How the Co-Founders of Netflix Killed Blockbuster

The biggest fumble in the history of the media business happened in Dallas, Texas in September of 2000.

Two desperate Silicon-valley entrepreneurs named Reed Hastings and Marc Randolph flew into Dallas for a meeting with John Antioco, the legendary CEO of Blockbuster. Hastings was an engineer who had botched several software startups. Randolph was a serial small business entrepreneur who made his name as a co-founder of MacWorld magazine in 1984. Less than three years earlier the two men had joined forces on a DVD rent-by-mail idea they called Netflix.

By September of 2000, their new venture was looking like a bust. On track to lose $50 million that year, Hastings and Randolph’s company wasn’t an entrepreneurial David hoping to defeat a corporate Goliath. Netflix was more like an entrepreneurial Faust willing to sell its soul to the devil if it could turn a profit amidst the ongoing dot com bust that year.

Pitching Blockbuster’s CEO

Pitching Blockbuster’s CEO

Blockbuster’s CEO Antioco was a long-time corporate executive, largely heralded as a genius of retail. He’d served as CEO of Circle K, which he’d led out of Chapter 11, and CEO of Taco Bell, which he’d turned around from three straight years of major losses. His gig at Blockbuster had to seem like easy street after that.

Hastings and Randolph had been finagling a meeting with Antioco for months. They knew their company had been a good idea. It was such a good idea, in fact, that Amazon had offered to buy Netflix two years earlier. Hastings and Randolph still thought they could make a go of it, so they turned down the opportunity. But now, external threats were looming larger.

People liked renting DVDs by mail, but the idea wasn’t catching on as quickly as they needed it to. Download speeds hadn’t gotten fast enough for streaming to be a viable option. So by now, the two entrepreneurs were growing sorry they’d ever said “no” to Amazon. All their hopes rested on Blockbuster, the unchallenged king of retail video, saying yes to their proposed buyout.

It hadn’t been an easy sell so far. Randolph and Hastings had only gotten the message that Antioco was willing to meet about 12 hours earlier. They’d been at Netflix’s first-ever corporate retreat, held at a rural location in California, when the invitation arrived. Antioco would meet them the next day in Dallas at 11:30 a.m. The two men put their heads together. There was no way to make the meeting with that kind of turnaround time.

A commercial flight schedule would never pull it off. Hastings suggested chartering a 5:00 a.m. flight. The company’s CFO said the idea was foolish — $20,000 wasted on an airplane when the company needed money badly? Hastings countered that $20,000 wasn’t much of a gamble when you stand to lose $50 million.

They chartered a plane. Vanna White’s plane, as it turned out. The next day, Hastings and Randoph pulled up outside the Dallas headquarters of Netflix on the dot of 11:30.

Show Me The Money

Show Me The Money

That year, Blockbuster would rake in $4.8 billion, and its corporate headquarters reflected its wealth and stature. Randolph later described it in his book “That Will Never Work” as “an unbroken cube of steel and glass.” He also said Antioco’s “loafers cost more than my car.” If Blockbuster’s executives meant to awe the two hopeful sellers, they succeeded.

Antioco’s team ushered Randolph and Hastings into a conference room with the CEO and other key members of the corporate leadership team. These executives were feeling their oats as they’d just managed to pull Blockbuster out of a slump after the company got distracted by things not critical to its mission, selling apparel, for instance. They were willing to hear out the internet-based startup guys, but no one was convinced the deal was worth taking.

Quickly, Hastings ran through each company’s strengths, then suggested the two companies join forces. Blockbuster would focus on the brick-and-mortar stores while Netflix would manage the online portion of the business. What did Blockbuster think?

The whole dot com hysteria is overblown,” Antioco said quickly.

Netflix’s business model, like that of all online businesses, would never work, explained Blockbuster general counsel Ed Stead. Still, Stead wanted to know, if a deal were on the table, what would it look like?

$50 million, Hastings said.   Antioco smirked.

 

So The Story Begins

In the great business stories, there are a few times that off-the-cuff comments have defined whole careers. The president of Western Union dissing the newfangled telephone, for instance. Or the head of 20th Century Fox proclaiming the demise of television. Or the king of IBM saying the world would never need more than five computers. But John Antioco may be the first powerful person to have his entire career story captured and distilled in a single smirk.

Indeed, it’s the only thing most people know about John Antioco — he was the big CEO who turned down Netflix and paid dearly for his shortsightedness. (In fact, Antioco might have pulled Blockbuster’s fat from the fire if his board and executive team had been willing to go along with his own innovative ideas, but they weren’t.)

Just seven years after that infamous meeting in Dallas, the expensive loafers were on the other foot. Antioco was meeting with Netflix, hoping against hope that the once-sinking internet media retailer could bail out a now-flailing Blockbuster. It didn’t happen, and today, Blockbuster exists only as a single store in Bend, Oregon, mostly dedicated to keeping alive the ambiance of a bygone era. Netflix, on the other hand, boasts 148 million paid subscriptions worldwide along with more than 5,000 employees and revenue of $15.794 billion a year.

How did the co-founders of Netflix build a media giant capable of bringing down Blockbuster?

