Speaker 1: Get in touch with technology with tech Stuff from how
Speaker 1: stuff Works dot com. Hey there, and welcome to tech Stuff.
Speaker 1: I'm your host, Jonathan Strickland. I'm an executive producer with
Speaker 1: How Stuff Works and I love all things tech. And
Speaker 1: we are now entering part three of our series about Netflix.
Speaker 1: The next episode, we'll kind of combine all the stuff
Speaker 1: that's been going on in ten years with uh, you
Speaker 1: know that kind of thing. That'll be the next episode.
Speaker 1: They'll be sort of where we are today. But this
Speaker 1: episode is all about Netflix is fight for survival when
Speaker 1: it was going up against some pretty big opponents in
Speaker 1: the world of video rental. So in our last two episodes,
Speaker 1: I looked at the founding of Netflix up to the
Speaker 1: departure of one of the co founders, Mark Randolph, the
Speaker 1: guy who actually wanted to build a web site that
Speaker 1: would be the Amazon dot Com of video rental. In
Speaker 1: this episode, I'll look at how the company began to
Speaker 1: usher in the era of digital delivery and fight off competitors.
Speaker 1: So to be fair, first of all, Netflix did not
Speaker 1: invent digital delivery of video. Video on demand experiments had
Speaker 1: begun in the mid nineties a few years before read
Speaker 1: Hastings and Mark Randolph co founded Netflix, so they did
Speaker 1: not invent this technology. Cable television had led the way,
Speaker 1: largely because cable could deliver the bandwidth required to uh
Speaker 1: to send video in the first place. During the nineties,
Speaker 1: many people access the Internet using dial up services, and
Speaker 1: that lacked the bandwidth to deliver real time video, so
Speaker 1: it wasn't the right time to use the Internet to
Speaker 1: deliver video services. Yet. It really wasn't until broadband internet
Speaker 1: slowly began to become a real thing in the early
Speaker 1: two thousands here in the United States that it was
Speaker 1: seen as a viable delivery mechanism for video content at all.
Speaker 1: But more about that in a little bit. In the
Speaker 1: spring of two thousand three, Netflix was a totally different
Speaker 1: company from a talent perspective than what the initial Netflix
Speaker 1: was all about. None of the original team members were
Speaker 1: still at the company. Read Hastings, who had provided the
Speaker 1: seed money for Netflix but who was not initially involved
Speaker 1: in the day to day operations of the company, was
Speaker 1: now running the show, and in March two thousand three,
Speaker 1: the company hit the landmark of one million subscribers that
Speaker 1: had long been seen as the turning point that this
Speaker 1: would be the moment when Netflix would turn into a
Speaker 1: profitable company. Blockbuster, meanwhile, I was trying to get into
Speaker 1: the game late and the end of two thousand three,
Speaker 1: they were looking to launch their own online the DVD
Speaker 1: rental service called Blockbuster on Line. Now. Originally the vision
Speaker 1: for Blockbuster Online was to be an online and in
Speaker 1: store hybrid service, but delays and changes and political shifts
Speaker 1: within Blockbuster ment that when the service finally debuted, it
Speaker 1: was an online rental subscription model, not that different from
Speaker 1: what Netflix was doing, but the nature of Blockbusters business
Speaker 1: with franchise owners opposing the very idea of online options.
Speaker 1: They were afraid that the online stores would cannibalize their
Speaker 1: own stores traffic. They argued to the CEO, John Antiocho,
Speaker 1: that this is a terrible, terrible choice. Don't do this.
Speaker 1: You're going to ruin our businesses. And so Antiocho in
Speaker 1: a way kind of capitulated a bit. He denied the
Speaker 1: online team any chance to leverage blockbusters established assets and relationships.
Speaker 1: So Blockbuster had relationships with movie studios. They were able
Speaker 1: to get really good deals on VHS titles for rental
Speaker 1: through these movie studios. None of that was available to
Speaker 1: the online team. They were not allowed to leverage any
Speaker 1: of the customer data that Blockbuster had gathered over the
Speaker 1: years of being in business, and it really put this
Speaker 1: initiative at a disadvantage. And if you listen to my
Speaker 1: episodes about Blockbuster, you know that this eventually doesn't work
Speaker 1: out so well for the company. But they were Despite
Speaker 1: these disadvantages, the team behind Blockbuster Online was still able
Speaker 1: to create a credible threat to Netflix. As for Netflix,
Speaker 1: it was going through a serious growth phase. By two
Speaker 1: thousand four of the company's share price had risen dramatically,
Speaker 1: quadrupling at one point and going beyond that to to
Speaker 1: quite high from its original opening amount. About three thousand
Speaker 1: new customers were signing up every day, a revenue growth
Speaker 1: was more than one year over year, and Hastings announced
Speaker 1: to investors than the company planned to introduce a movie
Speaker 1: download service at some point in two thousand five, which
Speaker 1: would then mean the company was dipping its toe into
Speaker 1: digital delivery, though in this case we're talking about digital
Speaker 1: delivery and that you would purchase a movie and download
Speaker 1: it to a device, uh, not digital delivery in the
Speaker 1: sense of streaming movies that still was in the future.
