Anyone who watched one of the recent entertainment award shows will note that one corporate name kept recurring: Netflix. Over the last several weeks, the company has won a passel of statues from the Golden Globes to Critics Choice. And its production of “Roma” (a winner at both these outings) and its director Alfonso Cuaron are among the favorites to win Oscars next month.
So it seems odd to recall that Netflix (NFLX) started not as a producer of original content or a provider of steaming services but as a company that mailed DVDs — other people’s films — to subscribers.
But mailing movies directly to consumers — the brainchild of co-founder Reed Hastings — turned out to be the start of a multibillion-dollar company that disrupted the existing model and set the entertainment industry into an entirely new direction.
Hastings, 58, was born in Boston. He attended Bowdoin College. Then he served two years as a Peace Corps math teacher in Swaziland. He returned to the U.S. to pursue a Master’s degree in computer science at Stanford. In several interviews, Hastings has said that his time there — and his first exposure to entrepreneurs he’d previously considered god like — proved a seminal experience in his life:
“It really helps to be around them, to see they are regular people with a good idea. The thing I took away was that if they can do it, I can do it.”
And he did. In 1991, he started Pure Software, whose main product was Purify, a software debugging program that proved immensely popular. But, he told the New Yorker, “The product was excellent; my management style was not.”
Learning From Mistakes
In a TED talk he recalled how at Pure “I was process obsessed. If someone did something wrong, we created a process so that it would never happen again.”
On a Masters of Scale podcast with LinkedIn (LNKD) co-founder Reid Hoffman, he added:
“What we failed to understand was that by dummy-proofing all of the systems, we would have a system where only dummies would want to work there. Which is exactly what happened. The average intelligence fell and then the market changed and we were unable to adapt because we had a bunch of people who valued the process more than (free) thinking.”
He found himself “coding all night, trying to be CEO during the day.” He believed he could solve the company’s problems simply by working longer and harder.
So shortly after the company was acquired by Rational Software in 1997, he left.
He and fellow Pure exec Marc Randolph searched for the next big thing. They found it supposedly because of a $40 late fee.
Hastings told Fortune magazine that the idea for Netflix started percolating in 1997, after Blockbuster assessed him a $40 late fee for his rental of “Apollo 13”.
“I remember the fee, because I was embarrassed about it. That was back in the VHS days and it got me thinking that there’s a big market out there.” The story has since proved apocryphal, though it helps explain what came next.
The pair admired the Amazon (AMZN) model, and began searching for a niche the mail-order giant didn’t fill. The movie rental business seemed ripe. But VHS tapes were too expensive and fragile to mail.
“I didn’t know about DVDs and then a friend of mine told me they were coming. I ran out to Tower Records in Santa Cruz and mailed (music) CDs to myself. Just a disk in an envelope. It was a long 24 hours until the mail arrived back at my house, and I ripped (the envelopes) open and they (the CDs) were all in great shape.”
Officially, Netflix launched on April 14, 1998, with 925 titles — virtually the entire DVD universe at the time. The company’s subsequent success can largely be attributed to a variety of factors, none the least of which is Hastings’ prescience. He recognized that DVDs were at least the short-term future. Also, at a time when only about 10% of the country had access to broadband, he predicted that streaming was the ultimate delivery system.
Hastings also applied what he learned from his mistakes at Pure. He created a different culture to propel his company forward. At Netflix he literally gave power to the people. “I pride myself on making fewer and fewer decisions,” he told the TED audience. “Sometimes I can go a whole quarter without making a decision.”
He added: “We’re like the anti-Apple. They compartmentalize. We do the opposite. Everyone gets all the information.”
Netflix employees are generally paid higher than the industry standard. There is no dress code. No vacation limits. But there is also full accountability, transparency and what Hastings calls radical honesty.
“We want people to speak the truth. We said to disagree silently is disloyal. It’s not okay to let a discussion go through without saying your piece,” Hastings has said.
Another aspect of the company’s success is Hastings’ restless nature. He’s never satisfied, always moving forward, looking for the new.
Under his stewardship the company kept changing the traditional rules: from singular rentals to a subscription service, no late fees, no shipping charges. It developed algorithms that measured what people watched and suggested a queue of what customers might enjoy.
At the same time, he understood that mailing DVDs was an unworkable long-term formula. “Continuing to (send) DVDs by mail for another two decades would have been a failure strategy, because the underlying strata was changing and internet delivery was possible,” Hastings has said.
Once the company went to streaming in 2007, its next hurdle was convincing content suppliers that Netflix was a partner, not a competitor. But film studios, afraid of online piracy, were reluctant to allow their newer products to be streamed. And, in any event, many top films were already committed to cable networks, such as HBO and Showtime.
Staying Ahead Of The Curve
In 2008, the company signed a break-through $30 million deal with cable network Starz allowing Netflix to stream its content. Other cable companies followed suit, when they realized that Netflix was not only a new source of revenue, but could actually improve the performance of the cable networks themselves. For example, when old episodes of “Breaking Bad” became available on Netflix, the ratings of new episodes jumped.
The next step, streaming all episodes of a show at the same time allowing customers to binge watch, was a logical outgrowth of what the company noticed during its DVD days. “We’d been shipping DVDs and boxed sets. People were watching HBO content. It was powerful to see all the episode sat once and it was something regular TV couldn’t do,” Hastings said.
“One thing I couldn’t do was engender brand loyalty. ‘Mad Men’ was a great show, but it was an AMC show. (Viewers) didn’t associate it with us even if they watched it on Netflix.” Enter “House of Cards”.
Taking a cue from HBO, which moved from airing films to producing original content and YouTube, a major streaming success, Netflix invested $100 million for two 13-episode seasons of the show.
“We weren’t confident,” Hastings recalled. “It was scary.” But the program, the first on-line only series to be nominated for major Emmy Awards, was an immediate success.
“It made the brand stronger. People watched ‘House of Cards’ and they talked about it and would associate it with us.” And while some may have questioned the size of the investment, it pales in comparison to the estimated $13 billion Netflix will spend on content this year.
The company just raised its subscription price by double-digit percentage points, which sounds worse than it really is. The lowest level sub went from $8 to $9 while the top tier went from $14 to $16. While it is probably less elsewhere in the country, single admission movie tickets in Manhattan cost as much as $16, making Netflix seem an even greater bargain. Wall Street agrees with this point of view, too. After the announcement, it presented the company with its own style award — an upswing in its price — which many consider worth more than an Oscar.
Saw the streaming future before others and created the first company to take advantage of it.
Overcame: Resistance from content suppliers who believed he was competition and not a partner, as well as his own poor background as a manager.
Lesson: Learn from past mistakes.
Quote: “We encourage employees to figure out how to improve the culture, not how to preserve it.”
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