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Management in Action

Reed Hastings Creates Chaos with Netflix

 

“Don’t be afraid to change the model.”

— Netflix CEO Reed Hastings

Several years ago, Reed Hastings, a California entrepreneur, incurred a $40 late fee for not returning a VHS tape to Blockbuster Home Video. “It was six weeks late,” he admits. “I had misplaced the cassette [and] I didn’t want to tell my wife. . . . I was embarrassed about it.” The next day he dropped off the VHS cassette and paid the late fee on his way to the local gym. As it turns out, his itinerary for the day was quite opportune: In the middle of his workout, he recalls, “I realized [the gym] had a much better business model. You could pay $30 or $40 a month and work out as little or as much as you wanted.”

Thus was born the idea for Netflix—paying a monthly fee for unlimited video rentals. But Hastings knew he needed to start slowly. So, when Netflix was launched in 1997, its only real innovation involved the convenience of ordering movies online and receiving and returning them by mail; Netflix merely rented movies for $4 apiece plus $2 for postage (and, yes, it charged late fees). Basically, the customer base consisted of people who wanted to watch movies without having to leave their home. But Hastings and co-founder Marc Randolph then quickly moved to test the subscription-based model, unlimited rentals by mail for a flat fee, and, perhaps more important, no due dates (and thus no late fees). Current customers were first offered the opportunity to shift from their pay-per-rental plans to subscription plans on a free, trial basis and then given the chance to renew the subscription plan on a paid basis. “We knew it wouldn’t be terrible,” says Hastings, “but we didn’t know if it would be great.” In the first month, however, 80 percent of Netflix users who’d tried the no-cost subscription plan had renewed on a paid basis.

“Having unlimited due dates and no late fees,” said Hastings back in 2003, “has worked in a powerful way and now seems obvious, but at that time, we had no idea if customers would even build and use an online queue.” The “queue,” as any long-time Netflix user will tell you, was the list of movies that the customer wanted to watch. Netflix maintained your queue, followed your online directions in keeping it up to date, and automatically sent you the next movie you wanted each time you sent one back.

The essence of queuing—and of the original Netflix business model—is clearly convenience. Today, with most users streaming content rather than using DVDs, Netflix has replaced traditional queuing with menus that keep track of what shows you have been watching and suggesting new ones related to your viewing habits. Although the ability to enhance customer convenience, even when combined with cost savings, often gives a company a competitive advantage in its industry, it doesn’t always have the industrywide effect that it has had in the case of Netflix. Not only did the Netflix subscriber model improve the service provided by the industry in an unexpected way, but ultimately it also weakened the competitive positions of companies already doing business in the industry—notably, Blockbuster. Blockbuster eventually declared bankruptcy and its few remaining assets are now owned by Dish Network. Netflix, meanwhile, has seen its market cap soar above the $151 billion mark in early 2020, with more than 61 million subscribers in 57 countries.

How had Hastings’s upstart company managed to put itself in such an enviable position? For one thing, it got off to a fast start. In 1997, when DVDs were just being test-marketed in the United States, Hastings and Randolph gambled that the new medium would eventually overtake videocassettes as the format of choice for both the home-movie industry and the home-movie renter. They were right, of course—by 2002, one in four U.S. households owned a DVD player, but the number today is more than nine in ten. (In any case, it would have cost about $4 to mail a videocassette both ways compared to the $0.78 that it costs to ship a DVD back and forth.)

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More important, as the first company to rent movies by mail, Netflix was the first to establish a rental-by-mail customer base. At first, says Hastings, “people thought the idea was crazy. But it was precisely because it was a contrarian idea that [it] enabled us to get ahead of our competitors.” As Netflix has continued to expand and nurture its subscriber base, it has also generated both brand recognition and brand loyalty. “Netflix has customer loyalty. It’s a passion brand,” explains Hastings, who hastens to add that keeping customers happy is crucial “because the more someone uses Netflix, the more likely they are to stay with us.”

Netflix also puts a premium on hiring the very best people. Hastings hires bright people, pays them above-market wages, and provides innovative and interesting benefits. For instance, Netflix employees can take as much vacation time as they want so long as they perform their jobs at a high level. But at the same time, the firm has very high-performance standards and employees sometimes complain about too much pressure. As Hastings says, “We treat our top performers very well. We provide average employees with reasonable severance package[s].”

Today Netflix continues to be at the forefront of innovation and has established a strong position in the growing video-on-demand (streaming) market. In 2013, the company obtained exclusive rights to distribute the original series The House of Cards, Hemlock Grove, Orange Is the New Black, and the revival of Arrested Development. Netflix soon began to expand its list of such original offerings as Russian Doll and Unbelievable and by 2020 was showing more original series and movies than any other media outlet. One very prominent Netflix movie, The Irishman, was nominated for several Academy Awards in 2020. All told, Netflix’s 61 million subscribers watch about 4 billion hours of programs every quarter on more than 1,000 different devices—indeed, on a normal evening, Netflix accounts for over a third of all Internet usage in North America!

Never one to stand still, Reed Hastings continues to look for the “next big thing.” Unlike most traditional managers, Hastings doesn’t have an office. He simply wanders around headquarters, talking to people about their work and their ideas and occasionally grabbing an empty chair or desk to check his e-mail. When he needs solitude to think and ponder major decisions, he retreats to a rooftop “cube” with four glass walls overlooking the Santa Cruz Mountains. And from that cube, Hastings will continue to ponder his next set of moves.*

Complete Below-

Reed Hastings Doesn’t Like Standing Still

1. You’re a Netflix employee, and Reed Hastings has just stopped by your desk. “I’d like to know,” he says, “what do you like most and least about working here?” How do you think you might respond?

2. You’re a major Netflix stockholder attending the firm’s annual board meeting. When you bump into Hastings at a reception, he asks you, “How do you think we’re doing with this company?” How would you respond?

3. You’re the founder and owner of a small media company, and Netflix has indicated an interest in buying your business. Hastings wants you to stay on and run the business as a unit of Netflix. In addition to price, what other factors (if any) are important to you?

4. You’ve been contacted by a marketing research company doing work for Netflix. The researcher asks if you use Netflix and, if not, why? If you do use Netflix, the researcher asks what you like and dislike most about it. What would you say?