Category: Managing Technology

Digging Below the Surface of Microsoft’s Tablet Strategy

Posted on June 21, 2012

With the introduction earlier this week of the Surface tablet, most observers seem to agree that Microsoft got a lot of things right, launching a well-designed product with features lacking in its chief competitor — Apple’s iPad — including a cover that functions as a keyboard and the ability to run desktop software programs.

But the presentation also left many unanswered questions, including the exact price, release date and battery life of the device. Perhaps more importantly, it is still unclear what the Surface offers beyond hardware — and if Microsoft can leverage successful offerings such as its Xbox gaming system and Office productivity suite to create a vibrant ecosystem to rival that of the iPad.

“At first glimpse, Microsoft appears to have gotten a lot right with the Surface tablet,” Wharton new media director Kendall Whitehouse says. “Including an integrated keyboard with the Surface is a great idea. More importantly, however, is that the Surface runs Windows 8. In this regard, Microsoft has leapt ahead of the competition. This is the eventual direction for tablet and mobile products: To close the gap between the mobile/tablet environment and the desktop/laptop environment.”

Whitehouse adds that making Windows 8 the operating system for the Surface is a “big bet” for Microsoft. “But I admire their courage in going ‘all in’ with their new OS. And, if they can pull this off by successfully implementing a consistent user experience across desktop, laptop, tablet and mobile phone devices, they could be back in the game in a big way.”

The move is also reflective of a growing trend in the tech sector, with companies focusing more on offering a full range of hardware and software similar to the Apple ecosystem, says Wharton marketing professor Eric Bradlow. “Every portal is trying to get into the device game,” he notes. “They are worried that someone else taking over the device market will create a friction cost so that the other portals are ‘harder’ to use. I treat Microsoft the same way. They are trying to develop a portal that will keep the Windows 8 platform and the Microsoft suite of products top of mind.”

According to Wharton operations and information management professor Eric Clemons, the iPad is “nearly perfect” as an entertainment device. But it is lacking in the area of productivity, which is where the Surface may be able to make inroads with consumers.

“Providing the Surface with twice the memory of an iPad was a nice move. Adding a USB port was even smarter. Providing Office was smarter still,” Clemons notes. “Until now, when I travel, I need three devices: I need an iPhone. I need a MacBook Pro. And I need an iPad for the plane ride itself. Now I can get away with only two devices, at least on shorter trips…. And a Surface would allow me to write real documents, send real e-mails and view my camera photographs — I mean from a real camera, a Nikon Digital SLR, not a camera phone picture.”

Clemons suggests that sales of the Macbook Air and the iPad could be threatened by the Surface “except that I expected this some time ago from a Microsoft platform, and I bet Apple did, too. So look for an iPad … that runs Office and has a USB port very soon.”

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Calling Facebook: Do You Really Need a Phone?

Posted on June 7, 2012

Rumors surfaced last week that Facebook is gearing up to launch its own smartphone. According to Facebook employees and others who spoke with The New York Times, the firm has begun recruiting former engineers from Apple to bring its existing plans for a Facebook phone — codenamed “Buffy” — closer to fruition.

The Times article notes that Facebook is not the only software maker looking to develop its own hardware: While the social network giant was dealing with the fallout from its inauspicious late May market debut, Google quietly completed its $12.5 billion acquisition of Motorola, “which could lead to the search giant’s making its own smartphone.”

And while integrating software and hardware may be the ultimate goal for many tech companies in a post-Apple world, some observers are not convinced that introducing its own smartphone would be the right move for Facebook. “[It] makes no sense at all — slightly more sensible than a Facebook dishwasher, but not quite as sensible as a Facebook toaster, which would alert all your friends every time you make toast,” says Wharton marketing professor Peter Fader. “I can’t imagine why they would want to get into such a competitive, commoditized market, and what they would hope to get out of it.”

