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 continuing our four part series about Netflix and uh,
Speaker 1: you know. In the previous episode, I covered the founding
Speaker 1: of the company and the challenges that they face just
Speaker 1: getting it up and running, going from the ideation of
Speaker 1: what Netflix would be to building an actual working business,
Speaker 1: and today we're going to continue that story. Less than
Speaker 1: half a year after Netflix's website went live in the
Speaker 1: spring of the company was making about a hundred thousand
Speaker 1: dollars in revenue per month. Now that's not profit, that
Speaker 1: was just revenue, but it did push Netflix into being,
Speaker 1: at least in theory, a million dollar company. You know,
Speaker 1: if they bring in a hundred thousand dollars per months,
Speaker 1: you multiply that by twelve months, you realize, oh, that's
Speaker 1: one point two million dollars. That's pretty impressive. And the
Speaker 1: company wasn't even six months old yet. The model Netflix
Speaker 1: used meant customers would rent films for four or five
Speaker 1: dollars per title, and then they would keep them for
Speaker 1: a week. They could also opt to purchase a title
Speaker 1: that they liked. They could end up buying it for
Speaker 1: a thirty PC discount and just keep the DVD. The
Speaker 1: company had rented out about twenty thousand DVDs in the
Speaker 1: first four months alone, so things were going pretty well.
Speaker 1: The development team was hard at work building new features
Speaker 1: for the company. The big one was what would become
Speaker 1: called the Q as in the line, the que that
Speaker 1: would order titles customers had expressed interest in but had
Speaker 1: not yet rented, so they could create a list of
Speaker 1: titles that they were interested in and even prioritize that list,
Speaker 1: put a movies they more they wanted to see more
Speaker 1: towards the front of the queue and the ones that
Speaker 1: they wanted to see, but there wasn't as big a
Speaker 1: sense of urgency towards the back. That would be something
Speaker 1: that the development team would work on for a couple
Speaker 1: of years before it was really ready to roll out
Speaker 1: in full form, but it became a foundational element of
Speaker 1: what Netflix would be, and that The work on the
Speaker 1: queue dates all the way back to the late nineties.
Speaker 1: Right after Netflix was founded. Programmer Eric Meyer built in
Speaker 1: features in search that would lead users to movies that
Speaker 1: were in stock, and it would exclude movies that were
Speaker 1: either not yet in Netflix's library and that they didn't
Speaker 1: have a copy of that DVD yet, or they were
Speaker 1: in Netflix's library, but we're currently rented out to all customers.
Speaker 1: So that way, when you come to Netflix and you
Speaker 1: start searching around for a movie, not a specific film maybe,
Speaker 1: but maybe a movie featuring a specific actor or actress
Speaker 1: or directed by a certain person, you would get results
Speaker 1: back that only reflected available films. On the business side
Speaker 1: of things, Netflix began to feature older films and uh
Speaker 1: that was far more prevalent than new releases, and this
Speaker 1: was largely because the company wasn't able to yet negotiate
Speaker 1: with movie studios for DVD prices, and new releases tend
Speaker 1: to cost the most money. So while the prices for
Speaker 1: DVDs were significantly lower than what it would cost to
Speaker 1: buy the same title on vhs. Remember DVDs when they
Speaker 1: came out, they were priced typically between fifteen and twenty dollars.
Speaker 1: VHS tapes if you were buying a copy for a
Speaker 1: rental place like like a Blockbuster or something, those tended
Speaker 1: to be between sixty five and eighty dollars if you
Speaker 1: didn't have the leverage to ask for a lower amount
Speaker 1: and do sort of a royalties approach. So building out
Speaker 1: an inventory at scale was prohibitively expensive if you wanted
Speaker 1: to go with all new releases, so Netflix opted to
Speaker 1: go for deeper cut films that weren't typically listed at
Speaker 1: full price. Then they would run promotions on the website
Speaker 1: that would feature these deeper cuts and leverage those titles,
Speaker 1: and they would tie it into things like holidays or
Speaker 1: news events, or maybe it's an actor's birthday and they say,
Speaker 1: to celebrate so and so's birthday, why not rent this movie?
Speaker 1: And that helped keep the business going even when they
Speaker 1: weren't able to have all the latest new releases in stock.
Speaker 1: The programmers built out a feature that would group similar
Speaker 1: film buffs together in mentor groups through a process called
Speaker 1: collaborative filtering, and the idea was that these users with
Speaker 1: similar tastes might end up directing each other to new
Speaker 1: films that fit those shared interests. So you might say, oh,
Speaker 1: you really like, uh, you know, martial arts films, Well,
Speaker 1: have you seen Fatal Flying Guillotine here? You should check
Speaker 1: it out. Netflix has it that kind of thing. Netflix
Speaker 1: also began building out a larger inventory of foreign cinema
Speaker 1: titles speaking of Fatal Flying Guillotine, particularly Bollywood films, Chinese movies,
Speaker 1: Japanese movies. It became a place where you could get
Speaker 1: hold of this foreign cinema much more easily. And in California,
Speaker 1: where you had a lot of immigrants from countries like China, Japan, India,
Speaker 1: it was very popular, and of course that's where Netflix
Speaker 1: was based, so it ended up being a very uh
Speaker 1: lucrative or at least a very active part of Netflix's library.
