the real challenge is estimating when the dam will break. Investing in latent demand requires as much faith as it does fact, as there is a risk of being perceived as over-investing if the upside doesn’t materialize soon.

One proven way of quantifying latent demand is looking at generational demand. In particular, looking younger is a very effective latent demand strategy. Some companies try to influence the point of entry into the category, which is much earlier than the point of entry into a specific brand. In particular, looking at the teen market can prove very fruitful. Several recent moves suggest Netflix is betting on teens and young adults an untapped source of consumers to come their way.

There are roughly 42 million 15- to 24-year-olds in the US. According to Nielsen’s 2012 Cross Platform Media report, 36% of total minutes for 18- to 24-year-olds are via streaming (game console, internet/PC, mobile) which is the highest of any age cohort. For simplicity’s sake, let’s assume share of minutes translates into penetration. So let’s say 15 million teens/young adults who actively stream. These 15 million consumers aren’t paying customers now, but could eventually become so. And this would grow the US streaming market potential nearly 40%. And each decade would add even more.

Netflix has quietly been sowing the seeds of latent demand with this group via smart sampling, habituation, and content. By charging a single price per household and allowing multiple users per household to use Netflix for free, they have let millions of teens and young adults enjoy the benefits of Netflix on their parents’ dime.

After some point in time, these young consumers will be habituated to the benefits of Netflix. My high-school-aged nieces, Emily and Kaitlin, are watching The West Wing with me on Netflix. It’s one of my favorite shows and I’ve gotten them hooked. As we talk about the show, I also ask them questions about their feelings about Netflix. My unscientific research with them and their friends yields some startling results. The vast majority of their media consumption is via streaming. The vast majority of their friends have Netflix. And the ones who don’t are sheepish about not having it. And while they can imagine sharing an account with friends, they prefer the privacy of an individual account. So, the thought of paying $8/month when they are on their own doesn’t faze them a bit.

Netflix also has the first part of latent demand going for them, which is the idea of unarticulated, unmet needs. The beauty of the media business is that great content has an amazing shelf life. The West Wing started the year my younger niece Kaitlin was born, yet 14 years later she found it. A business model that brings ever growing user base to evergreen content is great one.

Netflix’s content moves to create a Just For Kids section and their exclusive Disney deal suggests that they are trying to ensure habituation starts even earlier. If Netflix can win with latent demand, they may have a competitive advantage that HBO and even Amazon Prime may find hard to compete with.