Speaker 1: Netflix began to advertise on television in two thousand four,
Speaker 1: and they saw subscription numbers skyrocket. That sounds great, except
Speaker 1: there was one tiny problem, which was that to entice customers,
Speaker 1: new subscriptions would include a free trial for a month,
Speaker 1: so for the first month of a customer would have
Speaker 1: free rentals. And that meant that while you saw customer
Speaker 1: numbers increasing dramatically, the revenues weren't because people were taking
Speaker 1: advantage of that one month of free service. So the
Speaker 1: company actually posted a dramatic quarterly loss in two thousand
Speaker 1: four because so many people had signed up and we're
Speaker 1: using that free month and uh, it's kind of funny
Speaker 1: to think about, but in a way, Netflix was suffering
Speaker 1: such a big loss because they were so successful because
Speaker 1: they had so many new customers signing up. But the
Speaker 1: adoption of the service was helping Netflix more than it
Speaker 1: was hurting it. In the long run, the stock price
Speaker 1: had grown significantly. It led Netflix to split the stock
Speaker 1: in February two thousand four. I've talked about stock splits
Speaker 1: in the past. Typically it's when a company uh decides
Speaker 1: to create new shares, awarding those new shares to people
Speaker 1: who already hold shares in the company, and by increasing
Speaker 1: the number of shares, they reduced the cost per share,
Speaker 1: because you can't magically make a company more valuable this way, right,
Speaker 1: So if you have a hundred thousand shares and they're
Speaker 1: ten dollars a share, and then you decide to double
Speaker 1: the number of shares, you have to half the price
Speaker 1: per share. So you have two hundred thousand shares now,
Speaker 1: but now they're five dollars per share because overall the
Speaker 1: value of the company has to remain the same. The
Speaker 1: value of the company can increase as the market values
Speaker 1: it more, but you can't make it increased just by
Speaker 1: splitting the stock. And the whole point behind splitting stocks
Speaker 1: tends to be the philosophy that by having a lower
Speaker 1: per share price, you increase the liquidity within the market.
Speaker 1: People trade more readily, which is seen as or it
Speaker 1: can be seen as a way of measuring company health.
Speaker 1: Uh And you can you can encourage smaller investors to
Speaker 1: invest in your company this way because on a per
Speaker 1: share basis, the price isn't prohibitive. Right If if every
Speaker 1: share costs a hundred and fifty dollars, you're not going
Speaker 1: to get a love small investors, So they split the
Speaker 1: stock into thousand four. Later that same year, Netflix raised
Speaker 1: the fee for having three films out at a time.
Speaker 1: The fee had been nineteen dollars ninety nine cents per month,
Speaker 1: and they raised it to twenty one dollars nine cents
Speaker 1: per month. This initially gave Blockbuster a boost of confidence
Speaker 1: because they had their online service planned which had not
Speaker 1: yet launched, and they had already priced it to be
Speaker 1: the same as Netflix. So now when Netflix new prices,
Speaker 1: the Blockbuster offering would actually be cheaper. This would give
Speaker 1: Blockbuster the chance to undercut Netflix, which was seen as
Speaker 1: a very valuable tool. So the Blockbuster service entered into
Speaker 1: a test phase on July two thousand four, which happened
Speaker 1: to be the same day that Netflix was holding an
Speaker 1: earnings call, and this timing was not coincidental. Blockbuster was
Speaker 1: targeting the earnings call specifically in order to essentially send
Speaker 1: Netflix a message essentially saying watch your back. Netflix stock
Speaker 1: took a sharp dive in price as investors started to
Speaker 1: get nervous because Blockbuster had already proven to be a
Speaker 1: giant in video rentals, and if the company was really
Speaker 1: behind this this service, it could mean that they would
Speaker 1: price Netflix out. Of business. Even if Blockbuster were to
Speaker 1: take a loss in the short term, if they could
Speaker 1: outlast Netflix, if they could sap away enough customers so
Speaker 1: the Netflix isn't making enough money, then they could stand triumphant.