Speaker 1: The one genre Randolph decided not to carry was hardcore pornography,
Speaker 1: and that was more out of a business concern than
Speaker 1: anything else. It wasn't that he was necessarily morally opposed
Speaker 1: to that content, but rather he was worried about it
Speaker 1: from a political standpoint. The complicated nature of obscenity laws
Speaker 1: in the United States meant that it would be very
Speaker 1: difficult to make sure that Netflix was complying with laws
Speaker 1: on a state by state basis, because what is permitted
Speaker 1: in one state might be against the law in another state.
Speaker 1: And when you are a company that is trying to
Speaker 1: have a uh, you know, a country wide presence, a
Speaker 1: nationwide presence, it just didn't make any sense to carry
Speaker 1: that kind of content. On the marketing side, Netflix reached
Speaker 1: out to early Internet influencers like Harry Knowles, who was
Speaker 1: the founder and still is the founder of Ain't Cool
Speaker 1: dot com or Ain't It Cool News, And in those days,
Speaker 1: Ain't It Cool was growing beyond being a niche film
Speaker 1: fans site where you know, it kind of started out
Speaker 1: as a bunch of a place where a bunch of
Speaker 1: film geeks would get together and argue about movies and
Speaker 1: read various articles about upcoming films and rumors and things
Speaker 1: like that. And at this point it was growing beyond that.
Speaker 1: It was getting attention from directors and movie studios because
Speaker 1: the industry, the film industry had seen that Knowles and
Speaker 1: his staff that we're writing for and it Cool had
Speaker 1: enormous reach, and so for a relatively modest investment on
Speaker 1: the part of the studio, those companies could get a
Speaker 1: lot of marketing benefits. It was like a lot of
Speaker 1: word of mouth marketing through this website. So just by
Speaker 1: doing a little bit of investment in the website they
Speaker 1: could get a big payoff. So Netflix followed suit and
Speaker 1: invested money in and at cool dot com, and in return,
Speaker 1: Noels and his crew would frequently mention the service. Another
Speaker 1: clever move that Netflix made early on was they negotiated
Speaker 1: with DVD manufacturers to include a coupon for a free
Speaker 1: Netflix rental with new DVD players. So if you went
Speaker 1: out you bought a DVD player back in those days,
Speaker 1: inside the box would be a little coupon that would
Speaker 1: allow you to get a free rental off Netflix. So
Speaker 1: these promotions were drawing attention, but they were also costing
Speaker 1: Netflix money. The company was losing cash on every transaction.
Speaker 1: For one thing, the labor costs were very high, and
Speaker 1: the promotions were also cutting into revenue. They also had
Speaker 1: made a pretty terrible rookie mistake, so they didn't spend
Speaker 1: the money to build out a way to handle unique
Speaker 1: coupon codes. They had no system in place to create
Speaker 1: a sequential coupon code so that each code was unique
Speaker 1: and could only be used once, so they shipped out
Speaker 1: coupons that did not have unique identifiers on them. That
Speaker 1: meant that if you were unscrupulous, you could duplicate those
Speaker 1: coupons and use coupons multiple times, because you could just
Speaker 1: keep making copies and said each coupon appeared to be legitimate.
Speaker 1: Netflix would ship out rentals each time they got a coupon,
Speaker 1: so people were essentially scaming Netflix, and Netflix was losing
Speaker 1: money in the process. In August, Randolph was able to
Speaker 1: secure six million dollars in venture capital to keep the
Speaker 1: company afloat, but that would only managed to save Netflix
Speaker 1: until the end of ninety eight. Something else was going
Speaker 1: to have to happen. The one part in Netflix's business
Speaker 1: that was doing fairly well was in DVD sales, not rentals.
Speaker 1: There weren't enough customers who would return to rent a
Speaker 1: DVD after they had used up their free rentals they
Speaker 1: go through, They'd rent a couple of top titles for free,
Speaker 1: and then they wouldn't use the service anymore. So that
Speaker 1: was not really a revenue starter, but the sales were
Speaker 1: working better. However, that was a short term win, and
Speaker 1: Randolph knew it. He knew that it was not going
Speaker 1: to be long until you saw other big companies, established
Speaker 1: companies things like Amazon dot Com get into that space
Speaker 1: ace and start selling DVDs, and the retail business would
Speaker 1: be very crowded and Netflix, being a small time player,
Speaker 1: would be unable to uh to compete in that space,
Speaker 1: so he knew that that was not a way to
Speaker 1: build the future of a business. In early Read, Hastings
Speaker 1: began to become more involved in Netflix. Remember, up to
Speaker 1: that point, he had largely been hands off. He had
Speaker 1: provided the initial seed money for the company, and he
Speaker 1: had brainstormed with Mark Randolph when they were first talking
Speaker 1: about what Netflix would be and how it would be
Speaker 1: the Amazon dot Com of video rental, but apart from that,
Speaker 1: he really hadn't beencome very involved. Not long after Read,
Speaker 1: Hastings decided he was going to get his hands dirty
Speaker 1: and Netflix. He announced that he and Randolph would become
Speaker 1: co chief executives of the company, a move that apparently
Speaker 1: didn't please Mark Randolph very much. Hastings immediately set the
Speaker 1: tone for his style at this meeting, as he then
Speaker 1: fired the brand new HR manager, Lisa Battalia Rice. He
Speaker 1: announced that he was going to bring in his own
Speaker 1: HR manager, Patty McCord. And McCord had previously worked with
Speaker 1: Hastings at Pure Atria to run the human resources department there,
Speaker 1: according to the book Netflix, which was a great resource.
