Netflix: How a $40 Late Fee Revolutionized Television

The internet has completely changed the way
we watch television. Gone are the days when the whole family would
gather in the living room to enjoy the exact same program as everyone else. Technology has advanced to the point where
we’ve dumped the old immovable boxes in favor of our phones and computers. In today’s world you can watch whatever
you want, whenever you want, on-demand straight from the internet. We are now in the age of Video-on-Demand,
and so this week on Behind the Business we’ll be taking a look at the company that lies
at the heart of this recent revolution: Netflix. The year is 1991 and Reed Hastings was getting
ready to start his first company. Hastings was a rather unusual tech entrepreneur:
He came from Minnesota and after graduating from college and serving briefly in the military,
he decided to travel to Swaziland with the Peace Corps to teach math. After returning to the U.S. and getting a
masters in Computer Science, he and two of his friends started a company in 1991 called
Pure Software. The company sold a range of debugging tools
for Unix operating systems at a time when there were few good ones on the market, and
so it rapidly became a big player in the IT world. It doubled its revenue every year for 4 years
in a row and in 1996 it was sold to Rational Software for 700 million dollars. In the span of half a decade Hastings had
become a millionaire. Life seemed great, but in 1997 he suffered
an inconvenience that would eventually become a world-changer. Hastings had forgotten to return his video-rental
of Apollo 13 and as a result was slapped with a 40 dollar late-fee. He was embarrassed and didn’t want to tell
his wife, and that got him to thinking of a solution. Not just a solution to his own late-fee problem,
but a solution to everyone’s problem; an entirely new system of film-rental that would
make late-fees obsolete. Together with a friend of his, on August 29th
1997 in Scotts Valley, California, Hastings founded a brand new movie-rental service called
Netflix, with the idea of mailing DVDs to paying customers. The creation of Netflix was essentially a
bet on the DVD player. Now, the DVD player had been invented in Taiwan
in 1994 by Sony, but it wouldn’t be until March 1997 that one was first sold in the
US. Back then a player cost over a thousand dollars,
and when Netflix was formed, less than 1 percent of Americans actually owned one. In a move that seemed insane at the time,
Hastings gambled everything on the potential of DVD technology to replace the bulkier,
lower-resolution videotape as the nation’s format of choice. In 1997 it was almost impossible for people
to rent DVDs because very few places had any. After trying over 200 different mailing packages
and testing them out by mailing them to himself, Hastings discovered that he could safely ship
a DVD for the small cost of a first-class mail stamp. This way Netflix could guarantee that most
titles would be in stock, and by enclosing a stamped return mailer, they could make the
experience of film-rental as convenient as possible. Thus, on April 14, 1998, with 30 employees
and an assortment of 925 titles, Netflix opened for business. Their first offer was for a 7 day rental at
the price of 4 dollars, plus a 2 dollar shipping fee. They also introduced something that is now
one of Netflix’s proudest hallmark: smart suggestion algorithms. Once a customer had rented enough titles,
Netflix could automatically suggest new movies that were likely to interest them. Nowadays when Google and Facebook know everything
about us, it’s easy to take such algorithms for granted, but in 1997 they were practically
unheard of. Netflix started strong and just 48 hours after
opening they had to upgrade their website’s bandwidth due to excessive traffic they were
receiving. Soon Netflix signed promotional deals with
Toshiba, Hewlett-Packard and Sony, whereby they offered free rentals to people who bought
new DVD players. In July, 1999, Netflix secured a 30 million
dollar capital injections from Groupe Arnault, which allowed them to start a subscription-based
service called the Marquee Program. For just under 16 dollars per month, customers
could rent out as many DVDs as they wanted, as long as they had no more than 4 DVDs at
any given time: no late fees, no due dates; it was perfect. By that point Netflix was already receiving
10,000 DVD orders every day, but their total revenue was sitting at barely 5 million dollars. Compare this to Blockbuster’s 4.5 billion
dollar revenue and you’ll probably see why Netflix decided to try to team up with them. Blockbuster was one of the oldest video rental
companies and it was by far the largest, with 60,000 employees and 8,000 stores spread across
the US. As the popularity of Netflix grew, everyone
thought Blockbuster would soon enter the market, and with their vast resources they would’ve
probably crushed their young competitor. That is why Netflix decided to act first,
and so in the early year 2000 they invited Blockbuster to become a strategic partner
and investor. Netflix would become the Internet arm of the
Blockbuster brand, dropping the Netflix name altogether in favor of Blockbuster laughed them out of the boardroom. They were certain Netflix would crumble, as
it has yet to turn a profit three years after its creation. Instead, a few months later Blockbuster partnered
up with Enron Broadband, a division of the energy company you probably know today for
its notoriously fraudulent accounting practices. Of course at the time nobody knew that and
so investors praised Blockbuster’s decision. The situation for Netflix looked grim. They were losing money fast and by the end
of the year they reported a net loss of 57 million dollars. Despite doubts coming from all sides, Hastings
was convinced that DVD technology would prevail. The only thing that mattered to him was to
simply survive until that happened and 2001 was the year when things finally started going
his way. The price of DVD players plummeted, with some
going around for less than a hundred bucks. 2001 also saw the 9/11 terrorist attacks. Fearful Americans took refuge in their homes