Speaker 1: And then once Netflix is gone, they could increase prices
Speaker 1: or even get rid of the service entirely if they
Speaker 1: wanted to. So this was not a great move, and
Speaker 1: the dive in price meant Netflix lost about sixty percent
Speaker 1: of its market value in a week. Market value is
Speaker 1: that measurement we use when we we take the number
Speaker 1: of outstanding shares in the company and we multiply it
Speaker 1: by the price per share, then you get the market
Speaker 1: value of a company. If it hadn't been for Blockbusters
Speaker 1: other problems which were largely driven by the investor, Carl
Speaker 1: Icon and his attempts to steer the company in a
Speaker 1: particular direction. Specifically, he wanted a Blockbuster to buy up
Speaker 1: a rival, major UH competitor, Hollywood Video. All of those
Speaker 1: machinations going on in the background, we're really taking up
Speaker 1: a lot of of corporate focus, and the senior staff
Speaker 1: over at Blockbuster we're trying to fight off Icon. If
Speaker 1: that had not happened, Blockbuster Online might have posed a
Speaker 1: much larger threat to Netflix, but at the time it
Speaker 1: was probably a scary competitor, but it was small potatoes
Speaker 1: compared to another potential threat that appeared to be on
Speaker 1: the horizon, which was Amazon dot Com, which was rumored
Speaker 1: to be getting ready to launch its own DVD online
Speaker 1: rental service, and that seemed to be the real threat
Speaker 1: because again, Netflix originally was supposed to be the Amazon
Speaker 1: dot Com of renting videos online. If Amazon got into it,
Speaker 1: it would by definition be the Amazon dot Com of
Speaker 1: doing that. So to ward off Amazon, Hastings made the
Speaker 1: decision to cut the subscription price. They had raised it
Speaker 1: not that long ago. They decided, let's cut it too
Speaker 1: as low as we can possibly go without taking too
Speaker 1: big of a hit, and ultimately they cut the price
Speaker 1: by eight percent, down to seventeen dollars cents per month.
Speaker 1: Netflix had been buying properties in the United Kingdom. They
Speaker 1: were anticipating expanding internationally and launching the service over in
Speaker 1: the UK, but Hastings decided that they were going to
Speaker 1: have to put that on hold for a short while
Speaker 1: until late two thousand five at the earliest, because he
Speaker 1: wanted the company's full focus on competing against Amazon. Now,
Speaker 1: that was complicated by the fact that Amazon had already
Speaker 1: launched a net based DVD rental service in the UK.
Speaker 1: They had not launched one US, but they used the
Speaker 1: UK as sort of a testing ground. So Hastings told
Speaker 1: investors that Blockbuster wasn't something to worry about. He said
Speaker 1: that company has doomed itself. They said, if online rental
Speaker 1: is going to continue in its trajectory, it's going to
Speaker 1: increasingly pull business out of brick and mortar stores. That
Speaker 1: you're gonna see fewer and fewer people going to the
Speaker 1: stores to rent movies, and that if Blockbuster is putting
Speaker 1: effort behind this, then they're going to cannibalize their own business.
Speaker 1: They're going to take customers away from those brick and
Speaker 1: mortar stores, and so they're not ultimately going to come
Speaker 1: out ahead. They're gonna shift customers from one model to another.
Speaker 1: But ultimately, since the company itself was built upon the
Speaker 1: foundation of video rental stores, they would be marking themselves
Speaker 1: for their own destruction. And they said that Netflix would
Speaker 1: actually be in a really good position too to weather
Speaker 1: all of that, that it would be strong on the
Speaker 1: other side, whereas Blockbuster would end up taking the ground
Speaker 1: out from underneath itself, but waiting for this to happen
Speaker 1: was really hard. Blockbuster ran an ad during the two
Speaker 1: thousand five Super Bowl, and during that ad they dropped
Speaker 1: the price for their online service for video rental to
Speaker 1: fourteen dollars nine cents per month for a service that
Speaker 1: was very similar and essentially the same thing as Netflix's
Speaker 1: three out subscription base, which was three dollars more expensive
Speaker 1: per month. The CFO of Netflix argued they should hold firm.
Speaker 1: They should not drop their price again, and the reason was,
Speaker 1: he said, Blockbusters bleeding itself out. It is purposefully losing
Speaker 1: money per subscriber on this deal in the hopes that
Speaker 1: they will be able to put us under siege. Not
Speaker 1: the Steven Seagal film, and wait until we're out of money,
Speaker 1: and we should not try and get into a price war.
Speaker 1: That's just going to make it harder for us if
Speaker 1: we do that. By the end of two thousand five,
Speaker 1: Netflix posted a profit in three of the four quarters,
Speaker 1: which was good news. The company launched a download service
Speaker 1: in which customers could purchase a digital copy of a movie.
Speaker 1: At least they had that in a limited rollout, and
Speaker 1: in April two thousand five, Hastings set on a conference
Speaker 1: call that Blockbuster had thrown everything they had at him
Speaker 1: except the kitchen sink, and the very next day he
Speaker 1: found an enormous package waiting for him. It was from
Speaker 1: Blockbuster and inside was, of course, a kitchen sink. So
Speaker 1: what would come next? Well, I'll tell you, but first
Speaker 1: let's take a quick break to thank our sponsor. Now,
Speaker 1: on all of Netflix's woes were coming from outside the company,
Speaker 1: They weren't all external threats. One policy that landed Netflix
Speaker 1: into some trouble had to do with its algorithms that
Speaker 1: decided who would get the next available copy of a
Speaker 1: particular DVD. Not. On a previous episode, you heard how
Speaker 1: the algorithm was supposed to work, which is that you
Speaker 1: would create a queue, and you would put the movies
Speaker 1: in order in your queue, in the order you wanted
Speaker 1: to get them, and at least the idea was you
Speaker 1: would get the next available version of that title as
Speaker 1: soon as possible. That the higher ranked the movies were,
Speaker 1: the more likely you were going to get one of
Speaker 1: those titles, assuming there was any availability, And obviously new
Speaker 1: releases would be the hardest to get initially because everybody
Speaker 1: wants to see them. Now, you would think this would
Speaker 1: all be by the order in which users had placed
Speaker 1: a title into their cues, adjusted by the ranking within
Speaker 1: the queues themselves. So in other words, let's say that
Speaker 1: you and I both want to see Big Trouble in
Speaker 1: Little China, because, as we know, it's one of the
Speaker 1: greatest movies ever made. I put it in my queue.
