Digital Transformation is more than just digitising processes. Lack of it could be an existential threat. E.g. Blockbuster. This blogpost starts with some creative stuff that Blockbuster Video (and David Cook) did in the 1980s that shot them up to be a market leader and a $5 billion company. But how they didn't embrace the digital transformation well enough and got perished. And how Netflix transformed during the same time and became what it is today. Towards the end of the blog, I capture Netflix's cofounder's emphasis on the cultural aspects that drive continuous transformation and long term profitable growth. I thought it's best to capture all the aspects of the story form.

On to the stories::

Blockbuster Video

Blockbuster LLC was a US-based provider of home movie and video game rental services. Services were offered primarily at video rental shops. Still, later alternatives included DVD-by-mail, streaming, video on demand, and cinema theatre.

Blockbuster's beginnings can be traced back to another company, Cook Data Services, founded by David Cook in 1978. He opened the first Blockbuster Video in 1985 under Blockbuster Video Inc. Cook's experience with managing massive databases proved helpful in driving innovation within the industry. Following the early success of the company's first stores, Cook built a $6-million warehouse to help sustain and support future growth, allowing new stores to open quickly. Blockbuster often custom-tailors a store's inventory to its neighborhood based on local demographics.

Blockbuster saw the digital transformation coming, and around 1999, Blockbuster hired Shellye Archambeau (who had spent 15 years IBM then) as the president of Blockbuster.com, its online arm. 

As the newly minted head of Blockbuster Digital, she saw the future. And the future looked like Netflix. Although Netflix had yet to launch the streaming service we know today, it was already changing how people watched movies – by mailing DVDs in red envelopes. Shellye met with Netflix CEO Reed Hastings, and they both saw the vast potential of a partnership.

Shellye mentioned that Reed came out to Blockbuster and pitched, "Let's take Blockbuster.com, the brand, let's take Netflix, the technology, put them together, and spit it out and have Blockbuster.com, Inc." Shellye pitched this idea of a Netflix-Blockbuster partnership to her CEO. Shellye said the CEO just sat back and told her, "If that ever becomes anything, we'll just buy it." Because Blockbuster was a big business at that time. (Later, Blockbuster considered buying the popular Netflix service for $50 million, but they didn't pursue it further and dropped the idea.)

At its peak in 2004, Blockbuster consisted of 9,094 stores. It employed approximately 84,300 people worldwide – 58,500 in the United States and 25,800 in other countries. Its revenue was around USD 5.9 billion, and the market cap of about $ 5 billion. In the same year, Blockbuster launched Blockbuster Online. But their tech was years behind Netflix. But over the next decade … Blockbuster perished. Poor leadership and competition from Netflix's mail-order service, Redbox automated kiosks, and video-on-demand services led to Blockbuster's decline. It began to lose substantial revenue in the late 2000s and filed for bankruptcy in 2010. The following year, its remaining 1,700 stores were bought by satellite television provider Dish Network. By early 2014, the last 300 company-owned stores were closed.

Digital transformation is about innovation, and innovation has much to do with how willing you are to fail. The traditional companies that start with digital transformation need to appreciate that digital transformation needs to be a sustainable long-term cultural shift. 

Netflix

Reed Hastings, a computer scientist and mathematician, co-founded Pure Software in 1991. The original product was a debugging tool called Purify for Unix/C engineers. After adding new products such as Quantify and PureLink and doubling its revenue every year for four years, Pure Software went public with the help of Morgan Stanley in August 1995. In August 1996, Pure Software merged with Atria to form Pure Atria Corporation. Later, in August 1997, Rational Software acquired Pure Atria. Hastings sold Pure Atria to Rational Software Corporation in 1997 for $700 million, the biggest acquisition in Silicon Valley history. , giving Hastings the capital to start Netflix. During the acquisition process, Randolph was already thinking of the next venture idea. He was impressed with Amazon's model and wanted to find a broad category of portable items to sell over the Internet using a similar model. Hastings and Randolph considered and rejected VHS tapes as too expensive to stock and too delicate to ship. When they heard about DVDs, first introduced in the United States on March 24, 1997, they wanted to test if they could be mailed for renting or selling. Randolph says, "Reed and I were in downtown Santa Cruz, and we were saying, 'I wonder if we can mail these things’" Randolph said. "We went in and bought a music CD and went into one of the stationery stores … and bought a greeting card, stuck the CD in the envelope, and mailed it to Reed's house. And the next day, he said, 'It came. It's fine.' That was the start of Netflix. They decided to take on the $16 billion home-video sales and rental industry. Netflix launched as the world's first online DVD rental store, with only 30 employees and 925 titles available, almost the entire catalog of DVDs at the time. They used the pay-per-rent model, with rates and due dates similar to its brick-and-mortar competitor, Blockbuster.

