Napster - Seek Profits Now!

Napster absolutely must start making its profits now—regardless of what it does with its Success Formula. This will require that the company focus less on growth and more on efficiency and effectiveness so that it can make its profits now. But wait, you say. Isn’t market share the eventual pathway to profits and long-term success?

Well, no. That would be another aspect of the Myth of the Flats. There is little evidence to support that merely being big has any advantages at all for generating above average performance. It is well documented) that the company with the largest market share in an industry does not have a better likelihood than pure chance of having the highest performance in the industry. Companies must be distinctive in a way that matters in the market, and it’s becoming increasing difficult for big companies to do so.

Another basic tenet of the Phoenix Principle is Reap in the Rapids. There’s no evidence anyone is making profits in the online music industry during its current growth phase, which is a common mistake driven by The Myth of the Flats. According to the myth, companies should grab market share and not worry much about profits while growing. Then when the market slows, the dominant companies will be able to control margins and earn huge profits. Well, that’s a myth. In today’s copycat economy, there are no above-average profits in the Flats, you have to earn them on the way up—you must “Reap in the Rapids.”

So what should Napster do? One thing it could do is pursue any of the well-documented approaches to operational effectiveness available in the marketplace today. Another, less obvious but equally important action to take is to change its staffing mix.

People can be loosely grouped into two types, Explorers and Stabilizers. Explorers are hard-wired to be more comfortable with change and ambiguity and tend to be dominant in the early lifecycle stages, which is why efficiency takes a back seat. In contrast, Stabilizers are mentally wired to prefer making processes and practices consistent and dependable. Stabilizers are important in the early stages of the business—the Wellspring and the Rapids—to provide operational stability. Many companies in the Internet boom failed because they lacked the discipline and cautiousness that Stabilizers provide.

It is possible that Napster can make the changes needed to ensure enduring success. Whether they do or not depends on how locked in they are to historical methods for competing and seeking long-term success.

What are your thoughts: is Napster’s strategy solid or a setup for failure?

A New Life for Napster?

After terrorizing the recording industry and almost single-handedly ushering in the future of the music business, Napster is going mainstream. Gone are the rule-breaking, paradigm-busting pioneers—replaced by traditional thinkers and strict adherence to the law. Napster lost its battle with the music industry and for a while lingered in bankruptcy, and now wants to play by the rules and make a go of it as a legal music service. Unfortunately, it is no more likely to succeed this time around.

Why? Even though Napster is a small startup in a hip new industry, it is already racing ahead to the Flats portion of the business lifecycle, and will soon be entering the Swamp along with all the other players in the online music market. Roxio, Inc. purchased Napster with the intention of leveraging its famous name into a large share of the music download market. That’s a tenuous hope at best.

One of the basic tenets of the Phoenix Principle is “be distinct or be extinct,” and Napster is not yet distinct. This is a crowded market with very little differentiation among the players, and new companies are still getting into the market. The latest heavy-weights to enter the fray include Microsoft, Virgin, and Yahoo (through its purchase of Musicmatch). Napster’s strategy, to provide subscription services, is already being offered by established music services and it puts forward nothing new there. Nor are its marketing ploys such as pre-paid gift cards and targeting college students with giveaways likely to distinguish it from the crowd. These are simply too easy to copy.

The online music services industry is still in high growth mode, projected to grow at a double-digit rate for several more years. That puts it in the Rapids, so all the players should enjoy high growth for a while. But what happens when the music stops (so to speak), that is, when growth slows and the market becomes saturated? Commoditization, that’s what. When that happens everyone who doesn’t have a differentiated service offering will be plunged into the Swamp, and companies will begin to fail or consolidate in a Defend & Extend effort to find and preserve some profits.

Napster isn’t earning any profits now and won’t for a while, so Roxio is depending on $100 million in cash to keep it afloat. That won’t be enough. Napster needs to revisit its Success Formula now and devise a truly distinct value so that when the industry stops growing, it will remain strong. For instance, it could leverage its bad boy image in many ways—constantly “tweaking the nose” of the majors might help it develop a huge and loyal following among the rebellious youth.

The Phoenix Principle predicts that Napster is already set up to fail and the clock is ticking. Perhaps it would have been better for this industry icon to remain a martyr than to end up as just another business model gone belly-up.

Who bought the donuts?

Krispy Kreme is dead in the water. Two years ago a friend of mine was looking at the stock price chart for Krispy Kreme Donuts (KKD) and asked me if it was still a good investment. The stock had gone from it’s IPO of around $10 in early 2000 to $45 by end of 2001. Was the 2002 pullback a good buying opportunity? Not likely, I commented.

Krispy Kreme has been a “one-trick pony.” The company had a simple Success Formula: open more stores. A good product, a good concept, and they were using investor dollars to geographically expand as fast as possible. I asked my friend, “what will this company do when we have enough donut shops? What will happen when tastes change; and it won’t take much of a change when you live on one product sold 24 hours a day?” Krispy Kreme was putting no energy into understanding how locked-in they were to a fragile Success Formula built upon great promotion for their one product. They were projecting all the future by merely extrapolating the past.

Surely, the challenges came. Atkins diets became a challenge to a carb-laden product. As good as Krispy Kreme’s were, their expansion was taking them head-on into markets already laden with donut shops (including Dunkin’ Donuts) and grocers capable of “jumping on the bandwagon” in their local markets. Now, KKD execs are saying they have too many U.S. shops. Growth has disappeared as they are trying to find “profits” rather than “growth.”

Their one-product, simple success formula was too fragile for a dynamic marketplace, and too easily targeted by other competitors. What profits were to be made in their shops needed to be made during the rapid growth. Finding more profits now will be very, very difficult. They have gone from a growth company, to a retrenchment company. Krispy Kreme missed their golden opportunity to make the company into a great long-term brand. They should have found new avenues to build and grow. But, instead they locked-in and now they are struggling to compete.

For those who bought on the IPO, the stock is within a hair of the offering price. If you bought it then, and held it, you would have made a little capital gain (provided the price slide stops), but no dividends. If you bought anytime after the IPO – you’ve lost money and received no dividends. The lesson learned is to not invest in small companies with narrowly defined success formulas that are tightly locked-in to their competitive model. The risks are too great for any long-term investor.