Speaker 1: This may have been because McCord was seen as someone
Speaker 1: who could act as kind of a liaison between Hastings
Speaker 1: and staff, because Hastings took a very engineering approach to
Speaker 1: problems and was very blunt and could be quite critical,
Speaker 1: so she would sort of soften the edges a little bit.
Speaker 1: According to again people within the company, Randolph in Hastings
Speaker 1: were very different kinds of leaders. Mark Randolph was more
Speaker 1: empathetic and more outgoing. Read Hastings was more concerned with
Speaker 1: efficiency and performance, and if you weren't performing to expectations,
Speaker 1: you were alerted to that fact pretty quickly. Hastings was
Speaker 1: more quantitative, Randolph more qualitative. Hastings was said to have
Speaker 1: an engineering approach to pretty much any problem, including people problems,
Speaker 1: whereas Randolph was more about allowing people to explore creative
Speaker 1: approaches to challenges. And Hastings was a big hit over
Speaker 1: on the software engineering side of the business. Mark Randolf
Speaker 1: was more of a hero on the marketing and public
Speaker 1: relations and business plans side. By the end of the year,
Speaker 1: Read Hastings would assume the position of Soul CEO and
Speaker 1: bomp Mark Randolf down to president. Then a little later,
Speaker 1: Read Hastings would also take on the role of president
Speaker 1: and Mark Randolph became an executive producer. Hastings was also
Speaker 1: the chairman of the board. Mark Randolph had a position
Speaker 1: on the board that Read Hastings originally wanted to free
Speaker 1: up to UH to grant to an investor. Mark Randolph refused,
Speaker 1: said he absolutely insisted on maintaining his seat at the board,
Speaker 1: and Read Hastings relented at that point. Now, in part,
Speaker 1: Randolph kind of accepted this fate because he knew that
Speaker 1: Read Hastings was important. He knew that he needed Hastings
Speaker 1: in order to keep Netflix afloat. Because investors knew who
Speaker 1: Hastings was. Hastings had founded Pure Software. Pure Software had
Speaker 1: merged with a company called Atria, and the company Pure
Speaker 1: Atria was a huge success for investors. It got acquired
Speaker 1: for a massive deal that netted investors a huge amount
Speaker 1: of money. So Hastings was really popular with these guys.
Speaker 1: They said, this guy has made me money before, and
Speaker 1: if he says this company is worth investing in, I'm
Speaker 1: going to pay attention. So I gave Netflix a better
Speaker 1: chance at getting investment money if Hastings was the one
Speaker 1: in the spotlight. Hastings made a couple of controversial decisions
Speaker 1: in those early months, he declared that Netflix would stop
Speaker 1: selling DVDs and would have to find a way to
Speaker 1: make renting DVDs online profitable or the company would just
Speaker 1: have to close up shop. Then he reached out to
Speaker 1: Amazon dot Com and he suggested that Netflix direct customers
Speaker 1: to Amazon if they were interested in buying a film,
Speaker 1: and in return, Amazon dot Com would display ads for Netflix.
Speaker 1: So this was a deal that was struck up, and
Speaker 1: some of the folks over at Netflix, over in marketing,
Speaker 1: thought this was a colossal mistake because they thought that
Speaker 1: Netflix was effectively handing customers over to a competitor. Netflix
Speaker 1: also had early meetings with Hollywood Video and Blockbuster, the
Speaker 1: two big names in video rental VHS rental, and they
Speaker 1: were kind of feeling things out to see if either
Speaker 1: company might be interested in purchasing Netflix. Because again, one
Speaker 1: way that startups make a lot of money is not
Speaker 1: through creating a sound business plan, but by getting acquired
Speaker 1: by a larger company. Uh. Now, if those companies were
Speaker 1: at all interested in acquiring Netflix, it certainly wasn't at
Speaker 1: the price that Hastings and Randolph were willing to entertain. Uh.
Speaker 1: They were asking for a price much higher than what
Speaker 1: either company would be willing to to meet, and neither
Speaker 1: companies seemed particularly interested in any sort of collaborative efforts.