and Netflix subscriptions skyrocketed. Despite growing at an unprecedented rate,
Netflix still hadn’t turned a profit, and so in 2002 they went public to keep the company
going. In 2003 they crossed the 1 million subscriber
mark and finally had their first profitable year. Just as their fortune started to turn, however,
in 2004 Blockbuster finally released their own online DVD mail service. Before long Walmart also joined the fray,
and a three way battle to undercut one another ensued. Blockbuster and Walmart, however, were a bit
late to the party. Hastings admitted that “if they had started
two years earlier, they probably would have won.” On an end of year conference call Hastings
declared: “Blockbuster has thrown everything but the kitchen sink at us.” When the CEO of Blockbuster heard that, he
promptly had a kitchen sink delivered to the Netflix office; a fairly creative way of declaring
war. As the competitors undercut one another, Netflix
saw its brief profitability evaporate and its stock fell by 75 percent. Despite losing money they kept on growing
and by 2005 Netflix was shipping 1 million DVDs every day from their assortment of over
35 thousand titles. Eventually this drawn-out battle of attrition
took its toll and in 2005 Walmart decided to quit. Blockbuster followed suit, and as the era
of brick-and-mortar video rental came to an end, so did their success. In 2008 the same CEO that had rejected Netflix
was fired and by 2010 Blockbuster had filed for bankruptcy. Netflix had emerged victorious and in 2007
it celebrated the delivery of its billionth DVD. Then, in a single announcement, Hastings began
the journey of making the very bedrock of his company obsolete. This was his end-game; the reason he had been
willing to sacrifice profits for so long and the same reason he had prophetically cited
back in the year 2000: Video-On-Demand. Netflix first started offering streaming of
on-demand videos in 2007, and initially the service was at no additional charge. At first movie rights were hard to come by,
and the videos available to stream on Netflix were … well, pretty awful. But in October 2008 they signed a deal with
premium cable outlet Starz, which brought in some huge Disney and Sony Library releases. The deal cost Netflix only $20 million dollars,
a price that they soon discovered was an absolute bargain. The reason Netflix got such a great price
was because they were the only big player in town, and pretty soon they signed deals
with Paramount, MGM and Lionsgate. Netflix were also pushing for partnerships
with other brands and before long they were featured on nearly every major entertainment
system on the planet. They buddied up with Apple, Playstation, XBox,
Nintendo Wii and a bunch of other brands. By 2010 nearly 30 percent of all North American
broadband traffic during peak hours came from Netflix. They expanded into Canada in 2010, Latin America
and the Caribbean in 2011, and Europe in 2012. 2011 turned out to be a year of huge surprises
for Netflix. In response to the ever increasing cost of
content streaming licenses, Netflix announced the production of their first piece of original
content. It would be a political drama called House
of Cards, featuring Kevin Spacey and directed by David Fincher. Netflix managed to outbid HBO by ordering
the first two seasons upfront for 100 million dollars. In October of that year, however, Netflix
made a much less successful move. They introduced a new service called Qwickster,
which, yes, is spelled with a “w”. In reality there was nothing new about Qwickster
at all; it was basically the spin-off of Netflix’s old DVD rental service. The branding was sloppy, unimaginative, and
just not thought-out, but the public’s response to Qwickster was even worse. Netflix lost 800,000 subscribers in a single
month and three months later their shares had lost two thirds their value. Unsurprisingly they shut Qwickster down the
very next month, bringing the two arms of the business back together. The first piece of Netflix original content
was Lilyhammer, which aired on February 6, 2012. It was a relative success and it paved the
way for the bigger shows that were to follow in 2013. First and foremost was House of Cards, which
first aired on February 1 and became one of Netflix’s most acclaimed titles. Airing the entire 1st season all at once was
a bold move by Netflix and it revolutionised the way people watch TV shows. Following the same format came Arrested Development
in May, and Orange is the New Black in July. Netflix continued to use suggestion algorithms
to keep people glued to their computers watching series after series, each available in its
entirety on-demand. These algorithms have become exponentially
smarter in recent years, and they can now spot gaps in the market, giving Netflix an
edge in developing new shows. At this point Netflix can create original
content based solely on what their customers want before they even know that they want
it. That strategy has worked out marvelously for
them so far and in 2013 Netflix received 14 Emmy nominations, nine of which were for House
of Cards. They continue to create original content — from
TV series to documentaries to movies, though perhaps their faith in Adam Sandler, with
whom they are releasing 4 new movies, is somewhat misplaced. By the end of 2016 Netflix will have released
600 hours of new original content for the year and they will have spent a whopping 6
billion dollars on content acquisition. This aggressive expansion is the only option
they have, with Amazon and Hulu knocking on the door with their own on-demand services
and original content. Recently Netflix integrated its service with
Comcast’s X1 platform, a deal that could bring them upwards of 4 million new subscribers. In such a competitive market, however, a single
mistake can be deadly and there are more than enough companies out there eagerly awaiting
Netflix’s next stumble. It’s still on top at the moment, but the
real question is, how long can it stay there? Hey everyone, hope you enjoyed the video! Thank you to everyone who supports us on Patreon,
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