NETTING IT OUT

Why is the Netflix patent important? It’s a good example of how to turn customers’ moments of truth into a set of innovative business models. Netflix analyzed what was wrong with the movie rental model--customers hate late fees and deadlines--and turned that analysis into an innovative approach to the movie rental business.

Netflix’s customer loyalty speaks for itself. The company has over 1 million fanatically loyal and enthusiastic customers, each of whom uses the company’s services several times a month. By the end of 2003, Netflix expects to reach revenues of $255 to $275 million, EBIDTA of $47 to $55 million, with gross margins of 42 to 44 percent.

Yet, without patent protection, Netflix’ formula for success is easy to copy--note that Wal*Mart and others have already launched virtually identical services. But, with patent protection, Netflix has increased the value of its company substantially.

What can we learn from the Netflix business model? We can learn that focusing on customers’ moments of truth(1) may give you not only a leg up on the competition, but might even yield a sustainable and valuable competitive advantage.

SPOTTING A GOOD BUSINESS MODEL

It’s easy to spot a good business model once it exists--for months my friends and family have been extolling the virtues of Netflix.com. They talk about how much they like the huge selection of movies (15,000) and how much they enjoy searching and sorting through that selection and reprioritizing the movies on their current list of selected titles. They talk about how much they enjoy coming home to find new movies in their daily mail, as well as the anticipation of finding out which one of their top selections they actually received. They talk endlessly about how clever the business model is--how much they like not having to worry about late fees and meeting deadlines. They extol the virtues of the simple-to-use envelope the DVD’s arrive in and the fact that they don’t have to affix postage--all they have to do is slip the DVD into the envelope and pop it back into a mailbox on the way out. And they rave about the quick turnaround time--typically no more than two days from the time you mail a DVD back to the time you receive the next one on your list. (In New England, where we live, if we post the DVD on Tuesday morning, the next one will arrive in Thursday’s mail.)

Months ago, my husband and I agreed that this is a company whose stock would be a smart investment. Like so many other good intentions, neither of us took action. Now, it’s probably too late. Netflix’s stock price has been rising steadily. On June 25th, 2003, the day after the U.S. Patent Office granted a comprehensive patent to Netflix.com, Inc. and its founders, the stock price jumped 11.5 percent in a few hours and kept on climbing.

BUILDING A BUSINESS MODEL ON CUSTOMERS’ MOMENTS OF TRUTH

What’s at the heart of a good business model? We believe that it has three significant components: the first is to ensure that the model is designed around customers’ moments of truth(1). The second is to ensure that you address those moments of truth with innovative approaches that take full advantage of available technology. The third is to hone an efficient execution engine that: a) lets you make money while you’re meeting customers’ moments of truth, and b) builds barriers to entry through experience, scale, and distance traveled on the learning curve. Netflix has demonstrated its mastery over these three components.

Netflix isn’t the first company to build a successful business by catering to customers’ moments of truth. But it may be one of the first companies to receive a patent on a business model, e.g., “a method and apparatus for renting items” that is optimized around customers’ moments of truth. Specifically, Netflix has received a U.S. patent on a set of claims that, taken together, will probably revolutionize the movie/video game/music rental industry. Predicting whether the Netflix patent will stand the test of time (and litigation) is beyond our expertise. But we can comment on the appropriateness of basing an invention on meeting customers’ moments of truth.

Let’s take a look at the critical moments of truth that Netflix is addressing in its service and in its patent claims. First, we need to understand the Customer Scenarios® involved. By our definition, “I want to rent a movie” is not a customer scenario. Customers don’t really want to rent movies. What they want is to watch movies. The movie rental business sprang up as one means to satisfy the ad hoc “I want to watch a movie at home” scenario....