Speaker 1: Both companies turned down Netflix's offer. At the end of
Speaker 1: Netflix posted a loss of eleven million dollars and there
Speaker 1: were tons of free redual coupons still out there to
Speaker 1: do more damage to the company. So something was going
Speaker 1: to have to change. What was it? I'll tell you
Speaker 1: in a minute, but first let's take a quick break
Speaker 1: to thank our sponsor Read Hastings was able to keep
Speaker 1: Netflix going largely by getting investments from venture capitalists. Over
Speaker 1: the year and a half period, he would raise more
Speaker 1: than one hundred million dollars in investments. At the same time,
Speaker 1: he was changing the corporate culture. They company had started
Speaker 1: as sort of this chaotic creative environment with all these
Speaker 1: different people trying to figure out, how can we make
Speaker 1: a business plan that makes sense, how can we market it,
Speaker 1: how can we attract customers, how can we actually create
Speaker 1: the infrastructure that will allow it to happen. And it
Speaker 1: was uh sort of a crazy but really energetic place
Speaker 1: to work, and Hastings was changing things and buttoning things
Speaker 1: down and making it more hierarchical. Many of the founding
Speaker 1: team members for Netflix left the company in including Jim Cook,
Speaker 1: the the finance and operations director, Christina Kish left, Terse
Speaker 1: Smith left, and more. Joining the company was a guy
Speaker 1: named Tom Dylan, who took over operations from the outgoing
Speaker 1: Jim Cook. Dylan had actually worked at a company called
Speaker 1: c Gate, and he headed up an international operations division
Speaker 1: magnitudes larger than Netflix, huge h division compared to what
Speaker 1: Netflix was doing. Uh. Netflix presented a new challenge at
Speaker 1: a tiny scale in comparison, but Dylan needed to do
Speaker 1: some dramatic changes to really turn things around for the company.
Speaker 1: When he came on board, it cost Netflix six dollars
Speaker 1: to as symbol and ship and order. Now, most orders
Speaker 1: would actually include three discs at a time, so it
Speaker 1: wasn't just six dollars per disc. It was six dollars
Speaker 1: per order, but still was not an efficient system if
Speaker 1: you think like four dollars per disk, and so that's
Speaker 1: like twelve dollars per order and it costs you six
Speaker 1: dollars to send the order out. That's not great. So
Speaker 1: Dylan wanted to get the order cost down to a
Speaker 1: third of what it was. One thing he did was
Speaker 1: to change the shipping process so that each envelope would
Speaker 1: hold only one disc at a time. And that seems
Speaker 1: counterintuitive if you think, wait, if it costs six dollars
Speaker 1: to fill an envelope, but this actually cut down on costs.
Speaker 1: For one, it would let Netflix send out disks when
Speaker 1: they were available, instead of holding an order for all
Speaker 1: three discs to be ready at the same time. So
Speaker 1: if a customer is waiting on three different titles, then
Speaker 1: you can at least send one title out ahead while
Speaker 1: the other two are either coming back to Netflix or
Speaker 1: haven't yet been processed, and you can get orders in
Speaker 1: people's hands faster. Secondly, it brought the cost down on
Speaker 1: individual shipping. The individual envelopes were cheaper to send than
Speaker 1: the larger ones that would hold three disks, and he
Speaker 1: included a barcode system to help sort orders in the
Speaker 1: warehouse and increase efficiency. The next bit is particularly interesting
Speaker 1: to me. Dylan and his team discovered that people living
Speaker 1: within a one day delivery zone were far more likely
Speaker 1: to recommend the serve as to friends. So if you
Speaker 1: live someplace where you would get your order a day
Speaker 1: after you ordered it, you were more likely to be
Speaker 1: a loyal customer and to bring other people into the fold.
Speaker 1: So this helped with customer attraction and retention. And so
Speaker 1: Dylan got hold of a c D that held information
Speaker 1: about US Post Office delivery data for ZIP codes across
Speaker 1: the United States, and he headed up the creation of
Speaker 1: software that could identify the ideal locations to establish a
Speaker 1: distribution center in various regions across the US. And that way,
Speaker 1: he would say, all right, well, we see that there's
Speaker 1: a very dense population in let's say New York City.
Speaker 1: Where can we put a distribution center where we can
Speaker 1: guarantee one day delivery to as many people in that
Speaker 1: region as possible. And so they started taking all these
Speaker 1: data points and they started to look at maps, and
Speaker 1: they started to actually plan out the physical locations where
Speaker 1: distribution centers should be to be able to get one
Speaker 1: day delivery to the largest number of potential customers for
Speaker 1: any given region. Dylan also figured out that in order
Speaker 1: to support a distribution center, each center would need about
Speaker 1: fifteen thousand customers two to justify the existence of that center.
Speaker 1: So using these different points of data and this data
Speaker 1: analysis approach, they were able to point out a map
Speaker 1: and say here's where we need to build our next
Speaker 1: distribution center, and then they could guarantee one day delivery
Speaker 1: to customers in that region and build up the base
Speaker 1: of users they would need to generate regular revenue. And
Speaker 1: it's that kind of data analysis that I find really interesting.
Speaker 1: It's a very innovative approach to figuring out where to
Speaker 1: put your operations as a company. In the summer of
Speaker 1: Netflix began to experiment with a couple of different business
Speaker 1: models to get away from the per title rental approach
Speaker 1: the company had been using up to that point. So remember,
Speaker 1: up to this point, if you wanted to run a
Speaker 1: moview in Netflix, you're paying on a per title basis.
