Reed Hastings – Netflix co-founder, CEO and longtime proponent of the “digital media movement” – announced Sept. 18 that Netflix would be splitting along distribution lines into two separate companies. The online streaming service will maintain the Netflix brand, while the physical DVD service will spin-off under a new brand, Qwikster. The moves were announced in parallel with a mea culpa for how the transition was handled. Hastings explained that his July price hike and his decision to move the Netflix brand into a strictly Internet-streaming media service was to ensure the company had a future.
Hastings and the entertainment industry have been blindsided by the impact of Internet streaming on their businesses. Hastings thus acted in what he believed was best for the long-term prosperity of his company.
Many independent software vendors (ISVs) selling enterprise systems are facing a similar challenge and have a similar decision to make. In an attempt to not be left behind by the shift to cloud computing, many on-premise providers now offer software-as-a-service (SaaS) solutions. But are these ISVs moving boldly enough? Many are simply sticking their toe in the water, while cloud upstarts race forward with a singular focus – and platform.
As we approach a day when many providers will have to make a decision similar to Hastings’, I think the enterprise software industry can learn from the Netflix/Qwikster split.
Move Positions Netflix to Survive DVD/Streaming Transition
Media, investors and customers alike have chastised Hastings’ actions. Since then, Netflix shares have dropped from a peak of $298.73 on July 13 to under $130 at close on Sept. 23. Customer backlash has been intense – with the consensus being that the service has become too expensive, doesn’t offer enough quality content and will soon become too cumbersome to use.
Personally, I think Hastings’ move was a bold one that may be looked back upon as a deciding moment for a company and an industry. Yes, he may have damaged the Netflix brand, created a case study on “how not to do PR,” and lost some customers along the way. But Hastings is doing what Netflix has always done: charge forward as a leader in media entertainment services.
Hastings sucked it up, faced the brutal facts and made what he believed to be the best long-term move. Will on-premise ISVs do the same?
Some Band-Aids Are Better Ripped-Off Quickly
Through all of his missteps, this may be the lasting message of Hastings’ decision to not be left in the digital distribution dust. In his official announcement, Hastings even justifies his decision as one for the future livelihood of his business:
"Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business…Companies rarely die from moving too fast, and they frequently die from moving too slowly." – Reed Hastings, Netflix
Netflix has already been the cause of a direct competitors’ collapse. Blockbuster, the former media rental giant, is now bankrupt, defunct and forgotten – a Goliath slayed by Netflix and other subscription rental companies. Though Blockbuster entered the home delivery rental arena and played with a “no late fees” policy near their end, it was a case of too little, too late.
Blockbuster decided to ignore shifts in consumer demand, believing they could continue to focus on what they did best and survive. And like AOL and Borders, they were wrong. Hastings’ decisions, while negative for the short term, will position the company to be successful as the entertainment industry transitions to online streaming.
Successful ISV Transition to the Cloud is Possible
When it comes to enterprise software, there are clearly more variables to the equation. Netflix’s decision to raise prices and split into two companies didn’t change the core business model, which has been subscription based since 2000. For ISVs, however, a move to only offering subscription-based SaaS solutions would mean an immediate loss in licensing revenue. In addition to hampering the ability to invest and develop internally, lower revenue forecasts never make investors happy.
But I believe that the transition can be achieved in enterprise software – and actually, it has. Ariba, a provider of procurement, spend and contract management software, decided to make the switch to pure SaaS solutions back in 2004. In an excellent interview with Phil Wainewright in 2009, Ariba’s Chief Technology Officer Bhaskar Himatsingka explained that the transition was necessary and logical for their customers and the future viability of their offerings.
In the span of three years, Ariba effectively moved their offerings to being entirely SaaS and paid for by subscription. Financial data obtained from Ariba’s 10-K filing shows that revenue growth was stagnant while the company made the transition from license-based to subscription-based revenue:
Meanwhile, historical stock price performance shows that investors were hesitant through the movement to SaaS. But as subscription revenue approached that of licence revenue in 2001, stock prices began to rise:
Ariba not only made the transition, but they are now in a great position – and stand to continue growing in the future because of it. Following the Ariba model, ISVs that decide to make the transition to SaaS should anticipate the following:
- Subscription-based revenue will slowly eat away at licencing revenue, but slowly grow as the company – and customers – transition, to eventually reach original licensing levels.
- Investors will be hesitant while overall revenue growth remains stagnant, but will switch back to a buy mentality as subscription licensing shows continual growth.
- This will take a long time, and cash flow dynamics will prevent the company from executing on too many initiatives outside of the shift in business model.
A Lesson Learned for Enterprise Software
As we’ve seen with Blockbuster, AOL and Borders in media and countless ISVs – like McCormick & Dodge, Cullinet and SSA – a company that refuses to change gets left behind and leaves investors, employees and customers in the cold. So kudos to Netflix for making such a bold move.
Clearly, we can all learn a lot from Netflix. Most notably: if you do rip off the Band-Aid to make sweeping changes in software service delivery, it needs to be because it’s in the best long-term outlook for both the company and your customers. And from a PR perspective, the changes need to be clearly articulated to all parties – especially to paying customers.
What do you think is ahead for ISVs determining how SaaS will be a part of their long-term plans? Will they continue offering both? And what do you foresee as the implications of these changes for the company, brand, investors and customers? I’d like to hear your thoughts in the comments below.