But Wharton marketing professor Eric Bradlow, who co-directs the Wharton Customer Analytics Initiative along with Fader, takes a different view. Bradlow notes that firms like Facebook “are realizing that today, the ‘point of entry’ onto the web plays a big role.” As an example, he cites Amazon’s Kindle device, which the company sells to consumers for a price that is below its manufacturing cost. Why? “Because then the portal to Amazon products is at the touch of a finger — and the [customer lifetime value] for the person, despite the loss leader on the device, is still very positive.” Moreover, Facebook needs to protect its long-term consumer base, he adds. “Imagine that everyone starts walking around with Google phones, then all of a sudden Google+ becomes the social network hub.” 

The bottom line, according to Bradlow and other analysts, is that as users increasingly rely on their mobile devices to connect to the web, Facebook needs to follow suit — or be left behind. In fact, prior to its IPO, Facebook conceded that the challenges of gaining traction in the mobile market pose a potential risk for the firm — an admission which some analysts believe partly accounts for the stock’s dismal performance.

According to Kendall Whitehouse, Wharton director of new media, it isn’t clear that hardware is the only way for Facebook to balance the equation. Instead, the firm might simply need stronger mobile app development. He points to Twitter as one example of software that translates exceptionally well to a mobile environment, “because its interface is simple and elegant.” That’s not the case for Facebook, which is crammed with features and has an interface that is anything but simple. His advice? “Use the employees at Instagram” — the mobile photo application firm that Facebook recently purchased for $1 billion — “to develop a really good mobile app.”

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Are RIM’s Days Numbered?

Posted on May 31, 2012

On Tuesday, Research In Motion (RIM) announced that it will not make a profit this quarter — a big fall for a firm that was named the world’s fastest-growing company only three years ago by Fortune magazine. RIM also noted that it is working with two banks, J.P. Morgan Securities and RBC Capital Markets, to review its strategic options — a move that has many analysts wondering if the firm is looking to sell off all or parts of its business.

Following the profit warning, RIM’s stock fell 7.8% on Wednesday, bringing its market capitalization to below $6 billion. (It was $40 billion early last year.) Not surprisingly, it has been a tough time for RIM. The company’s BlackBerry smartphone has lost significant ground to Apple’s iPhone and Google’s Android devices, and last fall, its proprietary server network suffered high-profile blackouts affecting millions of subscribers. According to The Wall Street Journal, RIM’s share of the smartphone market fell below 10% this year.

What went wrong for RIM? Wharton management professor Daniel Levinthal says that “the longstanding problem and lost opportunity for RIM has been not decoupling their enterprise software from the [BlackBerry] device. Selling devices and software as a bundle didn’t matter that much in the world before [the advent of] ‘apps.’ But, once the Apple and Google/Android app ecosystems emerged, RIM as a standalone provider was no longer viable.”

Some analysts have suggested that RIM, which is gearing up for the rollout of a new operating system and series of phones, should get out of the hardware business altogether and focus on licensing its secure email system to other handset makers, or to companies like Google or Microsoft that would want access to RIM’s enterprise clients. However, Levinthal notes, “the window as a provider of enterprise software to a wide set of handset manufacturers is closing rapidly as a number of start-up companies are now focusing on providing that service to corporate clients.”

Others, like Wharton marketing professor Peter Fader, believe it might be too late for RIM to save itself. Still, he offers some advice: “Here’s what they should have done a few months ago, and should still try today: Focus on their strengths. They have a huge base of loyal, profitable users. Stop trying to mimic — or even compete with — Apple or the other producers of shiny objects.”

According to Fader, the company needs to “play to its business base as well as to consumers who [have] the same attributes” — such as little time for, or interest in, apps; a desire for real keyboards; a need for secure service and a preference for the company’s “good-but-not-as-novel-as-before” BlackBerry Messenger service. “That’s a whole lot of people, and none of the shiny-object producers have really won them over yet.”

Fader speaks from personal experience. “I’m loyal to my ancient BlackBerry and never want to give it up. I wish [RIM] gave me more reasons not to leave them when my battle-scarred, old phone dies” — which likely will be soon, he adds.

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Sunspots: Germany Proves Solar Energy Is No Mirage

Posted on May 30, 2012

Germany’s substantial investments in solar energy go back decades, and progress has been building gradually. But it passed a notable benchmark last week when its solar power met almost half of the country’s electricity demand at mid-day on a Saturday, and a third of its needs on a Friday, when industry was cranking full steam.