Speaker 1: It might be four dollars per title. It might be
Speaker 1: five dollars per title if you're running three movies, and
Speaker 1: that's twelve bucks or fifteen bucks, depending on you know,
Speaker 1: how how expensive each title was, and they were looking
Speaker 1: at alternatives to this approach. One of these was called
Speaker 1: the home Rental Library, So for twenty dollars per month,
Speaker 1: customers would be able to rent up to six movies
Speaker 1: at a time and keep them for as long as
Speaker 1: they wanted. There'd be no late fees, so if you
Speaker 1: kept them for three months, that's fine, and when you
Speaker 1: return them, and if you're paying the membership fee month
Speaker 1: to months, then you could get six more movies. The
Speaker 1: other approach was called serialized delivery. Now, in that version,
Speaker 1: a customer would first receive whatever the next available film
Speaker 1: is in his or her Q. I talked about the
Speaker 1: queue in the previous episode. That's the list of movies
Speaker 1: you've expressed interest in. And the more interested you are
Speaker 1: in a movie, the higher up you should put it
Speaker 1: in your queue. And so what would happen is you
Speaker 1: get a film, you'd watch your movie, you return it
Speaker 1: to Netflix. Netflix would scan the returning disk, they would
Speaker 1: register that you had returned your movie. They would look
Speaker 1: at your queue, and whatever the next available title in
Speaker 1: theory was that was on your queue, they would send
Speaker 1: that one to you next and uh. Then these both
Speaker 1: were really popular. Hastings ordered actually, that both serialized delivery
Speaker 1: and the home rental library and the new queue feature
Speaker 1: should all be tested at the same time, which drove
Speaker 1: marketing nuts because they wanted to be able to isolate
Speaker 1: these different approaches and to measure them against each other.
Speaker 1: It turned out the customers loved all three features, so
Speaker 1: Randolph decided that they should combine them into a single offering.
Speaker 1: Customers would pay a monthly subscription fee. This was an
Speaker 1: alter her native to the per title rental fee. It
Speaker 1: was not mandated originally, it was an alternative. These subscriptions
Speaker 1: would be in tears different levels that would allow customers
Speaker 1: to choose how many DVDs they could rent at a time,
Speaker 1: and each tier would cost a different amount. You know,
Speaker 1: the more movies you wanted to be able to check
Speaker 1: out at once, the higher you would pay per month.
Speaker 1: Then there would be no late fees, and upon returning titles,
Speaker 1: you would get the next available DVD from your queue
Speaker 1: that would be the next one to be sent along again.
Speaker 1: In theory, it's probably from this point that Hastings decided
Speaker 1: to go with the version of Netflix's history that was
Speaker 1: passed around as gospel for several years, and that was
Speaker 1: the version that I talked about in the last episode
Speaker 1: where he had said he got the idea for Netflix
Speaker 1: after he got a late fee for keeping Apollo thirteen
Speaker 1: from a blockbuster for too long. In reality, Netflix didn't
Speaker 1: go with this no late fee approach until it was
Speaker 1: about a year and a half old, so that was
Speaker 1: not a a key part of Netflix from day one.
Speaker 1: It was well after they had begun to do business
Speaker 1: that they adopted that philosophy. The new model that they
Speaker 1: used would debut on September. The plan would allow a
Speaker 1: customer to receive up to four titles simultaneously for the
Speaker 1: monthly subscription rate of fifteen dollars and nine cents, which
Speaker 1: I think is too low to qualify as a princely sum,
Speaker 1: but the rollout was targeted. Most visitors would not see
Speaker 1: this offer at all. They would just see the normal
Speaker 1: per title rental structure. But a few people did see
Speaker 1: the offer, and the people who saw it tended to
Speaker 1: sign up, so it's proven to be a hit. It
Speaker 1: was if a customer were presented the opportunity to use
Speaker 1: that particular model, they were more likely to do so,
Speaker 1: and so it became pretty clear that this was a
Speaker 1: solid business plan. In late September and Netflix rolled out
Speaker 1: this new plan at large, so everyone had a chance
Speaker 1: to see it and enroll in it. But they still
Speaker 1: also offered up the a la carte approach as an alternative,
Speaker 1: so they didn't get rid of that yet. But the
Speaker 1: new subscription model was much more popular, pushing the number
Speaker 1: of weekly shipments up to one hundred thousand discs per week.
Speaker 1: Now that didn't mean the company was magically profitable. In fact,
Speaker 1: it would close out nine with a twenty nine point
Speaker 1: eight million dollar loss. Good thing Hastings had gotten all
Speaker 1: that venture capital earlier in the year, they were running
Speaker 1: into new challenges, and one of those was that the
Speaker 1: subscription models were making it difficult to keep titles in stock.
Speaker 1: For one thing, Netflix was getting a lot more customers,
Speaker 1: and for another, those customers could keep movies for as
Speaker 1: long as they liked. Not everyone was watching a movie
Speaker 1: and then immediately returning it, some of them were holding
Speaker 1: onto the movies for a long time. If you talk
Speaker 1: to anyone who was a Netflix customer who rented DVDs back,
Speaker 1: you know there's still people who do, but back when
Speaker 1: that was more common, you could ask them what's the
Speaker 1: most expensive DVD you ever rented? Because if you rented
Speaker 1: a DVD and it arrives and it just sits on
Speaker 1: your table and you never watch it, you're still paying
Speaker 1: the monthly subscription fee month to month to month. There's
Speaker 1: no late fee. But if you think part of this
Speaker 1: monthly subscription is just going to the fact that I
Speaker 1: have this DVD in my possession even though I've never
Speaker 1: watched it, then those prices would rack up pretty high. Um,
Speaker 1: I want to say that Kiss Kiss Bang Bang was
Speaker 1: a really expensive one for me for a while. Anyway,
Speaker 1: that that was an issue, And because that was an issue,
Speaker 1: it meant that no one else could rent that particular
Speaker 1: copy of the movie because it was not in Netflix's hands.
