While conventional wisdom suggests that the Internet these days creates pain, not profits, for investors, there are still a few successful, or at least promising, companies that have recently been hatched on the web. According to Wharton marketing professor Peter Fader, some of the new ventures cropping up are “changing the world,” or at least changing the way people listen to music, watch DVDs and sell financial services.
Executives from three such companies spoke at a May 1 conference titled, “Catching Our Breath: Reorienting Strategy during the Internet’s Quiet Time,” sponsored by the Reginald H. Jones Center and the Wharton eBusiness Initiative.
Consider pressplay, a Los Angeles-based joint venture of Sony Music Entertainment and Universal Music Group, a unit of Vivendi Universal. “It represents the future of music in many respects,” said Fader.
The online music company, which started operating in 2001, is the music industry’s answer to Napster, charging users a monthly fee of $9.95 to download and listen to music and additional fees to burn CDs. “You download to discover, and you burn to own,” pointed out Larry Linietsky, senior vice president of business development and business analysis. Pressplay offers 300,000 tracks of all kinds of music.
“We’re trying to create a new business model for music,” Linietsky added. “People are embracing digital music. Whether they are doing it by stealing it or buying it is an open question.” In surveys, 26% of people say they have downloaded music, and 15% have burned CDs using songs they downloaded, he said.
Certainly, some people balk at the idea of paying a subscription fee to merely listen to music off the hard drive of their computers. After all, the radio is free, and so is downloading if you know how and aren’t bothered by ethically ambiguous behavior. These days, you only have to pay if you want to buy a mass-market CD.
Pressplay, in effect, asks its users to rent music, which Linietsky admitted seems weird to some. “It’s a paradigm shift but it allows people to listen to a lot of music for a small fee. And it parallels what people do with file sharing.”
The company is struggling with the same challenge faced by many dot-coms: How do you persuade people to pay for something that they are used to getting for free, whether pornography, news stories or new music? One way, of course, is to cut off their sources of free content. The music industry has tried to do that with lawsuits against companies such as Napster that ran music file-sharing websites. It has even sued four college students for running “mini-Napsters” on their campus networks.
While the suit against the college students settled, with each student agreeing to pay $12,000 to $17,000 to the recording industry’s trade association, the industry wasn’t so lucky with its suit against file-swapping services Streamcast (parent of the Morpheus software) and Grokster. A federal judge in Los Angeles last week ruled that the two companies are not liable for copyright infringement resulting from people using their peer-to-peer software.
The ‘Netflix’ Model
If pressplay is trying to get people to change the way they listen to music via the web, Los Gatos, Calif.-based Netflix is trying to do something similar with DVDs. “Netflix already has become a word like Kleenex or Jell-O,” Fader said. Blockbuster, for example, has talked about adopting the “Netflix” model.
Netflix’s website is really a doorway to an old-economy operation: a mail-order company. For $20 a month, the company rents its customers all the DVDs they want to watch – with no due dates and late fees. Customers make their orders online but the DVDs are delivered and returned by U.S. mail.
“At the beginning, a lot of venture capitalists and investment bankers dismissed us because we weren’t sexy,” said Barry McCarthy, chief financial officer. The doubts haven’t hampered the company’s growth. Its sales were $153 million in 2002, and it expects $265 million in sales this year. By year’s end, it aims to have 25 to 30 distribution centers, which will enable its DVDs to reach 60% of America’s households within a day or two.
That’s where the conduct change comes in. People are accustomed to trundling over to Blockbuster on a whim and pulling a movie off the shelf. With Netflix, they have to plan at least a day ahead. Why not just let customers download movies, the way pressplay does with music? “It’s not cost effective now, but we envision a day when it will be,” McCarthy said.
Even if the Netflix business model seems old-fashioned, like a Book-of-the-Month Club for DVDs, its systems aren’t. McCarthy said the key to its success has been the software that manages its inventory. “Our software sees all the DVDs and all the open orders in the country, so the location of DVDs finds the natural demand every day. A large percentage of DVDs aren’t necessarily coming out of a customer’s local market.”
Netflix, launched in 1999, started off with “a la carte” rentals, with customers paying per movie. “During the bubble, capital was largely free, and we raised $100 million privately. The bigger we grew the more money we lost,” noted McCarthy. So the company decided to move to subscriptions with unlimited rentals. “It scared us to death, and it was an overnight success.”
Management learned that people were drawn to the service by its unusual pricing. But after their initial excitement, “average usage is based on lifestyle, not cost.” In other words, most people watch only a handful of movies a month, even if you offer them far more. It’s similar to the economics of an all-you-can-eat restaurant: despite the allure of a smorgasbord, most people don’t pig out. And so it is with movies as well.
Netflix’s customer mix has changed, too. In the beginning, its customers were 80% male – “early [technology] adopters,” McCarthy said. “But today, we’re 53% female.”
Better Client Mobility
Where pressplay and Netflix cater to consumers, Fairfax, Va.-based Mantas sells compliance and behavior-detection software to large financial companies. NASDAQ uses the software to detect irregular securities trading. Merrill Lynch and Citigroup use it to sniff out money laundering. Goldman Sachs uses it for regulatory compliance.
“We have a small community of clients but they have a profound software expenditure budget,” said Simon Moss, the company’s chief executive. “We sell software that costs millions, and our job is to help keep our clients’ names out of the newspapers.”
The economic slowdown has hobbled Mantas’ clients nearly as badly as it has hurt the dot-coms. “The last 10 to 15 years were a golden age for financial markets,” Moss said. “Then all of the sudden, bam, straight into recession. Margins have been compressed. There’s pressure from regulators and clients. Many of the staff have never gone through this sort of thing.”
Initially, the industry responded by cutting thousands of jobs. But job cuts can only take companies so far; they also have to find new ways to generate revenue.
Some of them are turning to what Moss calls “legacy data mining.” That is, they’re using software such as Mantas’ to dig into older databases to learn more about their clients’ trading and buying histories. Their hope is that this will give them new openings for selling securities and services.
In other words, Mantas is enabling its clients to do something that pressplay and Netflix are doing at a less-sophisticated level: combing through customer data to make themselves better merchants.
Of course, companies aren’t the only ones who have more data, thanks to the web. Consumers do, too. As Moss pointed out, “One of the things that all this new technology did is improve client mobility.”
It enabled comparison-shopping – whether for books, airline tickets, cars or online brokerage services – like never before. Maybe that’s the real information revolution.