 The development broke all records for solar power — at peak output, Germany used 22 gigawatts of solar generated electricity. That highlights Germany’s leadership position in the field — it has nearly as much solar power capacity as the rest of the world combined. And, in a country that plans to eventually abandon all nuclear energy in the wake of the Fukushima nuclear disaster, the amount produced on these very sunny two days was equal to the generating capacity of about 20 nuclear stations, according to press reports.

Several key developments have helped Germany reach this point, beginning with a long-standing commitment to solar begun in the 1990s. Then, starting around 2001, Germany “heavily invested in solar subsidies,” says Ruben Lobel, a professor of operations and information management at Wharton. The subsidies were “very aggressive” and gave a long-term commitment aimed at benefiting consumers who placed photovoltaic panels on their roofs, and producers of solar equipment. In effect, says Lobel, the plan fixed subsidies for 20 years.

The subsidies locked in guarantees on the price that consumers would pay to generate solar electricity and additional guarantees on how much would be paid for excess electricity piped into the main grid when the generation exceeded consumption. Energy companies were required to buy that excess at fixed rates. Those funds helped to reduce the initial costs of equipment and installation, and the idea was that the level of subsidy would decline as the price for photovoltaic panels and related costs came down over time. To a large degree, that is how the program has worked out.

Kick-starting an Industry

The subsidy program has helped to kick-start a viable solar energy program by absorbing a lot of upfront costs. Now the system is getting closer to paying for itself, says Lobel, particularly as panels get more efficient and higher demand greatly increases the supply and makes them cheaper. The earlier installations “will drive down the costs of the next installations,” he points out.

The emphasis on residential-installed solar panels is particularly important. Subsidies on residential systems are more effective than on large solar arrays because local installations avoid the relatively large costs for transmission and distribution, Lobel notes.

“As a proof-of-concept, yes, renewable generation can be made economical,” Lobel says. “The best proof is what is happening with wind and solar now. The business model is now proven.” Recent developments put many renewables at or near “grid parity,” where their costs are roughly the same as energy produced by fossil or nuclear sources.

Still, the subsidies – known as the feed-in-tariff or FIT — have added some 10% to residential electricity costs and will cost consumers some 130 billion euros over 20 years. That has become controversial in a country that already has some of the world’s highest electricity prices. The subsidies have been gradually declining as intended as the price of solar panels has dropped, but not as fast as many would like. “In practice, the cost of producing solar dropped more quickly than the tariff cuts. That meant that customers were in effect simply ploughing money into massive profits for the booming solar industry,” according to the Global Post. 

Measuring Costs

But as this report from PV Magazine (Photovoltaic Markets & Technology) notes, sorting out all of the costs and benefits is far from straightforward. “Contrary to many reports that photovoltaics force up electricity bills for all consumers, the opposite was observed as the solar power kicked in. Called the merit order effect, solar power fed back into power grids brought down the price of electricity over the weekend in Germany…. This is amplified by the fact that photovoltaics provides supply at times when demand is high.”

What’s more, current cost calculations do not account for the benefits in reduced carbon dioxide emissions, which contribute to global warming, nor any savings from lower health care costs by reducing air pollution and the health disorders associated with it.

Some observers say that the subsidy system is just now coming into its own: The need for the subsidies is dropping, says Lobel, as the cost of solar panels drops dramatically (by 50% over the last six years, in part thanks to subsidized Chinese solar panel makers) and an increasingly efficient installation sector develops. Solar panels are said to account for only about a quarter of the cost of producing solar energy. The balance is made up by installation, financing costs and related costs

The U.S. could learn some lessons from the German system, Lobel says. Longer-term subsidies of the kind offered in Germany provide more certainty, and with that comes a higher level of confidence that large initial investments will pay off for consumers. Under many U.S. subsidy schemes, “the subsidy is either a tax rebate or earned credits for electricity that [a homeowner] produces and sells in the market. When you earn credit, you cannot be sure what it will be worth in a few years.”