Speaker 1: But in my queue, I put it in the fifteen spot. Uh,
Speaker 1: because I've seen the movie before. I love it, but
Speaker 1: there are other movies I want to see more at
Speaker 1: the at the time, so it's number fifteen in my queue.
Speaker 1: The following day, you add Big Trouble in Little China
Speaker 1: to your queue, but you put it at the number
Speaker 1: one spot. You know, I really want to see this movie. Well,
Speaker 1: based upon what we understood the algorithm to do at
Speaker 1: the time, we would have thought the algorithm would essentially say, well,
Speaker 1: Jonathan added it first, but he's also marked it at
Speaker 1: a lower priority by its place on the queue, So
Speaker 1: I'm gonna send it to the other person. This other
Speaker 1: person who has impeccable taste in movies, They're going to
Speaker 1: get the movie first because they ranked it higher. That's
Speaker 1: how we all understood the algorithm to work. But that's
Speaker 1: not how it actually worked, and Netflix admitted as much.
Speaker 1: They were forced to in the face of a class
Speaker 1: action lawsuit. The company revealed that it would give preferential
Speaker 1: treatment to people who had rented fewer DVDs when there
Speaker 1: was a high demand for certain titles. So why would
Speaker 1: people who aren't renting as many DVDs get their choice
Speaker 1: earlier than people who were loyal customers. Well, the corporate
Speaker 1: logic was that the people who were renting just a
Speaker 1: few DVDs were the most likely to leave the service.
Speaker 1: They were the least anchored to it, and Netflix would
Speaker 1: call those customers birds, and to prevent the birds from
Speaker 1: flying off, they would make sure the birds got what
Speaker 1: they wanted as quickly as possible. But on the flip side,
Speaker 1: that meant the loyal customers, the ones who would rent
Speaker 1: frequently and who were more likely to stick with Netflix,
Speaker 1: they got passed over more frequently. It didn't matter if
Speaker 1: they had assigned the title to a higher spot on
Speaker 1: their queue, or if they had added the title months
Speaker 1: before the birds had done so, and that seemed inherently unfair.
Speaker 1: Netflix would settle that lawsuit and a lot of claimants
Speaker 1: ended up getting free rentals as compensation, so that was something,
Speaker 1: but it was a message that a lot of people
Speaker 1: mark down as saying read Hastings doesn't necessarily take customer
Speaker 1: uh desires into account when he makes decisions, and that
Speaker 1: would be a feeling that would get reinforced multiple times
Speaker 1: over the next several years. Hastings incorporated a feature called
Speaker 1: Friends in the Netflix website experience. This would allow users
Speaker 1: to share their movie que selections with each other if
Speaker 1: they chose to. It's kind of like a social platform.
Speaker 1: They could say, all right, well, my friend Susie is
Speaker 1: also using Netflix, so I'm going to share my cue
Speaker 1: with Susie. Not not to share it across where Susie
Speaker 1: is going to get my movies, but that Susie can
Speaker 1: see which movies I am looking forward to watching. Netflix
Speaker 1: could not do that automatically because there are federal privacy
Speaker 1: laws in the United States that had previously established. Video
Speaker 1: stores were not allowed to publish what a customer had
Speaker 1: rented their rental history. That would be a violation of privacy. However,
Speaker 1: Netflix could create the opportunity for users to opt in
Speaker 1: and choose to share the information Netflix just couldn't do
Speaker 1: it automatically on its own. Another thing that the developers
Speaker 1: over at Netflix introduced was a concept called Profiles that
Speaker 1: would allow a single user account to create separate profiles
Speaker 1: within a household. So let's say that you know, it's
Speaker 1: it's a couple of spouses, some kids. Everyone could get
Speaker 1: their own profile with their own cues. That way, if
Speaker 1: one person favored action movies, someone else likes rom coms,
Speaker 1: someone else is really into, you know, deep thinking science fiction,
Speaker 1: they could each maintain their separate cues and they could
Speaker 1: get separate suggestions for films they might want to rent
Speaker 1: based upon their individual preferences and not have it just
Speaker 1: all filter into one big, messy que. Read Hastings actually
Speaker 1: did not like this feature at all. He did not
Speaker 1: want to implement it. He felt that it was going
Speaker 1: to make it harder to program changes because it added
Speaker 1: unnecessary complications. He just viewed this as being very messy,
Speaker 1: very human, not very efficient. But customers were actually calling
Speaker 1: for this feature, and as it turned out, both Profiles
Speaker 1: and Friends features would set off some more warning flags
Speaker 1: that would reinforce this idea that read Hastings did not
Speaker 1: necessarily consider. Customer wants and needs and desires to be
Speaker 1: very high among the priority lists of things that the
Speaker 1: company needed to focus on. Back on the block but
Speaker 1: sster warfront. Netflix won a victory when Walmart decided, after
Speaker 1: a failed attempt to get uh the online DV rent
Speaker 1: toll business going, that it was going to pull out
Speaker 1: of that business entirely. Walmart said, you know, we tried.
