Pandora And Micro-Channels

You might be familiar with Pandora, the streaming online music service? You list a half-dozen of your favorite artists, and then "the algorithm" streams you a series of songs that you, in theory, will enjoy listening to.

I have 1.5mbps DSL service, not anywhere near as fast as cable, but fast enough for me to get streaming Netflix movies via my Roku player, and more than fast enough to handle Pandora. I listen to Pandora through my Grace Wireless Internet Radio ($176 with free two-day shipping at Amazon), and I set up all of my NPR podcasts through this player as well.

Why the two-paragraph description of my viewing and listening habits?

Micro-channels.

Once you head down a path that is both convenient and more entertaining than a prior channel, you become less likely to go back.

There's no reason to listen to 103.7 FM (The Mountain) and endure twenty minutes of commercials and a half-dozen songs that I'm not interested in when Pandora delivers most of what I want, for free.

Once again, a profitable channel (radio) is replaced by a popular (to me) channel that is hard to monetize (Pandora).

And there's no way that 103.7 FM (The Mountain) can fight their way back into my life under the confines of the current business model. They can move their channel online, streaming what you hear on the radio. They can add "HD" stations, truly becoming "multi-channel". But the core premise of the brand is to sell twenty minutes of advertising, per hour, every hour, and to get me to listen to the advertising. That worked when music was scarce.

The problem for my preferred micro-channel combination (Pandora + Grace Wireless Internet Radio) is that maybe a few hundred thousand people (at most) prefer this combination. This combination, while futuristic, does not represent the future.

That's the challenge that we, the "multichannel generation", are facing. Somehow we were all smart enough to jump on the internet bandwagon a dozen years ago --- we could see that e-commerce was going to be important. Today, it's a lot harder to see the future. We simply cannot point to the "next big thing". We probably need to experiment in a hundred or a thousand micro-channels. But because none of it scales, we don't experiment, hastening our current trajectory.

The next generation of merchandising and business leaders will solve this problem. Oh, the opportunity!

Netflix: 2001 to 2012 Sales Trajectory

I'm spending an increasing amount of time helping new online businesses develop long-range sales forecasts.

There are two important components of a long-range sales plan for a new business.

First, we have to estimate how likely customers are to defect.

Second, we have to estimate how many customers we can attract via marketing, and what those customers will spend.

By being a publicly traded company, Netflix freely provides us with a rich history of marketing spend, and the customers attracted by marketing spend.

If you like, download a Netflix 2001 - 2012 spreadsheet I created, a spreadsheet that outlines historical results and a projection for the future. Change marketing spend in row 13 for years 2008 - 2012, to get an idea of how Netflix sales and profit might vary based on different marketing spend levels.

The spreadsheet is driven by churn rate, and more importantly, the marginal effectiveness of marketing and customer acquisition. The graph at the top of the page illustrates this trend at Netflix. In the early years, Netflix was able to greatly improve the effectiveness of marketing activities.

But after 2003, cost per new subscriber steadily increases as marketing spend increases. One can play with different marketing spend levels, understanding the long-term sales and profit potential of Netflix.

Give this simplistic spreadsheet a try. Give me a holler if you want a model built for your new or existing online business.

Blockbuster Versus Netflix

Blockbuster, the retail movie rental king, is increasingly challenged by Netflix, the online movie rental king.

So, Blockbuster implements an online rental program, leveraging retail stores as a key component in the new program.

And then the financial results come in, and they look awful. Forbes magazine has a headline that says "Online Service Costs Blockbuster". Forbes also lists an article that says "Blockbuster Gains On Netflix". Forbes also mentions "Netflix Losing Ground". Which article is "right"?

First, one needs to consider that Blockbuster executed a $35,000,000 advertising campaign to educate the public about the new program. If we assume that the advertising campaign was executed in an effective manner, it is highly unlikely the program will pay for itself in the short term. It may never pay for itself in the long term.

