The Genius Of Zero-Billion-Dollar Markets
How Netflix and others tackled markets that didn’t exist.
Originally posted on Readwrite.com 08.19.15
Forget the story you might have heard about how Netflix CEO Reed Hastings started the company because he got a $40 late fee from Blockbuster. The real story’s even better.
According to cofounder Marc Randolph, he and Hastings had the idea to start an e-commerce company in a whole new category. They settled on DVDs. The question was whether they could cheaply and safely mail them. In 1997, DVDs were so new they couldn’t even find one in a store, so they bought CDs at Tower Records instead. The CDs arrived safely, and they were off to the races tackling DVD rental by mail, a market that was worth zero billion dollars at the time.
That simple and powerful market insight — that people might want to go online, press a button, and get a movie — was the beginning of a whole new category of subscription-movie service and the start of Netflix.
Hastings refined the model along the way. While Netflix launched with late fees, like Blockbuster, he realized the fee was customer hostile and the growth of the Internet provided the potential to do something different. In 1999, when he introduced a flat monthly subscription for unlimited rentals, the business really took off.
Today Netflix is worth $52 billion, with everyone from HBO to Comcast racing to imitate its model, and it’s one of the most important entertainment companies on the planet. Blockbuster is all but a memory.
Don’t Tackle Existing Markets — Create New Ones
The path to success in the technology business is almost always an insight that leads to the creation of a whole new approach and a new market category. The history of our industry teaches us that most giant successes come from companies that pioneer what venture capitalist Steve Vassallo calls “zero-billion-dollar categories.”
That means a market that does not currently exist. Before Netflix, there was no category for subscription movies. Before VMware, there was no market for virtualization. GoPro invented the wearable camera and LinkedIn designed and dominates the professional social-networking category.
Entrepreneur and investor Peter Thiel encourages building “the kind of company that is so good at what it does that no other firm can offer a close substitute.”
That’s harder advice to take than it sounds. Every year in the technology industry, hundreds of companies launch thousands of new products. Most of these new products are pointed at existing categories. The thinking here is the bigger the market, the greater the opportunity. While some of these new products will find traction, many won’t. Because the technology industry is generally a winner-take-all game. And once a Category King is crowned, it is almost impossible to dethrone them.
To better understand these dynamics, last summer we began an ongoing research effort. We assembled a team of computer scientists, data scientists and business executives to comb through a variety of data sources to create a fact-based database on the velocity of market capitalization growth.
We examined approximately 26,000 U.S.-headquartered, venture-backed technology companies formed since 2000. We examined their 30,575 fundraising transactions and 69 IPOs with the goal of understanding how they grew in value and how much value in their market categories they captured.
We found that Category Kings typically earn 76 percent of the total market cap in their space, leaving dozens of competitors gnawing on scraps.
The Cautionary Tale Of Bing
In some cases attacking an existing market, with an established leader, is financial arson. Case in point: Microsoft’s Bing search engine.
In 2009, Microsoft’s then-CEO, Steve Balmer, launched the product saying that the search market “deserves a good feature war.” As you know, it didn’t work. Microsoft has invested more than $10 billion in Bing. Google still rules with 65 percent market share.
If Microsoft cannot beat Google with a $10 billion attack, why do so many tech companies pursue existing categories versus designing new ones? Said another way, who would you rather be — Netflix or Bing?
In spite of this reality, most technology companies attack existing competition, in existing spaces. There is comfort in addressing a known market versus placing a bet on a zero-billion-dollar one. When new technologies or companies fail, CEOs, entrepreneurs, product managers and investors often blame the product or company execution. Shitty products and poor execution of course lead to catastrophe. But history shows that many failures are actually category casualities.
Photo by Shardayyy
Originally published at readwrite.com on August 19, 2015.