Can Germany’s program be replicated elsewhere? “It depends on the price of electricity – but for sure, Germany is one of the less sunny places you would imagine people starting to promote solar energy, but they did it successfully.”

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New York to Silicon Valley: Watch Your Back

Posted on May 24, 2012

Knowledge@Wharton spent a few days this week at TechCrunch’s Disrupt conference at Pier 94 in New York. The burgeoning startup scene in the Big Apple was a hot topic of discussion during the event. As the New York scene solidifies and expands, attendees said that startups are now competing for clients with larger financial institutions; employees from large companies are making career moves to smaller organizations, and major tech firms are opening offices in New York to establish an East Coast presence (i.e., Facebook, Twitter and eBay via its acquisition of Hunch).

Many panelists, including David Tisch, managing director of technology accelerator TechStars NYC, noted a shift in student interest in smaller companies versus larger Wall Street corporations and highlighted the strategy of startups banding together to recruit from top universities. He also predicted two to three major exits out of New York in the coming year by either IPO or acquisition. Fred Wilson, co-founder of New York venture capital firm Union Square Ventures, said in a conversation with TechCrunch founder Michael Arrington that he expects the “next big thing” in tech will come not out of Silicon Valley, but out of New York.

Josh Miller, co-founder of discussion platform Branch, noted in a panel discussion that more computer science students are taking post-graduation roles at startups instead of banks, and others who go to larger firms are getting “bored” within one to two years and are leaving to join a startup.

Jake Schwartz, co-founder of NYC startup incubator General Assembly, says the GA team has “worked with universities like Wharton to get students involved and introduce them to the New York tech scene.” By working together to attract talent at joint events or career fairs, he noted, startups “mirror that same recruiting power that big companies have on college campuses.”

Perhaps the biggest challenge set forth was one from Alexis Ohanian, co-founder of social news site Reddit: “We need to come up with a better name than Silicon Alley.”

Discussion at the event also revolved around Facebook’s recent IPO and what attendees considered the next major priorities for the technology industry:

– Roelof Botha, partner at Sequoia Capital, knows a thing or two about IPOs and acquisitions.  Prior to his role at Sequoia, he helped take PayPal public as CFO and later participated in negotiations for the sale of PayPal to eBay.  In a conversation about the recent Facebook IPO, Botha cautioned entrepreneurs against selling too early, encouraging them to “build something enduring” and “something that really makes a dent in the universe,” stating that Facebook’s core value is in its platform.

Despite the challenges Facebook is facing on the stock market, Botha praised the social network’s innovation around ad formats, such as sponsored stories curated by your friends, to solidify the presence of the network. “Think about what would have happened to Facebook if they had taken an acquisition offer early on from Yahoo or Google,” he noted. “We have at least 10 companies that have produced 10 times the returns after going public.”

Botha also provided insights about Sequoia’s recently uncovered “stealth” program started more than two years ago, in which the firm wires funds to dozens of individual entrepreneurs, or “scouts,” who need cash to start a venture. Botha gave the example of two engineers working at a large company who “need $50,000 to afford to leave their jobs to get their idea off the ground” as the type of entrepreneurs who are recipients of these funds.

– Ron Conway, a prominent Silicon Valley angel investor, said the next two priorities for the technology sector should be immigration reform and reforms for H1-B visa authorization requirements, stating “We don’t have enough engineers in this country.”

Conway is involved with SF City, an organization mirroring a chamber of commerce whose members are technology companies in the city of San Francisco. The organization’s two main goals, he said, are encouraging job creation by hiring San Francisco citizens and reducing the city’s onerous payroll tax by shifting the tax burden to more of a gross receipts tax. Conway noted that San Francisco’s unemployment rate is falling faster than that of other cities in the country.

He shot down rumors that he is planning to run for mayor of San Francisco (after prodding by Arrington), but did confirm he was in attendance at Mark Zuckerberg’s surprise wedding ceremony over the weekend, revealing that it was the white flowers that tipped him off to the fact that the event was not, as advertised, a graduation party for Priscilla Chan.  Conway closed by urging every entrepreneur to read Zuckerberg’s letter to shareholders as it effectively maps out the type of “hacker” culture he would build if starting a company today.