The article states that Blockbuster added 800,000 new subscribers, bringing their total to 2,800,000. Netflix added 481,000 subscribers, bringing their total to 6,800,000 --- but more important, new subscribers were dampened by about 200,000 verses prior quarters.

In other words, Blockbuster may have dramatically over-spent (as is evidenced by the cost of the advertising campaign, directionally similar to the increase in loss verses last year) to acquire new customers, and cannibalize Netflix business.

Also, pay attention to comments that Blockbuster retail sales decreased significantly verses prior year. Only Blockbuster knows if the online business is cannibalizing their own retail sales.

This is where Multichannel Forensics can be applied both within and across businesses, with the advantage going to Blockbuster. Blockbuster has retail and online channels, and has competitive data provided by Netflix. Management can use Multichannel Forensics to forecast long-term changes in retail and online growth, and can incorporate Netflix information into the simulation. Over the next few years, Blockbuster management can see the long-term financial impact of their decision (which will hopefully be better than what is being reported today), and can project the potential damage inflicted upon Netflix.

What a wonderful, real-life laboratory we have in Blockbuster and Netflix. We see that multiple channels can be better for the customer, expensive for the multichannel brand, and can erode the growth of the online pureplay. I look forward to seeing what Netflix does to compete against this multichannel intrusion into their space.

If you were Netflix, how would you compete against Blockbuster?

Blockbuster Verses Netflix: Multichannel Forensics

Blockbuster's PR folks are doing a good job getting the word out that they are gaining ground in their battle with Netflix. A series of articles are circulating the press, including this one from Forbes. Blockbuster claims to have 2.0 million paying online subscribers, compared with the 5.7 million that subscribe to Netflix.

Financial documents from both Blockbuster and Netflix tell us the story of online and retail sales, during the third quarter of 2006 verses 2005. Some of these numbers may be a comparison of apples and oranges, especially given retail closures associated with Blockbuster. They can still be used for illustrative purposes.

Comparison of Rental Income, Online and Retail
Blockbuster Verses Netflix, in Millions
Third Quarter Results
	2006	2005	Change
Blockbuster Retail	$676.0	$726.5	-7.0%
Blockbuster Online	$64.7	$41.0	57.8%
Netflix Online	$256.0	$172.7	48.2%
Totals	$996.7	$940.2	6.0%
Blockbuster Total	$740.7	$767.5	-3.5%
Netflix Total	$256.0	$172.7	48.2%
Blockbuster To Netflix Ratio	2.893	4.444	-34.9%

Blockbuster claims that retail rental revenue decreased due to expense management associated with closing poorly performing real estate locations.

Between the two businesses, total volume increased by six percent in the third quarter, suggesting an expanding market, or suggesting that Netflix is taking market share from other competitors.

Multichannel forensics come into play for Blockbuster when evaluating the growth of the online subscriber base. If these subscribers are simply retail customers who are converting to the online channel, Blockbuster may have a series of additional future challenges.

By offering in-store dropoff and pickup of online movies, Blockbuster may stem loss of customers to Netflix. This strategy may allow Blockbuster to slow the rate at which Netflix is growing its customer base via customer acquisition. Given that Netflix likely has an annual customer retention rate of around seventy percent, Netflix must really amp-up the customer acquisition activity in order to continue the torrid growth rate Netflix has achieved.

If, however, Blockbuster is simply shifting its own retail rentals to an online subscription channel, then a very interesting set of dynamics shift into play. Can Blockbuster drive more visits to the store under this model? Management seems to think so. If this results in fewer visits to the store that result in a purchase, fixed store costs may not leverage as well, requiring Blockbuster to make a series of decisions about the true incremental value of the online initiative. It is possible that sales decrease in all stores, resulting in the eventual closure of underperforming stores. This could eventually lead to a more profitable business model, assuming Netflix doesn't clobber Blockbuster during this period of transition.

Stay tuned. Both companies appear to be moving their chess pieces around the board. Both executive teams must be feeling the stress of this multichannel verses online pureplay battle. Who do you think will win?