Reed Hastings disrupts DVD industry only to reinvent the company a decade later

The story of how Netflix originated has varied over the years but the one we like is how Reed Hastings talks about getting a late fee of $40 in 1997 for returning a Video tape, Apollo 13), late.

Hastings co-founded Netflix with Marc Randolph who claims that the two of them wanted to start a business that was the Amazon of something and settled on DVDs. Randolph later left the company in 2002 after only 3 years.

It should be noted that Reed Hastings is known by many as a brilliant individual that not only understood the engineering difficulties associated with building an online business but had incredible leadership and management skills. Hastings previously founded Pure Software in 1991 which was a debugging tool for engineers. This company was bought by Rational Software in 1997 for $750m and gave Hastings the means to start Netflix.

The foresight of Hastings to identify the market and understand that DVD’s were the future was one of the best decisions he made at the time. This was at a time that VHS, Video Tapes, were the dominant medium across households in America and the rest of the Western world and it was almost impossible to actually buy a DVD instore.

The gamble Hastings made by deciding to build his business around DVDs at the time was massive. At the time only 2% of America households had a DVD player. They knew if the market reached 20% of households that their business would be viable. They were effectively putting their hands of their business in the market penetration of another product. A risky move that Hastings had the foresight to make the call. DVD player penetration in the USA eventually grew to 95%.

He trialled the idea of movie-rental by mail by going down to the local CD shop and buying a few CDs and posting it to himself. Hastings wanted to test if the CDs would arrive intact. They did! This gave him the confidence to roll out the first iteration of Netflix – a DVD rental business conducted purely by mail.
The first concept was to allow people to rent a video by selecting it online and having it delivered to their door. What service! It wasn’t long though before Hastings changed his model and made it a subscription based business. Hastings started the subscription model with a free trial for a month and found that over 80% renewed to become a paying subscriber! Over the early years the Netflix team was able to increase conversions even further!

From its launch in 1999, Netflix gained 239,000 subscribers in its first year and went on to build a customer base of 1 million subscribers by 2003 and had also started to turn its first profitable quarter.

Many have asked why Netflix wasn’t called something like, DVD by Mail, and again it’s because Hastings had the foresight to see that movies would eventually be streamed over the internet and not only DVD. He was one of the few that saw this change coming and in hindsight was a valuable insight into how Hastings mind worked. A quote by Hastings states:

“Movies over the internet are coming, and at some point it will become big business,” he told Inc. at the time. “We started investing 1 percent to 2 percent of revenue every year in downloading, and I think it’s tremendously exciting because it will fundamentally lower our mailing costs. We want to be ready when video-on-demand happens. That’s why the company is called Netflix, not DVD-by-Mail.”

Netflix’s biggest competitor on launch was Blockbuster, a global chain of video stores where customers could go in and rent a video. Blockbuster took years before offering a a service similar to Netflix. By the time they went hard to overtake the mail subscription service that Netflix was offering, Netflix had already been starting the process of shifting the customers to streaming subscribers and doing away with DVDs.

Netflix IPO’d in 2002, only a few years after initially launching. They did so at $15/share and issued 5.5million shares.

Wal-Mart, also launched a DVD rental business in 2002. This caused a lot of heartache for Netflix and its shareholders as they watched their share price fall to $2.50.Netflix competed hard over the next 2 years and eventually did a deal with Wal-Mart to promote each other as Wal-Mart was missing out on the profits of selling DVDs rather than just renting them.

By 2007 Netflix had started to introduce streaming content subscriptions.

8 years into the journey of building Netflix, Hastings stated:

“It’s been eight years at Netflix and I feel it’s just beginning. I have no need or desire to be acquired. We’re making money, haven’t used cash for three years, and have no problem with scale sufficiency. Being an entrepreneur is about patience and persistence, not the quick buck, and everything great is hard and takes a long time. If we can transform the movie biz by making it easier for people to discover movies they will love and for producers and directors to find the right audience through Netflix, and can transform public education through charter schools, that’s enough for me.”

While Blockbuster gave Netflix a huge fight, Netflix ultimately brought Blockbuster to its knees when they filed for Bankruptcy in 2010. The funny part about this story was that Hastings actually visited the CEO of Blockbuster in 2010 looking to create a partnership. He was laughed out the room.

Netflix’s real rise to fame came when they decided to start producing their own content. In Feb 2013 they released ‘House of Cards’ with Kevin Spacey. The show was a massive hit and people flocked to Netflix just to be able to watch the show. Since then, Netflix has focused on producing a lot of their own original content which has continued to keep people flocking to the service.

Today Netflix has well over 50million subscribers in the USA and over 104million around the world. They have an annual retention rate of 97% with their customers and their lead cost is negligible due to the widespread adoption across the world.

Today NFLX is priced at around $190/share.