Netflix introduced the monthly subscription concept in September 1999 and then dropped the single-rental model in early 2000. In 2000, Netflix had just about 300,000 subscribers. They relied on the U.S. Postal Service for the delivery of their DVDs; their losses would total $57 million, and they offered to be acquired by Blockbuster for $50 million. They proposed that Netflix, which would be renamed as Blockbuster.com, would handle the online business. At the same time, Blockbuster would take care of the DVDs, making them less dependent on the U.S. Postal Service. After a brief hiccup during 9/11, Netflix saw a massive increase in its subscription business by early 2002.

Randolph, a dominant producer and board member for Netflix, retired from the company in 2004. Reed says that he always goes after the smallest market possible that can hold your 5- to 10-year growth ambitions. That helps him maintain focus.

For some time, the company had considered offering movies online. Still, it was only in the mid-2000s that data speeds and bandwidth costs had improved sufficiently to allow customers to download movies from the net. The original idea was a "Netflix box" that could download movies overnight, and be ready to watch the next day. By 2005, they had acquired movie rights and designed the box and service. They were prepared to go public with it. But they noticed the popularity of YouTube despite the lack of high-definition content. The concept of using a hardware device was scrapped. They replaced it with streaming; instead, a project that was completed in 2007.

How he transformed the business

Here’s Reed’s point of view on how he transformed the business from DVD mail-order rentals to streaming.

Reed: I have always thought a startup should go after the smallest market possible that can hold your 5- to 10-year growth ambitions. By the time we got to 2005, we had realized that DVD was probably going to peak by year 2010. It could no longer hold our 5 or 10-year growth ambitions that we had for DVD. Then we had to figure out how to expand the market definition. We said, “Okay, now is the time. We’ve got to expand into streaming.”

In 2007, Google had just bought YouTube at the beginning of 2007. Hulu started. Amazon did a thing called Unbox, which was its Internet delivery on video, and Netflix began to stream. All four of us entered basically in ’07, and since then it’s been a rocket ship.

In fact, we had to have DVD and streaming be separate so that streaming had to fight and win and be better than Hulu as a streaming service. We came up with this plan to separate DVD and streaming.

We did the thing that Kodak never did, that AOL never did, that Blockbuster never did. We transitioned our business successfully!

How you create long-term companies that continue to innovate.

Reed: There just hasn’t been enough thinking about what’s unique about creative companies. We’re trying to make a contribution around what would you do to optimize creativity. We believe that’s around employee freedom, which is supported by the no rules context.

Other people have other ideas, but they are still about how do you have a company that is able to do new inventions. Let’s take Amazon, an incredible company that has done amazing amounts of innovation, arguably more than Netflix. They’re not nearly as much as we are about freedom and no rules, but they’re about two pizza lunches, and they’re so willing to fail. They can do that whole mobile phone disaster, and then once in a while, they have an Alexa, and it changes the world.

Over time, the innovation sector will see that there are several different approaches and find the best way to combine them.

Google is fascinating because, of course, ten years ago, they were all about 20% time, and now that’s all gone. What did they learn? It’s pretty hard to do innovation one day a week. The big innovations that they made were things like Android, Google Drive, and Google Docs – massive projects. I’m guessing that they probably learned that, “Hey, at Google, the way we innovate is we can put hundreds of people on big ideas, and it’s no longer part-time innovation that matters.” (We want to build an autonomous car, and we’re going to put unlimited money for unlimited years into that)

Netflix and Amazon are closer to those bottom-up innovations, but Amazon has more lines of business. We’re still basically a one-service company, so we’re earlier in the phase. In Google terms, it’d be as if we only had searched.