 

It Started With A Fine (or did it?)

A popular story says that Netflix founder Reed Hastings got the idea for his company after being forced to pay a $40 fine when he tried to return Apollo 13 to Blockbuster. It turns out that story is more legend than truth, but it reveals why people liked Netflix more than Blockbuster from the beginning.

Blockbuster made $800 million, about 16% of its revenue in late fees. Customers who rented a video but forgot to take it back, got waylaid by another responsibility, or mislaid the movie would get slapped with a late fee. In many cases, stores forced customers to pay late fees on videos that weren’t late because the system “malfunctioned.” For some customers, going to Blockbuster felt more like preparing for punishment than it did browsing for some light entertainment.

Hastings and Randolph understood something fundamental about customer psychology that Blockbuster did not — nobody wants to do business with someone who is penalizing them. As soon as they have an alternative, they’ll take it. Consequently, Netflix created a subscription model. Instead of charging rent for videos, the new company offered them for a subscription fee. Pay a single amount of money each month, order whatever DVD you like, and keep it or send it back and ask for another one.

Nobody got penalized if a DVD got stuck under a stack of mail for a week. Turns out that customers liked and rewarded grace more than they liked and rewarded inflexible rules and stiff fines.

Navigating the Transitions

Navigating the Transitions

DVDs only entered this world in 1997. Before that, people rented movies on VHS tapes or Betamax tapes and watched them at home. As soon as the flat, easy-to-mail DVDs came out, however, Hastings and Randolph saw an opportunity. Amazon was shipping books through the mail, so why couldn’t they ship a DVD? To see if the disc would travel through USPS undamaged, they mailed a copy of a DVD to Hasting’s house. Sure enough, it arrived in pristine condition.

The two entrepreneurs knew they were on to something. Together, they launched the world’s first online DVD rental store. It had 30 employees and 925 titles for customers to choose from.

Initially, the idea was a success. Plucking a video out of the mailbox was certainly less time consuming than going to Blockbuster. Overall, though, Hastings and Randolph knew they would need more than a single rental approach if they were to keep up with the digital revolution that was brewing.

And they had a hunch that their return policy and rental fees, all based on Blockbuster’s time-tested approach, weren’t going to work for the long term. After 18 months, Netflix introduced the monthly subscription model. Six months later, they dropped the single-rent option altogether.

Taking The Idea Online

Taking The Idea Online

The dot com bust of 2000 nearly took the company under. After Blockbuster declined the opportunity to buy them out, Hastings and Randolph thought they might be finished. But in late 2001, DVDs really took off in popularity with players being the number one Christmas gift that year. Early adopters loved the Netflix model and raved about it to their friends. Netflix went public in 2002, and by 2005, it was shipping out one million DVDs a day.

Hastings and Randolph didn’t just innovate in the product and customer experience arenas. They also changed the way corporate America ran its offices. From the beginning, Netflix employees had no set hours and no vacation allotments. To this day, Netflix abides by five values in what it calls its “unusual employee culture:

  • encourage independent decision-making by employees
  •  

  • share information openly, broadly, and deliberately
  •  

  • are extraordinarily candid with each other
  •  

  • keep only our highly effective people
  •  

  • avoid rules
  •  

    Today, Netflix’s culture is a model for up-and-coming entrepreneurs. But in its early days, when white shirts and formal handbooks dominated the office, Netflix was a true oddity even by Silicon Valley standards. Keeping up with the wave of the future means more than putting out new technology. It also means understanding where the larger culture is moving and helping to lead that.

     

    Entering the World of Original Storytelling

    Randolph resigned from the company in 2003. He and Reed Hastings agreed that he functioned best at the early stage of a startup. Today, Randolph runs a corporate consulting agency from his ranch in California. He still owns some shares, mainly, he says, for sentimental reasons, and he pays a subscription to watch the service.

    Hastings, meanwhile, continues his role as CEO and chairman of Netflix. Under his leadership, in 2007, Netflix began experimenting with making its own original content. Since then, the company has created fantastic and popular shows such as The Crown, Stranger Things, and Orange Is the New Black. Hastings believes the future lies in Internet television, and the success of both his company and its original shows suggests he knows what he’s talking about.

    Randolph and Hastings didn’t build one of the few truly disruptive companies on a single idea alone, nor did Blockbuster fail for just one reason. Netflix succeeded due to its robust and attractive corporate culture, its understanding of the times, its sensitivity to customer interests, and its ability to create legendary entertainment. Blockbuster lost market share when it failed to innovate, insisted on sticking with an old revenue model, and failed to appreciate the power of e-commerce.

    The Netflix story offers many lessons in entrepreneurship, business, career development, and good old-fashioned gutsiness. But it also shows just how complex entrepreneurship can be. In the 19 years since Hastings and Randolph chartered Vanna White’s plane for their ill-fated trip to Dallas, Netflix has proven its genius over and over again, navigating the difficulties it has faced with intelligence and bravado.

    In fact, the Netflix story is so good, it’s almost worth turning into an original movie. And there’s just one company that could make it a blockbuster.

     
     

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    How the Co-Founders of Netflix Killed Blockbuster