Innovate by Looking for Problem Patterns

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Struggles at Zynga

As many of this blog's readers know, Zynga - the social gaming company - has suffered recently.  According to this Fortune magazine article, "Shares are down nearly 74% since its stock market debut. User engagement has dropped 53% in less than three years according to social game analytics firm dystillr."  What has happened to the firm?

Several factors explain Zynga's struggles.  First, the company's games lack the depth of some traditional console-based video games.  Therefore, the games appear to have a limited life span.  Many users seem to tire of the games fairly quickly. Here we see a catch-22.  Zynga's games don't require the kind of upfront investment to develop that console-based games need.  However, the payoff down the road may be more limited - less risk, less return.  Second, the company depends upon Facebook a great deal.  As Facebook users have shifted toward accessing the social networking site via mobile technology, Zynga user engagement has declined.  Zynga appears to make less profit on its mobile games, as opposed to games that users accessed via Facebook on their laptop or desktop.  

Beyond that, I think Zynga's difficulties point to a bigger trend in the video game industry.   The shift toward mobile and social gaming clearly has disrupted the console-based gaming business.  Most of these mobile and social games require much less money to develop.  However, they also appear to have a limited lifespan in many cases.  Therefore, we have moved to a situation where gaming companies may need to innovate much more quickly.   Users appear to require new versions and new experiences much more often now.  They enjoy mobile games, but they "consume" them very quickly.   The new winners in the video game business will be those firms that can churn out streams of hits.  

The question remains:  Will those winners be able to develop franchises (a big hit followed by a stream of sequels and spinoffs), or will they have to develop unique new games much more often than in the past?   In the movie business, sequels generally make less money than original films.  Video games defied that logic for many years.  In console-based gaming, sequels proved to be an engine of profitability.   Can that happen long term in mobile gaming, or will consumers demand variety and newness to a much higher degree?

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Can Redbox Disrupt The Ticket Business?

For years, Live Nation Entertainment's Ticketmaster business has held a dominant position in the ticket retailing business.  In fact, many artists and consumers have explained about Ticketmaster's power in this market.  Now, a new rival appears to be emerging.  Redbox has announced plans to sell tickets through its ubiquitous kiosks.  At first, Redbox plans to focus on selling surplus tickets.  In other words, the company will be trying to help unload tickets that otherwise aren't selling for key events (bad seats, leftover tickets, etc.).  

The question, of course, is whether the move to sell surplus tickets will eventually translate into a broader ticket retailing business.  We know that many disruptive innovators start out at the low end of the market, selling what appears to the dominant incumbent players to be "inferior" products or services. Gradually, however, the disruptor begins to improve its product, and it gains traction outside of a fringe consumer segment.  At that point, the disruptor becomes a major threat to the incumbent players.  We saw this happen as Redbox and Netflix disrupted Blockbuster.  Could Ticketmaster be facing a major threat in the coming years? 

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Kodak: More Than a Disruption Story?

Monitor's Larry Keeley has written an article for Fortune titled "The Kodak Lie."   In that story, he writes:

"The demise of Kodak isn't merely the classic disruption story that everyone loves to tut tut over. Nor is the company's downfall merely a result of recent bad decisions or the mismanagement of senior executives. It is the more nuanced story of how easy it can be to get things wrong, even when trying with the best of intentions to do everything right."

Keeley points out correctly that Kodak created one of the world's first digital cameras way back in the 1970s.   In his mind, that means the Kodak story doesn't fit the classic story of a disruptive technology.  Kodak didn't miss the boat completely.   He goes on to write:

"The digital photography field not only was slow growing but it actively undermined their largest source of profits: photo and motion picture films. The tiny sideline businesses simply could not scale at a rate that might make up for the loss of film revenues, so those inside the core business were unable or unwilling to do what it took to foster drastic transformation. This exact phenomenon plagues innovation in nearly every large firm. At least once a week, top executives tell me that new growth businesses in their firms are intriguing and potentially important, but they simply "don't move the needle." 