Speaker 1: This isn't working for us. It doesn't fall into our
Speaker 1: business plan. And the the agreement between Walmart and Netflix
Speaker 1: was that Walmart would instead direct customers to Netflix and
Speaker 1: even have a deal where people who had been customers
Speaker 1: of Walmart's online DVD rental business could become members over
Speaker 1: at Netflix for a reduced membership fee for a year.
Speaker 1: So that was a big deal in that this competitor
Speaker 1: and not not only was getting out of the market, they
Speaker 1: were handing over their customers to Netflix. Blockbuster did not
Speaker 1: like that. They also ended up having to raise prices
Speaker 1: to seventeen dollars nine for the three DVD at a
Speaker 1: time service. They had been at fourt but now they
Speaker 1: brought it up in line with Netflix, just as people
Speaker 1: and Netflix had predicted. They said, well, Blockbuster was going
Speaker 1: to have to do this because they were losing so
Speaker 1: much money on a per subscription basis that it was
Speaker 1: not something that could be supported indefinitely. Even better news
Speaker 1: for Netflix, it looked like Amazon was actually not going
Speaker 1: to get into the DVD rental space in the United
Speaker 1: States at all. So at the end of two thousand five,
Speaker 1: Netflix had a market value of about one and a
Speaker 1: half billion dollars. It also had eliminated its debt, and
Speaker 1: it had four point two million subscribers. Blockbuster, on the
Speaker 1: other hand, was more than a billion dollars in debt
Speaker 1: and had a market value of six four million dollars.
Speaker 1: So the fortunes had changed dramatically for both companies. But Blockbuster,
Speaker 1: though knocked down, wasn't out. It was still fighting, and
Speaker 1: there was another trick up Blockbusters giant sleeve that would
Speaker 1: cause Netflix more grief. Just a little later in two
Speaker 1: thousand six, the world was looking at the Internet as
Speaker 1: a possible delivery mechanism for long form video. So YouTube
Speaker 1: had launched in two thousand five that was already becoming
Speaker 1: a popular place for short form user generated video. But
Speaker 1: as for the studio backed stuff, that was a different story.
Speaker 1: For one thing, the landscape was really messy from an
Speaker 1: industry perspective, most movie and television studios were part of
Speaker 1: larger conglomerates, and those conglomerates also included distribution channels like
Speaker 1: cable networks or other cable distributors and Internet service providers
Speaker 1: were starting to buy up media companies to or get
Speaker 1: acquired by those same sort of conglomerates, and this thing
Speaker 1: made things really messy. You add lines of distribution content
Speaker 1: all getting bubbled up with each other, and an independent
Speaker 1: company like Netflix was put kind of outside of all that. Meanwhile,
Speaker 1: you had entrenched entities like HBO or Showtime, these premium
Speaker 1: channels that would pay enormous amounts of money to studios
Speaker 1: in order to get exclusive cable rights to different properties,
Speaker 1: so there were very few incentives in place on that
Speaker 1: side to change things up now. Originally the plan for
Speaker 1: Netflix was to roll out a wider download service like
Speaker 1: the one it had tested in two thousand five, but
Speaker 1: the company scrapped those plans, so instead there was a
Speaker 1: more bold idea in the works. It would involve a
Speaker 1: media player that would be uh that would run on
Speaker 1: a computer device, maybe a computer, desktop, laptop, maybe a
Speaker 1: portable device, and it would be allowed to play streaming
Speaker 1: video content, so instead of downloading something, you would stream
Speaker 1: it from a server. This was in contrast to a
Speaker 1: strategy that a company like Disney was trying to employ.
Speaker 1: Disney had introduced a proprietary set top box and a
Speaker 1: download service called movie Beam. Hastings felt that it made
Speaker 1: more sense to create a lightweight media player that could
Speaker 1: be installed on numerous types of hardware owned by other companies.
Speaker 1: So hardware manufactured by different companies and sold by different
Speaker 1: companies could also include this media player as part of
Speaker 1: the installation rather than producing their own hardware, and that
Speaker 1: would bring price down for development and more importantly, for adoption.
Speaker 1: You wouldn't have to have, you know, a brand new
Speaker 1: set top box sold by Netflix for a couple hundred bucks.
