The Business Strategy Silicon Valley Giants Use to Disrupt Industries

Series:  How to Beat the Silicon Valley Giants at Their Own Game

In this series, we will show you how you can compete against the Silicon Valley giants and win. They won’t be able to copy you. They won’t be able to catch you.

You’ve read the headlines. “Silicon Valley Giant Disrupts Centuries-Old Industry, Gains Massive Market Share in Just a Few Years.”

The existing companies in the old industry are caught flat-footed and their profit model disintegrates, as their customers migrate to the new business model of the new digital competitor.

“Long Distance Telephony Disrupted by Skype”

“Craigslist.org Disrupts Newspaper Classified Ads”

“Apple Disrupts the Entire Music Industry with iTunes”

“Amazon Disrupts All of Retail, Especially Department Stores and Shopping Malls”

“Uber and Lyft Disrupt the Taxi Business”

“Tesla Disrupts the Automotive World”

“Airbnb Disrupts Hotels and Lodging”

It seems like the disruption will never end.  These digital natives, mostly based in the Bay Area of California, use some combination of the Internet, big data, artificial intelligence and venture capital to rethink an existing industry and then begin to take large chunks of market share seemingly at will.

How do they do it?

In this blog post, we will examine one devastatingly effective strategy that these companies use when entering industries they know very little about. Throughout this series of blog posts, we will examine ways that you can use the same strategy to defend your business and, even, fight back.

The Counter-Positioning Strategy

Counter-positioning is finding part of your competitor’s business model that they cannot do without and flipping the script on them. It was popularized in a book called “7 Powers” by Hamilton Helmer. It is especially effective when you are a smaller and/or newer competitor going up against an established giant.

Netflix and Blockbuster Video

Here’s one famous example of counter-positioning. Many people know that Netflix is a successful streaming content company that has come to dominate movies and TV worldwide. But you may not know how it all began. The modern myth is that the Netflix founder, Reed Hastings, had rented several movies from Blockbuster video and forgot to return them promptly and, therefore, owed a hefty late fee upon returning them. (This may or may not be true; Reed has changed his story often.) This upset him enough that he decided to start a competing company that charged no late fees – ever. That company became Netflix.

In the 1990s, there was no streaming; Internet connections were too slow. So, Hastings and his partners instead started a DVD-by-mail service under the Netflix name, even though they knew that streaming movies would someday be the better choice. By using the post office, he was able to deliver movies on disk directly to people’s houses, which was very convenient.  He could also limit the number of DVDs that a person possessed, because you couldn’t receive another disk until you returned the one you had. The financial model was a once-a-month fixed payment for the customer. It was a simple model and it resolved the whole “late fee” mess for customers.

So, what did Blockbuster do, you ask?  Here was an enterprise that, at its peak, had 9,000 stores and made almost $6B in revenue per year. Blockbuster was closely examining the tiny startup that had “disrupted” their customer base in two ways. First, Netflix had eliminated the much-hated late fees. Second, Netflix disks came directly to customers’ homes, so there was no trip to the video store necessary on those snowy Friday evenings, because your disk was already snuggled in your cozy living room.

What Blockbuster did was…nothing. They did not create their own DVD-by-mail service. They did not eliminate late fees. They did…nothing.

Was this the result of poor management at the behemoth company? Laziness? Complacency?

Possibly, but not necessarily. Instead, it was because Blockbuster was chained to their current business model with a beautiful set of golden handcuffs.

Late fees, loathed by Blockbuster’s customers, were loved by their investors. In fact, late fees made up 16% of the company’s profit. Late fees were the gravy on top of the profits generated by normal rental fees.

Remember, the second advantage Netflix had was convenience: DVD-by-mail. Why wouldn’t Blockbuster at least try this?  Because there was another sweet, sweet source of profit that Blockbuster couldn’t give up – concessions.  If you ever stood in line to rent a movie in a video store back then, you probably noticed the giant racks of microwave popcorn, licorice, candy bars and soda. And how were the prices of these items? Same as the grocery store across the parking lot?  No way.  Not even close. These were highly profitable items that capitalized on perfect placement at your fingertips. Blockbuster was addicted to these concession profits as much as to their late fees.

After 1994, Blockbuster was actually a private company, taken over by the giant Viacom. But it didn’t make them any more agile than a public company would have been. Blockbuster executives could not go to Sumner Redstone, the chairman of their parent company Viacom, and tell him that they had forsaken two of their best profit streams (late fees and concessions). You would get beaten up badly in either case – probably fired – whether public or private.

So they did…nothing. Now, eventually Blockbuster did follow Netflix into a mail-order service and they also eliminated late fees. But only after it was far, far too late. Netflix had years and years to build up their market share and Blockbuster was on a certain path downward to what they have today – one single, solitary store in Bend, Oregon.

Netflix found the Achille’s heel of their giant, well-funded competitor and used it to launch their own empire. Netflix drove Blockbuster out of business in less than a decade. Counter-positioning at its best (and most scary).

You can probably think of many other examples of counter-positioning. In 2007, Google introduced Google G-Suite with a word processor, spreadsheet, presentation tool, etc. to compete against Microsoft Office. It had two big advantages – it was online, so collaboration was easy, and it was also free. It took many years for Microsoft to be able to respond effectively to the threat and, subsequently, Google’s market share went from 0% to 60%, far overtaking MS-Office in the process.

Discount stockbrokers like Charles Schwab took on the big Wall Street firms like Merrill Lynch when they offered a way to do cheap stock trades for the everyday investor. Schwab was subsequently disrupted by Scottrade, E*Trade and Ameritrade when these digitally native brokerages found ways to reduce overhead even more and bring the marginal cost of a stock trade down to zero. In each case, the bigger firms could not effectively compete because they were addicted to the giant margins attached to each stock trade, so they left this “bottom end” to their competitors, who scooped up the customer base gladly.

And finally, the Chief Content Officer of Netflix (yes, Netflix again!), Ted Sarandos, famously said “We need to become HBO faster than HBO can become us.” That was in 2013.  He gave HBO full warning of where Netflix was going and what he feared from HBO. But HBO did not make their streaming app available to people without a cable subscription (known as the cord-cutters) until two years after Sarandos’ statement and didn’t get really serious about standalone streaming until they released HBOMAX in 2020, seven years hence.  Why so slow?  Again, HBO didn’t want to cannibalize their cable subscriptions. It probably didn’t help that their parent company was Time Warner (later named Spectrum), one of the largest cable providers in the U.S.

So that’s the strategy. Counter-positioning. Find your competitor’s golden handcuffs, the profit stream they can’t live without, and flip the table on them in a way that they cannot easily follow you until it’s too late.

Counter-positioning is not the only tool that Silicon Valley giants use against existing industries, but it is a powerful one. In this series, we will uncover a path where existing industries, in automotive, consumer appliances, retail, finance, and anything consumer-facing – can use counter-positioning against those very same Silicon Valley giants and their own Achilles’ heels.

Stay tuned for the next article “The Looming Threat to Automotive” in this series: How to Beat the Silicon Valley Giants at Their Own Game.

Daryl Kulak is a Principal Studio Director at LeadingAgile and co-author, with Dr. Hong Li, of the book “The Journey to Enterprise Agility: Systems Thinking and Organizational Legacy” (Springer International, 2017) available in hardcover, Kindle format and Audible audiobook.