The Buddy System

On September 30, TiVo and Netflix tersely announced a vague alliance—the existence of which had been the subject of rumors for several weeks. The two post-bust Silicon Valley cult brands pledged to work together so that, one day, owners of TiVo’s digital video recorders (DVRs) would be able to download films provided by Netflix, the online DVD rental store.

Sounds exciting. But if you squint a little, it’s possible to detect the white flag of surrender amid the smoke signals.

Seemingly designed with the needs and interests of harried New Yorkers on their minds, TiVo and Netflix blew up existing business models by providing elegant, concierge-like solutions to addled home-entertainment consumers. But just a few years after their respective breakthroughs, the disruptive technologies find themselves on the receiving end of serious disruption, courtesy of some of the largest and most vicious competitors in the Fortune 500.

In the past, innovators, particularly in technology, could depend on having the field to themselves for a few years. Protected by patents (in some cases), a head start, and the large investments required for competitors to horn in on their markets, first-movers generally had a few years to improve products, use excess profits to branch off into related businesses, or simply grow fat and happy as incumbents slumbered. Henry Ford’s Model T owned the nascent U.S. car market for a decade and a half. Xerox introduced its breakthrough copier in 1959 and didn’t face serious copycat copiers from Japan until the late sixties. More recently, Microsoft, Intel, and managed to build empires on the strength of a single great idea.

Today, however, the window for an entrepreneur to devise and launch a business, go public, cash in, endow a foundation, and introduce version 2.0—before somebody with deeper pockets gazumps your business model—has narrowed to a slit.

Netflix, launched in September 1999, was a godsend to Gothamites. Pay a monthly fee of $21.99, pick a bunch of DVDs from the 25,000-title library, and you receive three at a time in the mail— takeout for videophiles. For any poor soul who ever braved a Blockbuster on a Friday afternoon—lines snaking out the door, clerks moving product with all the urgency of a pro golfer addressing a tricky putt at the Masters—Netflix represented nirvana. No more treks in the chill of winter to return videos and no ruinous late charges that meant paying $20 for the dubious pleasure of watching some of Grosse Pointe Blank. Just put the DVD back into the mailing sleeve.

TiVo likewise functions as a diligent, low-maintenance personal assistant. Life in New York is a constant series of choices. Go jogging in the springtime after work and forget about catching Will & Grace. The Tuesday 7:30 P.M. New York City Ballet series means forgoing an entire season of NYPD Blue. Worse, with the expansion of cable, the cultural literati must be conversant with a dozen-odd new shows: Nip/Tuck, Entourage, Queer As Folk. And the broadcast schedules are so inconvenient. Once 5 a.m. morphs from last call to baby’s wake-up call, staying up to watch The Daily Show is a dream.

“Almost instantly, TiVo and Netflix faced tough, shamelessly derivative competition.”

The solution: TiVo. Or, as FCC chairman Michael Powell calls it, “God’s machine.” Founded in 1997, the company made a video recorder that could download and store programming onto a hard drive. If Netflix was takeout, TiVo was a fridge that restocked itself with ready-to-eat meals whipped up by Mario Batali. With its brilliant ad-skipping technology, TiVo could condense a poky Giants game into two hours of brisk action, a half-hour sitcom to twenty minutes of scripted mirth.

But a funny thing happened on the way to market dominance. While TiVo and Netflix quickly became fixtures—nay, necessities—of daily life for their customers (1.9 million and 2.2 million, respectively), neither company really got to enjoy the fruits that normally accrue to first-movers. Almost instantaneously, each faced tough, shamelessly derivative competition that ate into margins and forestalled the possibility of massive profits.

Wal-Mart in June 2003 started an online DVD rental service, priced below Netflix’s service. This summer, Blockbuster launched one, too. The competition is taking a toll. Netflix, which went public in May 2002, is profitable. But its subscriber growth—up 6 percent in the most recent quarter—has slowed substantially. Its stock, which nearly touched $40 a share in January, now trades at about $18.

TiVo, which has never made a profit, is threatened by a host of lower-priced competitors. EchoStar, the satellite-TV company, started offering DVRs in 1999 and now has more than 1 million customers. It offers a set-top box that can record shows as part of its basic package. Meanwhile, cable giants Time Warner and Comcast have been rolling out DVRs—manufactured by Motorola and Scientific-Atlantic, not TiVo. By the end of July, 600,000 of Time Warner Cable’s 4.6 million digital-video customers had DVRs. “The cable operators can do this without TiVo’s help,” says Joshua Bernoff, a principal analyst at Forrester Research. Bernoff estimated that the number of DVRs should rise from 6.5 million at the end of 2004 to 50 million by 2009. But it’s likely that only a small fraction of them will be TiVos. Its stock trades at about $7, miles from its January 2000 top of $71.50.

In fact, both companies’ business models—so innovative and futuristic just a few years ago—now seem dated. Netflix was designed for a pre-broadband era in which the digital content encoded on DVDs had to be sent to users via mail. TiVo was crafted for an industry in which content providers—Hollywood studios, television networks, etc.—exerted ironclad control over TV schedules. With America’s homes’ increasingly wired for fat broadband connections and momentum slowly building toward video-on-demand, the firms’ raisons d’être are being undermined.

And so the recent joint venture to “develop technology” and “work with Hollywood studios to secure content for digital distribution” is more of a rearguard action than an assault. Worse, there’s not much evidence that the two companies will be able to find serious synergies. Netflix may own copies of the 25,000 movies it sends out via the mail, but it doesn’t own their digital rights. Companies like Starz Encore and HBO already have exclusive deals for the electronic sale of films made by major studios such as Disney. And there’s little reason to think that consumers will choose TiVo’s products over the cheaper jobs that come with their cable or satellite service.

TiVo and Netflix aren’t going the way of Webvan and anytime soon. But while TiVo may have introduced a new verb into the English language, it won’t dominate the market it created in the same way that and eBay have. There will be no vast TiVo or Netflix—or TiVo-Netflix—empire, sustained by a steady stream of first-mover profits. And the company’s founders may never enjoy the massive paydays and nine-figure fortunes that their mid-nineties counterparts did. The 4.323 million shares that Netflix CEO Reed Hastings owns directly are worth almost $80 million, which is still real money in Silicon Valley. But the 1.6 million shares TiVo CEO Mike Ramsay owns are worth slightly more than $11 million. (And watch what happens to the share price if he starts selling them.)

More than anything, the plateauing of Netflix and TiVo signifies how the financial and cultural moments defined by technological and popular-culture breakthroughs are growing ever shorter. Apple’s iTunes store is already being challenged by the Beast of Bentonville (Wal-Mart), Virgin, and several other deep-pocketed upstarts. In the dot-com era, the big guys—Wal-Mart, the cable companies, Microsoft— learned a lesson or two; they are too smart to let start-ups metastasize into truly serious competitors. And so the half-life of a brilliant business breakthrough today is shorter than that of an American Idol finalist, whatever her name was.

The Buddy System