In a legendary 2002 interview with Wired.com, Reed Hastings, Co-founder and CEO of Netflix, laid out the vision for Netflix that still holds true.
“”What motivates you these days?” I ask. He lifts his mouth from his cup; a trace of foam clings to his upper lip. “The dream 20 years from now,” he [Reed Hastings] says, “is to have a global entertainment distribution company that provides a unique channel for film producers and studios.” He nods toward the mermaid logo above my head. “Starbucks is a great example. Howard Schultz talks about building the brand one cup at a time. I’d love to be Howard Schultz. As Starbucks is for coffee, Netflix is for movies.” Wired, 2002
This is a milestone that Netflix reaches as early as 2013 when they have the scales to start creating Netflix Originals. Add another 5 years, and they start formulating the target of having 85% of the Netflix-aired content created by their own studios, using a budget of $8b in 2018.
Netflix launches in 1997 with their website going online in April 1998. It is one of many dot-com companies that move things onto the internet. They start with a traditional pay-per-rental model, a selection of 925 titles and 30 employees. Users rent DVDs through the website and receive (and send back) the title via mail. Initially, this happens in the nearby Valley and Bay areas (a perfect external environment), soon expanding to the entire US.
They move to their signature subscription business model from September 1999. The industry was known for dreaded late-fees that could be multiples of purchasing the title. The new value proposition was that subscribers could rent unlimited titles (with a maximum of three titles at a time) with no late fees, no postage or handling fees. A few months later, they cancel the individual rentals to fully focus on the new business model and to avoid customer confusion.
The lack of scale in the early days makes it hard to become profitable. These financial struggles make Reed Hastings offer Netflix up for purchase to the then-dominant brick-and-mortar Video rental company Blockbuster for a mere $50m. In an “epic fail” and a “lack of vision” the offer is being rejected. With the onset of the dot-com bust in 2001, things go further south and Netflix has to let go one third of their then 120 employees.
In May 2002, Netflix goes public in an IPO that by today’s standards would be considered early for a tech company (simply because more VC funds would be available today). But Netflix needs the financing sources in an environment that sees big players moving into their niche. Blockbuster, Walmart and Amazon mention their ambitions but don’t follow through until a few years later. Competition moving late (“initially they ignored us and that was much to our advantage” Netflix then-CFO about Blockbuster in 2002) the lack of focus gave Netflix valuable time to scale up and optimise their website and infrastructure.
Netflix has a value proposition to both sides of their business, customers as well as the studios. Distribution channels like Blockbuster only amplify the phenomenon of, yes, blockbusters, i.e. a few titles raking up most of revenues. Netflix on the other side helps to popularise titles that are not showered in great marketing budget, thus less known. An important piece of software called CineMatch is the pendant to Amazon’s recommendation system.
“The average video store generates 80 percent of rental activity from 200 titles. Netflix encourages subscribers to rate the movies they’ve viewed, and CineMatch recommends titles similar to those well liked — regardless of a film’s popularity at the box office. As a result, the average renter expands his or her tastes. Seventy percent of the movies Netflix customers rent are recommended to them on the site; 80 percent of rental activity comes from 2,000 titles.” Wired, 2002
The fact that the recommended titles can be rented for no additional costs (given the flat fee) makes this a credible offer rather than a see-through hard-sale.
Not only is this the beginning of a data-driven business that creates personalisation (and with that, soft switching barriers for the customer). It is also an incentive for studios and distributors to agree with Netflix to a commercial model that is conducive to early scale, the revenue-sharing model. Netlifx’s CineMatch promotes movies that are under such agreements and ignores those that are not. These important business model blocks help Netflix to scale fast.
At a time where the competition seems to be closing in, Reed Hastings outlines some of the key milestones on the way to his visions. In 2002, he lays out downloadable movies as the next key milestone:
“Today, it can cost more than $30 to send a DVD-quality film over the Internet. As that figure drops, Hastings will consider going digital. “In five to ten years, we’ll have some downloadables as well as DVDs,” he says. “By having both, we’ll offer a full service.” Wired, Dec 2002
This, once again happens earlier than anticipated. By 2005, Netflix has developed the Roku player which can download movies overnight. But Reed Hasting hasn’t anticipated streaming. While in 2005, it is not possible to stream high-fidelity movies at a speed that you could watch them fluidly, Hastings realises that streaming will be the future. The nascent success of Youtube convinces him of this. He sources the Roku player out to a separate company. A bold decision that focuses Netflix on streaming, the technology that soon succeeds.