Speaker 1: This was super important because it was clear Netflix was
Speaker 1: going to have to spend a lot of money to
Speaker 1: get into this digital distribution world, because it was going
Speaker 1: to cost a huge amount to get the rights to
Speaker 1: serve up streaming media from the various content creators. Netflix
Speaker 1: wasn't creating its own content yet in those days, so
Speaker 1: it was gonna have to pay licensing fees to all
Speaker 1: the different creators out there. That were making the stuff
Speaker 1: that people wanted to see. The licensing fees were going
Speaker 1: to be an incredible expense, so there had to be
Speaker 1: a way to convince a large number of people to
Speaker 1: enroll in the service to offset these huge costs that
Speaker 1: the company was going to encounter as it built out
Speaker 1: a streaming inventory of TV shows and movies. Meanwhile, Netflix
Speaker 1: and Blockbuster Online traded lawsuits with each other. Netflix alleged
Speaker 1: that Blockbuster Online was infringing upon trademarks, and Blockbuster Online
Speaker 1: said Netflix was suing them in order to try and
Speaker 1: force a competitor out of an industry and create an
Speaker 1: effective monopoly. Eventually, the company settled both lawsuits, and one
Speaker 1: of the terms of the settlement allegedly because this has
Speaker 1: never been publicly acknowledged, but as far as I can tell, UH,
Speaker 1: one of the terms was that read Hastings would no
Speaker 1: longer be allowed to tell his story that Netflix was
Speaker 1: the creation that was inspired by a late fee from Blockbuster,
Speaker 1: and it was around this time that if read Hastings
Speaker 1: did tell that story, the identity of the video store
Speaker 1: in question would no longer be a Blockbuster, but rather
Speaker 1: a mom and pop video rental store in California that
Speaker 1: had long since gone out of business. So uh, this
Speaker 1: was another indication that that story of Netflix's origin was apocryphal.
Speaker 1: Now I have a bit more to say about what
Speaker 1: Netflix and Blockbuster did toward the end of the first
Speaker 1: decade of two thousand, but first let's take a quick
Speaker 1: break to thank our sponsor. In two thousand seven, on January,
Speaker 1: Netflix announced it would launch a streaming video service online,
Speaker 1: and the initial library was limited to one thousand titles.
Speaker 1: So whenever you get on Netflix then you say there's
Speaker 1: nothing to watch. Just imagine back when it was only
Speaker 1: a thousand titles total. So why would you launch a
Speaker 1: service with so few titles in the first place. The
Speaker 1: general consensus was that Netflix's hand was sort of forced
Speaker 1: because it was still trying to fight off Blockbuster, and
Speaker 1: Blockbuster had launched a service called Total Access that ended
Speaker 1: up being incredibly popular and was rapidly siphoning away customers
Speaker 1: who would have signed up to Netflix and instead they
Speaker 1: were signing up with Blockbuster. Now here's the funny thing.
Speaker 1: Total Access was a hybrid DVD rental service, and it
Speaker 1: was what Blockbuster Online was intended to be years earlier.
Speaker 1: It was supposed to be this combination of online and
Speaker 1: brick and mortar stores. UH. It was supposed to leverage
Speaker 1: the strengths of Blockbuster along with this new online delivery
Speaker 1: model and UH or at least online rental model, I
Speaker 1: should say, because the the delivery was still in DVD format.
Speaker 1: So here's how it was going to work. In fact,
Speaker 1: here's how it did work. If you signed up for
Speaker 1: the service, then you could create a queue very similar
Speaker 1: to what you would do on Netflix of different movies
Speaker 1: you wanted to watch, and based upon the level that
Speaker 1: you had subscribed to, you would get a number of
Speaker 1: DVDs from that queue sent to you. After you watched it,
Speaker 1: you could do one of two things. You could PLoP
Speaker 1: the the viewed DVD back into an envelope and mail
Speaker 1: it back to Blockbuster, whereupon, once it was processed, they
Speaker 1: would send you the next one on your list. Or
Speaker 1: you could actually take that DVD and return it to
Speaker 1: a Blockbuster store. And if you return it to a
Speaker 1: Blockbuster store, that DVD would also act as if it
Speaker 1: were a free rental coupon. You could immediately rent any
Speaker 1: movie in that Blockbuster store for free, and meanwhile, the
Speaker 1: Blockbuster store would scan in your return, which would immediately
Speaker 1: indicate to the distribution center to send you the next
Speaker 1: movie on your queue. So not only were you getting
Speaker 1: a free rental that didn't have to be on your
Speaker 1: queue at all, the next movie under queue, at least
Speaker 1: the next available movie on your queue, would then get
Speaker 1: sent to you. So this was a very attractive proposition.
Speaker 1: It was something that Netflix could not offer because they
Speaker 1: didn't have those brick and mortar stores and Blockbuster had that.
Speaker 1: You know, that was an established, entrenched model for Blockbuster.
Speaker 1: So this was an opportunity for Blockbuster to really put
Speaker 1: the hurt on Netflix. Their service attracted more than two
Speaker 1: million customers in just a few short months, uh and
Speaker 1: it really posed another big threat to Netflix. Now, the
Speaker 1: problem for Blockbuster was that the way they were pricing
Speaker 1: this model was unsustainable. They could not do it indefinitely.