– Jeff Jordan, general partner of venture capital firm Andreessen Horowitz, noted that his firm’s strategy is to “look for companies that can … create … value each year and be core franchises in their markets.” His message to Wall Street is that there is currently “an unparalleled opportunity for the growth of technology companies,” noting that “the addressable market has just exploded” because compared with 1999, the cost of getting products to market has plummeted.

“If you can get product/market fit, there is virtually no [limit] on how fast a product can grow,” he said, referencing Pinterest as the fastest growing Internet firm ever.  He also admitted that he spends more time in New York now than he did when he was CEO of a public company — largely because of the number of fast-growing e-commerce companies launching out of New York, including Fab.com, Warby Parker, Birchbox, and Bonobos.

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Barclaycard Turns to Crowd-sourcing to Build a Better Credit Card

Posted on May 4, 2012

The new Barclaycard Ring MasterCard aims to be both simple and social. But more than ease of use, what the company is really pushing about the new card is that holders will have a say — up to a point — in how it is managed, serviced and even marketed by participating in an online community.

“This could be a major step in the likely application of ‘crowd-sourced everything’ to consumer credit,” says Wharton business and public policy professor Jeremy Tobacman. “Card issuers, craving gimmicks that will help them attract attention and stand out in the genuinely cutthroat competition for new accounts, could view this as an interesting marketing salvo.”

Billed by the company as the first “crowd-sourced” credit card, the product has been in pilot testing since December and opened to the general public last month. It comes with an 8% APR that applies to all balances, including purchases, transfers and cash advances. There’s no annual fee and the international transaction fee is 1%.

In addition, customers won’t have to pay a penalty APR if they default. New regulations have made it “extremely limiting to make meaningful money using [penalty] repricing these days,” says Jared Young, senior director of consumer markets for Barclaycard. “And when we were developing this product, we were looking for aspects of credit cards that are often complicated to explain to the customer. Even if [these features] made us a little bit of revenue, we decided to pull them out and make it as simple as possible.”

The card’s website is unclear about exactly what type and level of influence card holders will have, but screenshots from the card’s media site show a sample profile page that displays Foursquare-style badges awarded to a consumer for switching to paperless billing and referring friends; a sample discussion page with a query for users about how active community members should be rewarded for their efforts, and a community stats page with information including the number of accounts, the percentage of members in good standing and the number of posts and questions answered in the online community.

Young says the company is open to card holders having a high level of influence — but within a framework based around the profitability of the card. “There are a lot of different places we can go. Everything online is up for grabs, but we have to provide a framework — we can’t give away the farm,” he says. “There’s going to be a trade-off with all of the decisions that are made. If there’s a feature the community wants to build, we’ll share [information about] the expense of actually building it, and discuss how to fund it.”

Another feature of the card is that it gives community members a look at aspects of the card’s profit and loss (P&L) statements. Tobacman warns that those numbers “will be subject to a lot of assumptions that most cardholders won’t be able to evaluate.” Young acknowledges that it would be “very difficult” to report the profits of a specific portfolio. “For example, we have taken out some of the accounting treatments we’re required to put into [financial] statements because it’s so confusing,” he notes. “We’ve treated the P&L on a more cash flow basis, created a good-faith estimate of P&L and created a rewards program based on how well that P&L performs.”

The Giveback rewards program is billed as a way for card holders to share in the profit. But the card’s terms and conditions note that “this profit sharing feature is not based on the actual profits of the program. Instead, the Giveback program contains a transparent calculation that is used to determine what will be shared with the community members and which may or may not approximate actual profits.” But Young notes that the company is hoping to use the level of consumer control over how the Giveback funds are used to build trust with card holders.

Young declined to say how many people have signed up for the card so far (although he noted that the figure would be available in the first month’s profit and loss statement). He said engagement levels from the card holder community have been strong, but noted that “in almost all online communities, including Wikipedia, the law of participation is usually that 90% of people just kind of come in and read, 9% occasionally add content to the site and 1% of the community is really engaged and drives most of the volume. We’re not expecting anything different.”