Speaker 1: It was in some Yahoo's hands like myself, so that
Speaker 1: complicated matters. Meanwhile, Hollywood Video was taking an even bigger
Speaker 1: loss after supporting a competing format. There was actually a
Speaker 1: format that Netflix had entertained carrying for a short while.
Speaker 1: That format was out of circuit city. It was called
Speaker 1: Divis d I v X. The Divis format was super
Speaker 1: heavy on the d r M front, So the concept
Speaker 1: was that you could rent a movie on the Divis format.
Speaker 1: So it's essentially an optical disc, very similar to a DVD.
Speaker 1: But these discs had heavy encryption on them, so if
Speaker 1: you put them in your Davis player and you did
Speaker 1: not have authorization to watch the content, you couldn't actually
Speaker 1: see anything. So the reason the way this works is
Speaker 1: that your player would actually have to have a modem connection.
Speaker 1: It would connect back to a home computer home base
Speaker 1: computer like a server essentially, and it would check to
Speaker 1: make sure that you had that authorization, that you had
Speaker 1: paid a rental fee to watch that particular content, and
Speaker 1: if you had, it would decrypt the signal and you
Speaker 1: would actually be able to watch whatever it was you
Speaker 1: had rented. And then once your rental agreement expired, maybe
Speaker 1: it's like for three days, then you would no longer
Speaker 1: be able to decrypt that information on your player and
Speaker 1: you wouldn't be able to see it anymore. Randolph had
Speaker 1: actually decided not to support that particular format, mostly because
Speaker 1: it wasn't logistically feasible for Netflix to stuck every title
Speaker 1: in both the DVD and the DVICS format, and they
Speaker 1: had already committed to the DVD format, so they were
Speaker 1: kind of they had pushed their chips into the DVD
Speaker 1: hot but since dvis as a format essentially died, in
Speaker 1: turned out that Netflix had backed the right horse, that
Speaker 1: it was a good thing they didn't do this. Hollywood Video, however,
Speaker 1: had really gone in on DVICS and they took a
Speaker 1: huge bath when that format lost support. In January two thousand,
Speaker 1: Netflix rolled out a new feature called cent a match,
Speaker 1: and the idea was to find films that would please
Speaker 1: couples who were trying to figure out what films they
Speaker 1: should rent based on their own individual likes and dislikes.
Speaker 1: So the company had found it challenging to build out
Speaker 1: algorithms that could suggest movies to users that people actually
Speaker 1: wanted to see. They thought at first that this was
Speaker 1: going to be easy, right that you just look at
Speaker 1: somebody and you say, oh, well, they really like movies
Speaker 1: that feature horror and they like slashers, so we're going
Speaker 1: to send them, uh, the you know, Friday the Thirteenth series,
Speaker 1: and it turns out that the person doesn't like that
Speaker 1: at all. That was that was that seemed to fly
Speaker 1: in the face of the cold logic approach. Right, you
Speaker 1: like X, so you must like why because Why has
Speaker 1: stuff in it that X also has. That turned out
Speaker 1: to not be as reliable. So Cinematch was more about
Speaker 1: sorting people into like minded groups, groups of users who
Speaker 1: had rated movies in a similar way, and then looking
Speaker 1: at their various histories behind the scenes, not sharing that
Speaker 1: out in the open, but making recommendations based on that,
Speaker 1: and those seemed to be much more um successful than
Speaker 1: the algorithm based approach that had previously been in place.
Speaker 1: Cinematch also took into account the films and Netflix's inventory
Speaker 1: before making any recommendations, so it wasn't about to recommend
Speaker 1: a movie that was not in stock, because that would
Speaker 1: just become a frustrating experience. The board of directors was
Speaker 1: starting to get itchy. They wanted to move toward an
Speaker 1: initial public offering to take the company public, but at
Speaker 1: that point the company was still losing money. So read
Speaker 1: Hastings had a big decision to make. I'll explain more
Speaker 1: in a second, but first let's take another quick break
Speaker 1: to thank our sponsor. On Valentine's Day two thousand, Netflix
Speaker 1: officially ditched the alakrt rental model and went to subscription only.
Speaker 1: Hastings had argued it was the only way toward profitability.
Speaker 1: In addition, the cost of a subscription increased to nineteen
Speaker 1: dollars cents per month, so it went up by four
Speaker 1: bucks per month, with the first month of rentals being free,
Speaker 1: but customers would have to submit their credit card numbers
Speaker 1: to get that free month. That was a strategy that
Speaker 1: would help protect Netflix in the case of DVDs never
Speaker 1: getting returned, but it also made it easier to convert
Speaker 1: people into full members from trial to full members because
Speaker 1: they had already inserted their credit card information, you weren't
Speaker 1: asking them to do that after the month was over.