Speaker 1: They were losing money on every transaction, especially since these
Speaker 1: returned disks to the Blockbuster stores were resulting in free
Speaker 1: rentals that took away the opportunity for the business to
Speaker 1: rent that to someone else, so there was lost revenue.
Speaker 1: It was seen as valuable in the sense that Blockbuster
Speaker 1: was trying to catch up and overtake Netflix. But there
Speaker 1: was no way it could keep doing this forever. So
Speaker 1: the question was could Netflix stick around long enough to
Speaker 1: outlast Blockbusters attempt to run them out of business. John
Speaker 1: Antiocho would not get the chance to find out this answer.
Speaker 1: He was the CEO of Blockbuster at that time, but
Speaker 1: he had a really big fight with Carl Icon, who
Speaker 1: owned a significant percentage of Blockbuster and controlled the vote
Speaker 1: of a lot of shareholders in Blockbuster and had a
Speaker 1: lot of power as a result. So Antiocho would resign
Speaker 1: as CEO. Uh This was largely after a dispute he
Speaker 1: had with the board of directors based on his bonuses
Speaker 1: that he had earned that year he was those bonuses
Speaker 1: were cut in half despite an agreement that had been
Speaker 1: arrived at earlier in the year. So he leaves and
Speaker 1: the news incoming CEO was a guy named James Keys.
Speaker 1: I talked all about this in the Blockbuster episodes, but
Speaker 1: Keys wanted to refocus on the brick and mortar stores
Speaker 1: and he saw the online stuff as being unnecessary and distracting,
Speaker 1: and it was a huge blow to Blockbusters strategy that
Speaker 1: was actually working, at least in the sense that it
Speaker 1: was having a big impact on Netflix's business, so pretty much,
Speaker 1: Keys is a rival at Blockbuster, spelled the eventual doom
Speaker 1: of Blockbuster Online, and ultimately you could argue the company
Speaker 1: as a whole. So when Hastings announced that they were
Speaker 1: going to do this inner streaming service, some people were
Speaker 1: skeptical that it would ever succeed because there are people
Speaker 1: who are saying, who the heck wants to watch a
Speaker 1: movie on a small screen? Who wants to watch a
Speaker 1: movie on their laptop or on a desktop or on
Speaker 1: a portable device when they have a big screen television
Speaker 1: and home theater sound system. Because the prevailing wisdom at
Speaker 1: the time was that the quality of the experience mattered
Speaker 1: more than the convenience. But we've seen time and time
Speaker 1: again that convenience matters a whole lot. I mean, the
Speaker 1: MP three compression format proves convenience matters a lot because
Speaker 1: a lot of people are willing to listen to formats
Speaker 1: that are lossy, that where you literally lose information you
Speaker 1: don't have the full sound file represented there, and they're
Speaker 1: willing to do it because the convenience of the form
Speaker 1: factor was more than it seemed to compensate for the
Speaker 1: decline in quality the streaming form at would essentially prove
Speaker 1: the same sort of thing, but for video. And one
Speaker 1: thing that would really help Netflix in the long term
Speaker 1: would also debut later in two thousand seven. That would
Speaker 1: be Apple's iPhone. Now, the iPhone did not initially support video,
Speaker 1: it did not natively support Netflix when it launched, but
Speaker 1: it would create a new market for consumers, a new
Speaker 1: category in the industry, which would be the consumer smartphone.
Speaker 1: There were smartphones before the iPhone, but they were largely
Speaker 1: the domain of business executives. But the iPhone made smartphones
Speaker 1: more consumer friendly and attractive, and the form factor would
Speaker 1: set the stage for mobile viewing of content. And it
Speaker 1: would take some time before the iPhone would support video,
Speaker 1: and more time for a Netflix app to be available,
Speaker 1: but even more time for cellular technology to actually support
Speaker 1: streaming video to a mobile device. But this was setting
Speaker 1: the groundwork, and there's no doubt that the smartphone in
Speaker 1: general helps submit streaming videos place. Two thousand and eight
Speaker 1: was a great year for Netflix because Blockbuster Online was
Speaker 1: essentially a non factor. Now they no longer really had
Speaker 1: a competitor, at least in the online space. Um Blockbuster
Speaker 1: had abandoned the total access service Keys had had argued
Speaker 1: for that customers who had opted for Blockbuster over Netflix,
Speaker 1: now we're coming back over to Netflix because Blockbuster no
Speaker 1: longer had a product there. Netflix's instant streaming service was
Speaker 1: gaining in popularity faster than even Hastings had anticipated. And
Speaker 1: Hasting saw online video is belonging to three categories. You
Speaker 1: would have the download category, where you purchase a piece
Speaker 1: of content and you get to download it to a device,
Speaker 1: and he said, Apple owns that space. We are not
Speaker 1: going to be able to compete with Apple. That's their domain.