But will the social aspect of the card encourage consumers’ decision making? Tobacman says that remains to be seen. “Consumers at some point could come to realize that they will feel especially guilty about defaulting on their credit cards if they have shaped the terms and they think that other card holders’ rewards are at stake,” he notes. “If consumers realize this after signing up for this card — as Barclays may dream — they will repay even in very tough times. If consumers realize this before signing up for this card, maybe they will conclude social networks are better used to sustain the self-control to avoid getting into debt in the first place.”

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How Adobe Is Finding Its Creative Sweet Spot

Posted on May 2, 2012

Software maker Adobe Systems last Monday unveiled a new version of its biggest product, the Creative Suite 6 software package used by graphic and digital designers. The update comes with a twist — a $49.99 monthly subscription plan as an alternative to the regular purchase price of between $1,299 and $2,599. The subscription plan is part of Adobe’s recently launched Creative Cloud offer, and a component of the firm’s broader effort to expand its market and win more customers among corporate marketing departments.

Wharton experts see both as smart responses from an agile company in an evolving market. “It’s a tweak to a business model. But it is a natural progression,” says Wharton marketing professor Peter Fader. “The whole idea of s-commerce or subscription-commerce is becoming increasingly popular. Plenty of other software providers have made moves in this direction or spoken about it (e.g., Oracle and SAP). You don’t tend to see it quite often at such a high price point, but it is no less sensible at that price point than it is for more mundane items and services.”

For Adobe, s-commerce could mean more than a marketing play. The company is still smarting from losing a battle last year with Apple. Late Apple CEO Steve Jobs banned Adobe’s Flash multimedia platform from Apple iOS devices, calling it unreliable, insecure and a battery suck. Adobe countered Apple’s claims, but last November the company announced that it would cease developing the media player for mobile devices and instead focus on the HTML5 technology that Jobs championed. The company last year also shuttered a business unit aimed at information technology departments and overhauled the business model for its Creative Suite software, as a Wall Street Journal article recounts. “If you’re going to make a left shift, you don’t increment your way there,” Adobe CEO Shantanu Narayen told the Journal.

Wharton new media director Kendall Whitehouse says “it’s worth noting how flexible Adobe Systems has been in terms of both product focus and business model over the past 30 years.” He recalls the company starting by selling its PostScript software to printer manufacturers even when that was not in its original business plan. The firm then expanded to become a shrink-wrapped desktop software company with programs including Illustrator, Photoshop and Acrobat, before further growing to offer web development tools, mobile solutions and enterprise product offerings. (Adobe co-founders Charles Geschke and John Warnock recounted the firm’s evolution in interviews with Knowledge@Wharton in 2008 and 2010, respectively.)

“This latest repositioning — focusing on integrating desktop, mobile and cloud technologies and offering a subscription-based pricing plan — is only the latest evolution of the company,” says Whitehouse. In a 2011 Knowledge@Wharton article after Adobe announced its Creative Cloud plan, Wharton legal studies and business ethics professor Kevin Werbach noted that “the old model of selling software in a box or [through] an enterprise server license and then charging for periodic upgrades has been disrupted.”

Adobe’s resolve to more actively sell its design tools to marketing departments at companies also seems to be a sound business decision, according to Fader and Whitehouse. But Fader doesn’t read the move as a reaction to the Flash debacle or “a desperate move” to boost revenues. In fact, “it’s much tamer than that … and a sensible way to change the nature of the relationship,” he says.

Whitehouse, too, suggests that Adobe’s “focus on marketing makes sense.” But he doesn’t see that as an easy game. “Of the various approaches Adobe has taken over time, perhaps the most challenging has been the company’s attempts to become an enterprise software company,” he notes. “Becoming a large-scale enterprise software and services company is a difficult transition for a consumer-based software company. All the same, the renewed focus on marketing takes advantage of Adobe’s enterprise offerings while staying close to the designer/creative ‘prosumer’ [professional consumer] customer the company knows well.”

Adobe expects customers to move to subscriptions gradually but has still warned investors that its growth will suffer as it changes to the new model, according to the Journal report. But Fader isn’t worried about that. “To [Adobe's] credit, it is a much more broadly diversified company than most people think,” he says.