Speaker 1: That would have acted as another barrier to entry. So
Speaker 1: by ripping off the band aid right at the very beginning,
Speaker 1: you were more likely to keep people on as a
Speaker 1: as a subscribed member. In the spring of two thousand,
Speaker 1: Hastings hired on Leslie Kilgore to become part of the
Speaker 1: marketing department, and Mark Randolph, the co founder of Netflix,
Speaker 1: saw his role decrease yet again. Kilgore tackled redesigning the
Speaker 1: company logo and colors. She also campaigned successfully to have
Speaker 1: the marketing and public relations departments consolidated into a single entity,
Speaker 1: and Hastings would say in an executive meeting that he
Speaker 1: considered kill Gore a potential successor to the position of
Speaker 1: CEO in the future, which more than ruffled a few
Speaker 1: feathers among executives at Netflix who had hopes of one
Speaker 1: day maybe getting that position. She's the one who kind
Speaker 1: of led the way to redeveloping Netflix's logo so that
Speaker 1: it would have that red and black and white appearance,
Speaker 1: so the color read the theatrical color. That's largely due
Speaker 1: to her her leadership. Something else was going on that
Speaker 1: created an existential threat to Netflix, and that was the
Speaker 1: infamous dot com crash, when the speculative bubble that formed
Speaker 1: around the dot com industry imploded. Startups that had tons
Speaker 1: of investment money but not much to show for it
Speaker 1: apart from some flashy offices and ridiculous recruitment strategies began
Speaker 1: to fold as investor confidence would collapse around them. The
Speaker 1: stock market took a huge bump, and employees who on
Speaker 1: paper were millionaires before the dot com crash because they
Speaker 1: had received ginormous numbers of stock options, suddenly had to
Speaker 1: deal with a reality where those same stock options weren't
Speaker 1: worth the paper they were printed on. It became a
Speaker 1: point where everything when you're when you're awarded a hundred
Speaker 1: thousand stock options, but then every stock option is worth
Speaker 1: less than a penny, it suddenly is not that big
Speaker 1: of a reward. Netflix had luckily secured additional investments just
Speaker 1: before this dot com collapse, and they were doing so
Speaker 1: in anticipation of holding their own initial public offering, but
Speaker 1: they held off on that obviously because the dot com
Speaker 1: had so destabilized the market that it was not the
Speaker 1: right time to try and to clear going from a
Speaker 1: private company to a public company, but it did have
Speaker 1: enough money to get through this initial slump. It was
Speaker 1: around this time that Hastings and a couple of executives,
Speaker 1: including Mark Randolph, met with Blockbuster executives, and this was
Speaker 1: the infamous meeting during which Blockbuster had the opportunity to
Speaker 1: acquire Netflix. Netflix's asking price was somewhere in the fifty
Speaker 1: million dollar range, and that was considered way too high
Speaker 1: by the executives over a Blockbuster. They said, there's no
Speaker 1: way you haven't demonstrated that you have this value, especially
Speaker 1: in today's market where we're seeing internet companies go belly
Speaker 1: up left right. So John Antiocho, the CEO of Blockbuster
Speaker 1: at the time, said, no, Dice, you don't have the
Speaker 1: staying power. You probably won't even be in business in
Speaker 1: a year, and so Blockbuster walked away from that deal. Now,
Speaker 1: while that was a setback for Netflix, the team decided
Speaker 1: to push even harder to get to profitability. The customer
Speaker 1: retention numbers were looking promising, and Hastings said in interviews
Speaker 1: that he expected by the end of two thousand one,
Speaker 1: that Netflix would have five hundred thousand paying subscribers and
Speaker 1: that they would become cash flow positive as a result,
Speaker 1: they ended up being a little ambitious. The executive team
Speaker 1: also made some other big predictions, some of which have
Speaker 1: sort of proven to be true, but in a different
Speaker 1: way than what they had necessarily intended back in two
Speaker 1: thousand one. One of those predictions was that Netflix will
Speaker 1: become such a popular platform that independent filmmakers would use
Speaker 1: Netflix as their production studio. Essentially, they would create films
Speaker 1: meant to go straight to Netflix's service and bypass studios
Speaker 1: and movie theaters entirely, to go a different direction than
Speaker 1: what typically you would see in the industry. And you
Speaker 1: could argue that we're seeing a lot of that today,
Speaker 1: only now we're looking at it from digital delivery, you know,
Speaker 1: broadband delivery as opposed to DVDs, but the same principle
Speaker 1: seems to apply. So it was a very forward thinking prediction.
Speaker 1: The web designers. Meanwhile, we're working to identify ways to
Speaker 1: make the online experience more intuitive for new web users,
Speaker 1: because up to this point, Netflix's customer base consisted primarily
Speaker 1: of technologically savvy young men, it was not a diverse group,
Speaker 1: but more and more Americans were getting online, more people
Speaker 1: were getting computers, more people were getting Internet service providers
Speaker 1: or online service providers like a O L Online, and
Speaker 1: so the potential to reach a broader audience was there.
