Netflix CEO Reed Hastings writes
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. Eventually these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.
When Netflix is evolving rapidly, however, I need to be extra-communicative. This is the key thing I got wrong.
In classical economics AOL should have died. Borders should have died.They should have spun every dime out to the shareholders who could have invested in the next big thing themselves.
However, Hastings is specifically saying this is the mark of a bad CEO and everyone nods there heads. He is saying that we should burn shareholder profits in an effort to move away from what made the company great.
Per Cowen’s law there should be a literature on this, but I have not seen it and it seems like a big deal to me.
8 comments
Comments feed for this article
Monday ~ September 19th, 2011 at 2:16 am
Blue cat
Very interesting idea. Some companies should decide that they will continue to operate as long as their current business lasts, and then close. During that period, all profits not required for operation will be issued as dividends. The value of the company will then be based on the market’s estimate of the income stream it will generate. Presumably that’s true in general, but in cases like this, it will be much easier to estimate. A good current candidate to operate in this mode is RIMM. The problem is that if they don’t pay out their earnings but burn them in a futile effort to move to the next product, they will have cheated their shareholders.
In some ways this is like putting a company in hospice care. It has decided to die; the only question is how painless a death can one arrange for it. A slow profitable decline would not be that bad.
Monday ~ September 19th, 2011 at 6:52 am
anon
If the company’s “burning earnings” is truly futile, then the stock price will decline as expected dividends fall. If expected dividends fall enough, someone will eventually issue a takeover bid for the firm and liquidate its assets–which is what you are advocating here.
Tuesday ~ September 20th, 2011 at 12:06 am
jsalvati
Note that “poison pill” agreements and a host of laws have made hostile takeovers very difficult. http://www.overcomingbias.com/2010/01/enable-raiders.html
Monday ~ September 19th, 2011 at 2:18 am
rhmurphy
It’s called Austrian economics? The market process? The Kirznerian entrepreneur?
Monday ~ September 19th, 2011 at 2:22 am
Blue cat
Very interesting idea. Some companies should decide that they will continue to operate as long as their current business lasts, and then close. During that period, all profits not required for operation will be issued as dividends. The value of the company will then be based on the market’s estimate of the income stream it will generate. Presumably that’s true in general, but in cases like this, it will be much easier to estimate. A good current candidate to operate in this mode is RIMM. The problem is that if they don’t pay out their earnings but burn them in a futile effort to move to the next product, they will have cheated their shareholders.
In some ways this is like putting a company in hospice care. It has decided to die; the only question is how painless a death can one arrange for it. A slow profitable decline would not be that bad.
P.S. I tried to post the above, but it apparently failed. In the mean time, it occurred to me that even Apple might be seen in this category. They can come out with new versions of their current products. But eventually, those lines will terminate. The company will fail unless it finds new product lines. Of course it is betting that it will.
Monday ~ September 19th, 2011 at 6:49 am
Hyena
Not sure that the classical approach would be correct. One issue is that it might be less efficient from an organizational capital perspective. Physical capital and legal capital (contracts, IP, etc.) can be liquidated but organizational capital almost certainly has to be destroyed.
Possibly, there is room to work the issue in; taking a Parfit-like attitude, we could argue that (say) Netflix effectively sells its organizational capital to Netflix’. If investors don’t think this move would be profitable, they could jump ship.
Monday ~ September 19th, 2011 at 10:51 am
mn
It’s not the move that is baffling it’s the way they are going about doing it. They could have transformed themselves seamlessly without inviting all this bad PR with their customers. Hastings seemingly wants everyone to know he’d a good, innovated CEO instead of being a good innovated CEO without anyone noticing. Does Netflix need shock and awe to grow? Or could they have just moved along with a superior product seamlessly transforming into a different company. My guess is this will work in the long run but they have needlessly lost business.
Monday ~ September 19th, 2011 at 10:55 am
Curt Doolittle
Peter Klein works on the theory of the firm on our side.
I have a less gregarious position than he does:
1) Organizations distribute the minimum profits tolerable by investors — the minimum profit necessary to perpetuate credit expansion. No other action on their part is logical.
2) Credit is the most valuable competitive asset a company can have. There is no value in distributing more profits than are necessary to maintain or increase credit.
3) Profits necessary for expansion attract competitors and rent-seeking employees – both of which increase the cost of the opportunity (asymmetry) that the business exploits in exchange for profits. In most businesses employees are the only marginal difference between firms. So market leadership requires increasing consumption of revenue by the staff.
4) And so, all bureaucracies seek self-perpetuation, expansion and opportunities for rent seeking.
5) Conversely, existing accounting methods are insufficient for tracking consumption of credit and investment because the life span of a company is measurably shorter than our forecasts allow. (Microsoft for example is only alive today because of rent seeking on the network effect, and the irrationality of investors.) This weakness is offset in public companies by the liquidity provided by the capital market
6) Entrepreneurship is a lottery. If it wasn’t there wouldn’t be a wide enough incentive to take the high risks and personal sacrifices needed to innovate.
7) Investors are lenders seeking speculative returns. Any semblance of ‘ownership’ is little more than a bit of marketing left over from the era where family owned businesses grew large enough to need to hire professional executives. Investors are lending in search of higher returns through speculation and that is all.
8) Due to state-induced inflation and high taxation on dividends, investors cannot seek profits from either appreciation of savings, or seek sufficient returns from secure investments, so they must seek profits from speculation.
9) Because of the above properties of organizations, profits at scale are very hard to come by (small) but easy to maintain (volume). Just look at the data by sector. Most businesses have a very hard time staying ahead of inflation. The most profitable businesses are small (ie: Day Care of all things.)
10) Organizations are another application of swarming/flocking/schooling after opportunities. They reduce costs for members. Like capitalism itself, this self interest serves consumers by increasing choice and decreasing costs. But organizations have no ‘higher interest’.
The virtue of companies is that they die. Governments do not. And unfortunately laws do not die with the idiots who write them. Instead, democracy tends to create and perpetuate in law the ‘silly ideas’ which would die under evolutionary pressures in the market. Things like inter-temporal redistribution under the ruse of insurance that requires permanent population expansion – ie, our Ponzi scheme.
Sorry. Had to put that one in there.