Fader sees Adobe’s business as one where companies are going to win some and lose some. “It’s a portfolio play and not everyone can be a perfect market capturing sensation,” he notes. “Overall, I’m upbeat about their future. They have a lot of good products and services in the pipeline.”

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Netflix’s Next Episode: Winning Back What It Lost

Posted on April 26, 2012

Streaming media and DVD rental provider Netflix is facing renewed scrutiny over its business model after announcing poor first-quarter results on Monday. The Los Gatos, Calif.-based company reported a $4.6 million loss in the quarter ending March 31, compared with a profit of $60.2 million in the year-earlier quarter. Its revenues, meanwhile, grew 21% from $718.6 million to $869.8 million. Following the news, the firm’s stock has fallen more than 19% (as of this morning).

Clearly, Netflix has yet to recover from its recent 60% price increase and failed attempt last September to spin off its DVD delivery business. The company’s U.S. customer base has eroded from 24.6 million last June to 23.4 million currently. (It also operates in Canada.)

Netflix’s problem is threefold: content partners, competitors and customers, according to Wharton operations and information management professor Kartik Hosanagar. “First, it was obvious that Netflix’s original margins were not sustainable in the long run,” he says. “Netflix secured some of its early [content] licenses at very low costs, and it was clear that the content owners would seek more the next time around.” That explains why the company’s costs have gone up over the last year — and the situation is unlikely to get better, he adds.

Increased competition is Netflix’s second hurdle, says Hosanagar. He points to the likes of Hulu and Amazon and also to streaming services being introduced by cable-TV firms like Comcast. “This competition will only get worse in the next 12 to 24 months.”

Customer loyalty represents Netflix’s third problem, he notes. “Customers used to be Netflix’s biggest strength.” But the past year “hasn’t been great for Netflix” because of several missteps — the most important of which were the debacle with pricing and the spinoff plans, he adds.

Netflix’s solutions lie in continuing to grow its customer base and “up-selling existing customers” — or launching higher-value offerings — to address the partner and competitor issues, Hosanagar says. “Going forward, the key to Netflix’s success will be to win back customer confidence. Investor confidence and Wall Street will follow.”

Filmmaker James Kerwin took a dour view of the business model behind Netflix’s streaming business in an interview with Knowledge@Wharton in January 2011, soon after Netflix announced its offering of streaming movies and videos. The company’s model is not economically sustainable, he noted, because studios will find that streaming rights cannibalize their DVD sales. He also warned that fee increases were inevitable: “Netflix is going to have to jack up the rates that their customers pay and/or they are going to have to limit the number of videos that a customer can stream per month — because the studios are going to start demanding higher rates. Otherwise, this is just going to implode.”

According to Wharton legal studies and business ethics professor Kevin Werbach, much of the criticism of Netflix “is overblown, just as the company was over-hyped earlier.” Netflix is still fundamentally well-positioned to exploit the ongoing transformation of video, he says. “Ultimately, Netflix will have to provide value-add, whether in its recommendations, knowledge of its users or ability to function as an independent ‘honest broker’ unaffiliated with all the other industry segments involved,” he notes. “The basic function of getting any content users want to any platform, whenever users want it, will become the table stakes.”

Technology companies, including Netflix, are increasingly adopting the concept of customer lifetime value (CLV), Wharton marketing professor Peter Fader noted in a recent Knowledge@Wharton article. CLV is a marketing formula based on the idea that firms should spend money up front, and sacrifice initial profits, to gain customers whose loyalty and increased business will reap rewards over the long term. According to Fader, following a CLV model can keep companies from panicking when making big strategic decisions. An example he offers is Netflix’s move to raise subscription prices as its business focus shifted from offering DVDs by mail to the streaming model. In Fader’s view, Netflix was smart in the way it split its business and pricing, but not so in the way it announced those changes.

Still, for Netflix, such “screw-ups are a blip,” he said. “Dropped subscriptions are likely to be picked up again because Netflix really doesn’t have a comparable competitor.”

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