Speaker 1: So research was looking into ways to make the process
Speaker 1: easier for newbies to navigate the website. Meanwhile, Hastings and
Speaker 1: the executive team decided one way to make Netflix look
Speaker 1: like a legit player in the space would be to
Speaker 1: pick a fight, and so they began to compare Netflix
Speaker 1: favorably against Blockbuster, which was the big dog and home
Speaker 1: video rentals. Hastings would say that Netflix's inventory was many
Speaker 1: times larger than even the biggest Blockbuster store, saying, we
Speaker 1: have more titles in our inventory then you'll find in
Speaker 1: any Blockbuster location. Now, granted, you're looking at two different things, right,
Speaker 1: because Blockbuster as a whole, if you looked at all
Speaker 1: the different stores, had way more copies of way more
Speaker 1: titles than what Netflix had. But on an individual shop basis,
Speaker 1: if you lived in a community that had one and
Speaker 1: only one Blockbuster, you would have greater variety if you
Speaker 1: went to Netflix. That was hastings argument and the team
Speaker 1: really hammered home the idea that there were no late fees,
Speaker 1: something that was one of the chief revenue generators for Blockbuster.
Speaker 1: But it was clear that Netflix wasn't going to make
Speaker 1: the goals Hastings had originally said he wanted to hit
Speaker 1: in two thousand one. There was little chance for an
Speaker 1: I p O in that time, and to look viable
Speaker 1: in investors eyes, the company was going to need to
Speaker 1: cut costs and prove that the subscription based model was
Speaker 1: a viable one. So to do this, Hastings would cut
Speaker 1: about forty percent of the workforce at Netflix. In September
Speaker 1: two thousand one, the remaining members of the original founding
Speaker 1: team of Netflix were either laid off or they chose
Speaker 1: to quit. With the exception of Mark Randolph, the co
Speaker 1: founder of Netflix, he was the only one of that
Speaker 1: initial team who would put Netflix together to remain at
Speaker 1: the company after September two thousand one. Profitability would have
Speaker 1: to wait, because at this point Hastings was focused on
Speaker 1: getting the company lean and nimble enough to gain the
Speaker 1: confidence of investors and finally have that initial public offering.
Speaker 1: He and his executives spent late two thousand one and
Speaker 1: early two thousand two, laying the groundwork for this I
Speaker 1: p O, and they were able to hold it on
Speaker 1: May twenty three, two thousand two. Mark Randolph had resigned
Speaker 1: from the board of directors before that point, but he
Speaker 1: did remain with the company, and the fact that Netflix
Speaker 1: had survived the dot com crash when so many other
Speaker 1: companies had folded helped Netflix quite a bit. There was
Speaker 1: a message saying, we don't have the same problems as
Speaker 1: those other companies had. We are going to stick around.
Speaker 1: So the idea was a success. It raised more than
Speaker 1: eighty million dollars and shares were trading at around fifteen
Speaker 1: dollars apiece. Mitch Lowe started testing out an idea in
Speaker 1: two thousand two called Netflix Express. He and Mark Randolph
Speaker 1: landed a pilot program. They talked to a chain of
Speaker 1: grocery stores called Smith's and they got the agreement to
Speaker 1: put in a video rental kiosk in a Las Vegas
Speaker 1: grocery store. Now, unlike the vending machine style kiosks low
Speaker 1: had wanted to create, this one actually had an employee
Speaker 1: who would fill customer rental orders manually. And the test
Speaker 1: went very well. But Hastings wouldn't get on board with it.
Speaker 1: He didn't see this as being a viable business, and
Speaker 1: he had his sights set on the future of digital
Speaker 1: distribution and anticipated that such a move was going to
Speaker 1: require a substantial investment on the part of Netflix to
Speaker 1: make it possible, and that creating a new means of
Speaker 1: renting out DVDs would require an investment on the company
Speaker 1: that would take away from the money he saw as
Speaker 1: being necessary to pursue this digital download or digital rental
Speaker 1: experience in the future. So he said, that's going to
Speaker 1: be a distraction. We're not going to do it. So
Speaker 1: Mitch Lowe wouldn't end up leaving Netflix. In January two
Speaker 1: thousand three, he met with an executive from McDonald's who
Speaker 1: had previously expressed interest in a partnership with Netflix, but
Speaker 1: Hastings had nixed that idea, so this negative. A guy
Speaker 1: named Greg Kaplan had a similar vision too, low and
Speaker 1: together they ended up heading a new venture that would
Speaker 1: be called red Box. As for Mark Randolph, when that
Speaker 1: Kiosk experiment was deemed unworkable by Hastings, he bowed out
Speaker 1: he left Netflix. In fact, he and Hastings had already
Speaker 1: discussed severance conditions before the Kiosk experiment began, the message
Speaker 1: being if this doesn't work out, you should probably just
Speaker 1: pack up and leave. So in two thousand three, Mark
Speaker 1: Randolph would leave the company he had co founded. He
Speaker 1: had been the original CEO of Netflix. It was his
Speaker 1: ambition to become the Amazon dot Com of something, and
Speaker 1: while Netflix's biggest days were ahead of the company, he
Speaker 1: would no longer be a part of them. So what
Speaker 1: is Randolph up to these days? While he sits on
Speaker 1: the boards of numerous companies, he's also a frequent speaker
Speaker 1: at technology, business and leadership conferences. He acts as a
Speaker 1: mentor to entrepreneurs, so he's still doing pretty well for himself.
Speaker 1: As for Read Hastings and Netflix, their journey was just beginning.
Speaker 1: In our next episode, we'll look at the following adventures
Speaker 1: of Netflix, especially it's massive battle with Blockbuster Online. If
Speaker 1: you have any suggestions for future topics for me to
Speaker 1: cover in episodes of tech Stuff, send me an email.
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