Again, Keeley is right on the money.  However, this story is PRECISELY the disruptive technology story told by Clayton Christensen.   Clay has documented many, many examples of upstarts disrupting incumbents in industry after industry.  In many of those cases, the incumbents didn't  miss the threat completely.  They were not simply blind (Polaroid too invested in digital photography R&D in the early days).  Some executives understood the new technology and recognized that it had some promise. However, the core business and the corporation's resource allocation process undermined the firm's ability to shift effectively into new markets.   The "move the needle" problem occurs in many firms, as well as a host of other pressures in the resource allocation process that make cannibalizing the core a very difficult thing to do.

The real challenge of "move the needle" thinking is somewhat different than what Keeley has suggested.  Many large firms become dismayed when new ideas don't seemingly "move the needle" in terms of revenue growth.  However, time and again, we have instances in which executives misjudge the actual revenue potential of new business opportunities.  They overestimate some and underestimate others... by a significant amount.  Thus, dismissing a new venture because it won't move the needle proves to be a very dangerous move. 

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Social Makeover at Electronic Arts

Fortune reporter Alex Conrad wrote a good article this week on the challenges facing Electronic Arts.  EA once stood at the pinnacle of the video game business.  Eight years ago, I wrote a case study about the firm.  At the time, EA had a stable of high-performing video game franchises, with healthy profits each year.   Today, EA faces many challenges.  It lost in excess of $1 billion in 2009, and it lost more than $300 million in the second quarter of this year.  Social gaming firms such as Zynga have burst onto the scene and disrupted the console-based video game industry. 

Interestingly, the signs of trouble stretch back to a time well before Zynga arrived on the scene.  EA became increasingly reliant over the years on building franchises, with a series of sequels building off of a popular game.  Moreover, those franchises often relied on others' intellectual property (whether it was a movie character or John Madden and the NFL players/teams).  Acquisitions played a key role too.   Fewer and fewer blockbuster hits emerged organically within EA's studios based solely on its own intellectual property.  As EA became more reliant on others, and less successful at creating home-grown hits, the threats to its competitive advantage increased.  Then, just as EA became vulnerable due to these trends, social gaming came along to disrupt the business substantially.

Now, EA must decide how to counter the social gaming threat.  The article suggests that one way it will do so is by adapting some of its popular titles for the social world.  However, one wonders if that is the optimal strategy.  Perhaps they will leverage those strong brands to make popular social games.  On the other hand, one must acknowledge the significant differences between console-based games and social games such as Farmville.  Will a firm trying to adapt titles from the console business end up creating a suboptimal social gaming experience?  Will the mindset of creating high quality, graphics intensive console games (which require substantial R&D expenditures) get in the way of producing successful social games (which have simple graphics, much less technological sophistication, and which require much less development investment)?   Companies focusing completely on social games, without the history of console game development, may actually have an advantage here.   EA itself seems aware of these challenges.  That may be why they have acquired several social gaming companies.  How they manage those acquisitions will prove critical to their future success.

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Netflix and Qwikster: What are they thinking?

Why did Netflix decide to split itself in half?  Why create a new brand called Qwikster?  Most people have criticized the move quite heavily.  Slate has an interesting article about the decision.  Farhad Manjoo writes that Netflix seems to have taken guidance from Clay Christensen's model of disruptive innovation.  Manjoo bashes the move in the first few paragraphs of the article, but then writes the following:


I think it's an idiotic strategy.... And yet: It could work. In The Innovator's Dilemma, Christensen argues that the companies that are most vulnerable to disruptive technologies are those that have really good management. The problem with good managers is that they tend to listen to customers. And the problem with customers is that they don't always know what's best for them. If you were a devoted Blockbuster customer in 2001, and if Blockbuster's CEO sent you an email announcing he was closing all the company's stores and switching to a DVD-by-mail service, you would have balked... As Christensen explains, disruptive technologies usually start out as inferior substitutes, proving attractive only to a small fringe of customers. For years, the people who ran Blockbuster saw Netflix as irrelevant. It's easy to call them stupid now, but at the time they were mostly right. Blockbuster's customers considered Blockbuster better than all the alternatives; if they didn't, they wouldn't have been Blockbuster customers. And Blockbuster's managers were doing what good managers do—they were investing in the parts of the business that customers liked (opening more stores) rather than coming up with a whole new business that might alienate their current users.  The key advantage of Netflix's new model is that it will give each side of the business—the DVD side and the streaming side—flexibility to manage its service in a way that pleases its own customers. As a combined service, any move to strengthen one side of the company over the other would have been perceived negatively by one group of customers. 

For me, the negative reaction to the move has more to do with the seeming inconsistency of management's actions than anything else.  Several months ago, Netflix championed an integrated service at a low price.  Then, they raised prices dramatically on the integrated service, but allowed customers to opt for a lower priced streaming-only service.  Then, after a short period of time, they announced a split into two brands, one for streaming and one for DVD-by-email.  The series of changes in strategy over a short period of time give the impression of a management team unsure of how to move forward.  That makes investors uneasy (rightfully).  Secondly, people have criticized the move because they don't necessarily see the connection between setting up a separate business unit and establishing a second brand.  In Christensen's writings, he provides several good examples of companies establishing independent units to pursue an innovation, without necessarily creating a new brand. Take IBM's creation of a unit to launch the personal computer; it existed independent of the mainframe business, but it leveraged the existing IBM brand.

Despite all the questions, I understand Netflix's predicament.  They face unchartered waters, as a young growing company facing the inevitable demise of the original business.  In the old days, companies may have experienced the disruption of their core business after decades of success.  For Netflix, that demise of the core may be occurring just a decade after the firm rose to prominence.     

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GameStop: Trying to Counter a Disruptive Threat

GameStop made news this week by announcing that it will accept trade-ins of Apple iPods and iPhones at its stores throughout the country, after testing the concept in Texas for several months.  This article quotes CEO Paul Raines as saying, ""We're selling refurbished iPod Touches like crazy."   I find the news interesting for reasons beyond the fact that all things Apple tend to attract attention these days.  GameStop clearly faces a serious threat of disruption for two fundamental reasons. First, many people see the future of console-based video games shifting to downloads as opposed to buying CDs at retail stores.  Second, console-based games themselves are under attack from the shift toward mobile and social gaming.   GameStop clearly will have to evolve its strategy, or face a future that looks more like Blockbuster and Borders  than they would like.  I'm intrigued by how Raines, who I interviewed years ago when he was at a different firm, has continued to experiment with the business model and evolved the strategy in the face of these threats.  They seem much more agile than other brick-and-mortar retailers who have been disrupted, but it remains to be seen whether they can thrive amidst these challenges. 

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Postal Service Blues: Substitution is Always the Biggest Threat!

Over the past few weeks, we have heard a great deal about the troubles at the US Postal Service.   The USPS experience offers a crucial lesson regarding threats to competitive advantage.  Many firms spend enormous amounts of time conducting competitor analysis of various kinds.  They worry constantly about how their rivals might overtake them.  However, the most dangerous threat to competitive advantage really does not come from direct rivals in your industry.  Instead, it often comes from substitutes.  In other words, different goods or services emerge that address the same customer need, thereby supplanting your product in the marketplace.  Think digital photography undermining instant cameras, NetFlix destroying Blockbuster, tablets eroding the position of traditional PC makers, mobile and social gaming undermining the position of traditional console-based video games, and clearly... email and other electronic forms of communication threatening the sustainability of the USPS business model.  In sum, companies should spend much more time scanning the external environment for the rising threat from potential substitutes, as opposed to fixating on their existing direct competitors.  Of course, in so many cases, companies fail to acknowledge the threat from a substitute until it's far too late... even though they are aware of the emergence of this alternative good or service.  Unfortunately, existing mental frameworks often make it difficult for executives to get their arms around the very different business model associated with the substitute.  

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