Speaker 1: Then you had free user generated content which you would
Speaker 1: watch in streaming format, and YouTube was clearly the destination
Speaker 1: for that. So Netflix was not going to own that
Speaker 1: space either. But Netflix could be the home of the
Speaker 1: third branch of online video, which was a subscription based
Speaker 1: service providing streaming premium content. And it was also two
Speaker 1: thousand and eight when Netflix began a strategy that would
Speaker 1: end up being incredibly successful. The company signed an agreement
Speaker 1: with l G which was creating a set top box
Speaker 1: with some smart TV capabilities. So the agreement meant that
Speaker 1: Netflix is streaming software that video Player would get installed
Speaker 1: directly onto the set top box. So it became a
Speaker 1: native application on this hardware device, and it allowed customers
Speaker 1: to watch their streaming content directly on their television sets
Speaker 1: without having to hook up a PC to the entertainment system,
Speaker 1: which was a barrier for a lot of people. For
Speaker 1: a lot of people, the idea of trying to hook
Speaker 1: up a computer to a television was intimidating. It didn't
Speaker 1: seem as intuitive as setting up a cable box or VCR,
Speaker 1: a DVD player some other set top bucks that was
Speaker 1: made specifically for that purpose, and this marked the beginning
Speaker 1: of a movement for Netflix to try and make sure
Speaker 1: that it's video player was as was available on as
Speaker 1: many different platforms as was possible. The idea was go
Speaker 1: to where the people are, and the Roku box, which
Speaker 1: followed later in that year was another big example. In fact,
Speaker 1: Roku had started off as a fledgling company within Netflix itself.
Speaker 1: It was incubated by Read Hastings and then a guy
Speaker 1: named Anthony Wood, and the original Roku was a small
Speaker 1: set top box that was easy to set up and
Speaker 1: would give customers access to more than ten thousand movie titles,
Speaker 1: mostly through Netflix, and all it required to access those
Speaker 1: would be a Netflix subscription, so it was very intuitive
Speaker 1: to use, it was easy to set up, it was
Speaker 1: so it was reasonably priced, and it was a very
Speaker 1: popular uh uh electronic divi ice in two thousand eight,
Speaker 1: and so much so that they sold out frequently and
Speaker 1: would have to you know, restock and go through another
Speaker 1: manufacturing run several times in order to meet demand. That
Speaker 1: was followed by Netflix being included as a service you
Speaker 1: could access through Microsoft's Xbox three sixt console that was
Speaker 1: announced at E three and two thousand eight, So again
Speaker 1: it was about get in front of people where the
Speaker 1: people are. Those deals open up more opportunities with hardware manufacturers,
Speaker 1: from Blu ray players to smart TV companies, to laptops
Speaker 1: to mobile devices. So from two thousand eight to two
Speaker 1: thousand eleven, Netflix would end up being incorporated directly into
Speaker 1: two hundred different Internet enabled devices, so it really was everywhere.
Speaker 1: In two thousand eight, Hastings decided to get rid of
Speaker 1: that profile's feature that he had resisted a few years earlier,
Speaker 1: and there was considerable backlash among Netflix users at that announcement,
Speaker 1: so in a rare remove, Netflix would actually reverse course
Speaker 1: and reinstate the feature about a week and a half
Speaker 1: after they took it out, at least for the time being.
Speaker 1: They would remove it again a couple of years later.
Speaker 1: As two thousand eight came to a close. The United
Speaker 1: States was entering a recession, but that actually helped Netflix.
Speaker 1: So how could that be? While people were turning to
Speaker 1: Netflix as a source of affordable entertainment compared to going
Speaker 1: out to the movies or going to an expensive restaurant.
Speaker 1: You could stay in and you could watch Netflix, you
Speaker 1: could order a pizza. The fact that you could get
Speaker 1: Netflix on so many different devices with the streaming service,
Speaker 1: coupled with the fact that you could still rent DVDs
Speaker 1: through their online service gets sent through the mail. All
Speaker 1: of that was still around two and meant that Netflix
Speaker 1: was in a pretty strong position despite the recession. So
Speaker 1: the battle with Blockbuster was pretty much over. By mid
Speaker 1: two thousand eight. They were already removed rumors that Blockbuster
Speaker 1: was going to have to declare bankruptcy. That would not
Speaker 1: happen until but at that point, Netflix had sort of
Speaker 1: changed it's it's crosshairs. They no longer consider Blockbuster to
Speaker 1: be their big threat. Now their biggest competitor, according to Hastings,
Speaker 1: was red Box, which, of course was founded by a
Speaker 1: former Netflix executive, and they also we're running into more
Speaker 1: problems between movie studios and television studios. A lot of
Speaker 1: those companies resented Netflix's dominant position in online delivery, and
Speaker 1: before long, new digital services would soon arise to challenge
Speaker 1: Netflix in that arena, and Netflix itself would also make
Speaker 1: some pretty notable mistakes in the next couple of years,
Speaker 1: some of which would end up being the basis for
Speaker 1: some some extensive jokes at Netflix's expense. So in our
Speaker 1: next episod, we'll look at how Netflix transitioned to focus
Speaker 1: primarily on streaming and and the DVD became a less
Speaker 1: important part of its business, and how a little move
Speaker 1: called quickxter blew up and read Hastings face. That wraps
Speaker 1: up this episode. However, if any of you out there
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