Streaming goes live in 2007 as a complementary offer. With only 1% of DVDs titles available but free for Netflix subscribers, streaming goes online with 1,000 titles. It coincides with the time where Blockbuster launches their most successful counter offer (Total Access) in the multi-year battle among the two companies. But activist investor Carl Icahn pulls the plug on this (and gets the CEO removed) due to the costs associated with it despite its unprecedented boost to subscriber growth while bringing Netflix’s user growth to a screeching halt.
Streaming scales fast despite the fact that the competition reacts faster this time with the launch of Hulu (a joint venture of Walt Disney and Comcast-owned NBC) as well as Amazon Prime Video who remain important competitors to date. Getting their decisions and timing right, Netflix makes best use of external economies of scale first with DVD players becoming affordable and then with the expansion of broadband. This helps streaming to scale fast despite setbacks in the experimentation with pricing models and price wars. It is further accelerated by bringing Netflix onto any mass consumer electronic screen available, such as tablets, mobile phones, game consoles, set-top boxes and more.
Netflix uses streaming to further improve on their value proposition by allowing to binge-watch entire seasons of shows through the release of all episodes at once. This is a differentiating value proposition that cable, let alone broadcast TV are not willing or able to replicate. Netflix also refrains from including advertising. From 2016, they enable watching on-the-go via downloadability.
Netflix starts their international expansion from 2010: Canada, Mexico and other parts of the American continent (2010 & 11), UK, Scandinavia, Central Europe (2012-14), Oceania, Japan, Western Europe (2015) and finally the rest of the world in 2016 (with the exception of US-sanctioned countries and China).
At the same time, Netflix achieves the scale to economically produce their own shows and movies (Netflix Originals) from 2013. A vision set in the early days. Prevailing low interest rates in the aftermath of the Global Financial Crisis (2008) and Euro Debt Crisis (2011/12) help Netflix to get cheap funding to invest into creation and marketing of content. By 2018, Netflix reaches a debt level of >$20b.
Over time, Netflix becomes more confident and focussed on their own content leading to the goal of investing 85% content funds into self-created content. This may prove to be another case of great timing just one step ahead of studios and traditional distributors building their own streaming platforms and not licensing their content to Netflix anymore. Netflix Originals may further be able to generate additional revenues after initial use on their own platform through licensing out to others, including broadcast TV.
Netflix Originals are an important step toward vertical integration from a content and distribution perspective. But it does not include the internet transport layer. In a landmark 2010 ruling, the FCC Open Internet Order (also referred to as “net neutrality”) decides that “Broadband service providers cannot block or deliberately slow speeds for internet services or apps, favor some internet traffic”.
But over time, district courts and later FCC appointees roll back elements of it. Shifting net neutrality rules pose an ample threat to Netflix. This is not least seen in Netflix paying Comcast for “fast-lanes” and other incidences.
Netflix starts building further brand assets with the acquisition of Millarworld, a comic book company. Up to that point, Netflix licensed from Marvel to then create the content. Netflix will need to invest a lot funds to build and popularise the respective characters. But at least these content and marketing expenses build their own assets rather than the Walt Disney owned Marvel brand.
Since owning their own distribution channel with the advent of streaming, Netflix has been putting increasing emphasis to bolster this with exclusivity. They did not want to be just-another distribution channel. This can be seen not only in creating their own content, building their own characters but also in taking out taking exclusive licenses to enhance their appeal over that of competitors.
In line with this, they also decide no to air their best movies in cinemas ahead of publishing on their own platform. This puts them in confrontation with many incumbents and influencers in the wider industry. Lobbying efforts get Netflix Originals banned from participating in the Cannes Film Festival. This is significant in that Netflix pours considerable amounts of money into promoting their titles at the most popular Film Festivals to gain promotion and external endorsement.
Netflix is loved by users and by filmmakers alike. Netflix’s biggest achievement may be what was observed from the very early days: the ability to find segments that mass marketing can’t target, expanding tastes and preferences. Netflix may be able to serve the art of filmmaking and foster innovation by providing alternate paths around gatekeepers and incumbents.