Netflixed Read online

  PORTFOLIO / PENGUIN

  NETFLIXED

  Gina Keating is a freelance business journalist. She previously covered media companies, law, and government as a staff writer for Reuters and United Press International for more than a decade. Her articles have been reprinted in newspapers around the world, and her freelance work has appeared in Variety, Colloquy, Du Jour, Southern Living, and Forbes. She lives in Texas. This is her first book.

  PORTFOLIO / PENGUIN

  Published by the Penguin Group

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  Penguin Books Ltd, Registered Offices: 80 Strand, London WC2R 0RL, England

  First published in 2012 by Portfolio / Penguin, a member of Penguin Group (USA) Inc.

  Copyright © Gina Keating, 2012

  All rights reserved

  LIBRARY OF CONGRESS CATALOGING IN PUBLICATION DATA

  Keating, Gina.

  Netflixed : the epic battle for America’s eyeballs / Gina Keating.

  p. cm.

  Includes bibliographical references and index.

  ISBN 978-1-101-60143-3

  1. Netflix (Firm) 2. Video rental services—United States. 3. Video recordings industry— United States. 4. Internet videos—United States. I. Title.

  HD9697.V544N484 2012

  384'.84—dc23

  2012027444

  No part of this book may be reproduced, scanned, or distributed in any printed or electronic form without permission. Please do not participate in or encourage piracy of copyrighted materials in violation of the author’s rights. Purchase only authorized editions.

  To the people of Netflix and Blockbuster for letting me into their story

  and

  To John A. Sopuch III and Margaret Romero for holding me up

  CAST OF CHARACTERS

  NETFLIX (ALPHABETICAL)

  Lisa ­Battaglia-­ReissHuman Resources manager

  Jessie BeckerMarketing, vice president

  James BennettRecommendation System, vice president

  Corey BridgesMarketing, Customer Acquisition

  Jim CookFinance/Operations, director

  Deborah CrawfordInvestor Relations, vice president

  Chris DarnerProduct Management, director

  Shernaz DaverPublic relations consultant

  Tom DillonChief operating officer

  Boris DroutmanWeb Engineering, manager

  Vita DroutmanSenior Systems, architect

  Jonathan FriedlandCorporate Communications, vice president

  Reed HastingsCofounder/chairman and chief executive

  Jay HoagBoard member/investor

  Neil HuntChief technology officer

  Leslie KilgoreChief marketing officer

  Paul KirincichFinancial Planning and Analysis, vice president

  Christina KishMerchandising, director

  Kirby KishBusiness Development, director

  Stan LanningCinematch, developer

  Mitch LoweBusiness Development and Strategic

  Alliances, vice president;

  Redbox, president

  Barry McCarthyChief financial officer

  Patty McCordChief talent officer

  Eric MeyerChief information officer

  Joel MierResearch and Analysis, director

  Marc RandolphCofounder/chief executive

  Andy RendichChief service and operations officer

  Ken RossCorporate Communications, vice president

  Ted SarandosChief content officer

  Therese “Te” SmithCorporate Communications, director

  Steve SwaseyCorporate Communications, director

  David WellsChief financial officer

  Erich ZieglerMarketing, director

  BLOCKBUSTER (ALPHABETICAL)

  John AntiocoChairman/chief executive

  Bryan BevinU.S. Store Operations, senior vice president

  Edward BleierBoard member

  Sam BloomBusiness Development, vice president

  Aaron ColemanBlockbuster Online, chief technology officer

  Ben CooperBlockbuster Online, director of marketing acquisition and business development

  J. W. CraftBlockbuster Online, vice president of strategic planning

  Rick EllisBlockbuster Online, operations consultant

  Shane EvangelistBlockbuster Online, senior vice president and general manager

  Gary FernandesBoard member

  Bill FieldsChairman/chief executive before Antioco

  Sarah GustafsonBlockbuster Online, senior director, customer analytics

  Jules HaimovitzBoard member

  Lillian HesselBlockbuster Online, vice president, customer marketing

  Jim KeyesChairman/chief executive

  Karen RaskopfCorporate Communications, senior

  vice president,

  Nick ShepherdChief operating officer

  Michael SiftarBlockbuster Online, director, applications development

  Nigel TravisPresident

  Strauss ZelnickBoard member

  Larry ZineChief financial officer

  COSTARS (ALPHABETICAL)

  Robert BellAT&T Laboratory, Statistics Division, researcher

  Jeff BezosAmazon.com founder/chief executive

  Martin ChabbertNetflix Prize winner, ­French-­Canadian programmer

  Tom DooleyViacom, senior vice president

  Roger EnricoPepsiCo, chairman

  John FlemingWalmart, chief executive

  Brett IcahnCarl Icahn’s son

  Carl IcahnBlockbuster investor/board member

  Michael JahrerNetflix Prize winner, Big Chaos team, machine learning researcher

  Mike KaltschneeHackingNetflix, founder/blogger

  Gregg KaplanRedbox, chief executive

  Mel KarmazinViacom, chief operating officer

  Yehuda KorenNetflix Prize winner, AT&T Laboratory, scientist

  Warren LieberfarbWarner Home Video, president

  Joe MalugenMovie Gallery, chairman/chief executive

  Dave NovakYum! Brands, chairman/chief executive

  Michael PachterWedbush Morgan, analyst

  Martin PiotteNetflix Prize winner, ­French-­Canadian programmer

  Sumner RedstoneViacom, chairman

  Stuart SkormanReel.com, founder/chief executive

  Andreas ToscherNetflix Prize winner, Big Chaos team,

  machine learning researcher

  Chris VolinskyNetflix Prize winner, AT&T Laboratory, Statistics Division, executive director

  Mark WattlesH
ollywood Video, founder/ chief executive

  CONTENTS

  About the Author

  Title Page

  Copyright

  Dedication

  CAST OF CHARACTERS

  PROLOGUE

  CHAPTER ONE

  A SHOT IN THE DARK

  (1997–1998)

  CHAPTER TWO

  THE GOOD, THE BAD, AND THE UGLY

  (1998–1999)

  CHAPTER THREE

  THE GOLD RUSH

  (1999–2000)

  CHAPTER FOUR

  WAR OF THE WORLDS

  (2001–2003)

  CHAPTER FIVE

  THE PROFESSIONAL

  (2003–2004)

  CHAPTER SIX

  SOME LIKE IT HOT

  (2004–2005)

  CHAPTER SEVEN

  WALL STREET

  (2004–2005)

  CHAPTER EIGHT

  KICK ASS

  (2004–2005)

  CHAPTER NINE

  THE BEST YEARS OF OUR LIVES

  (2005–2006)

  CHAPTER TEN

  THE EMPIRE STRIKES BACK

  (2006–2007)

  CHAPTER ELEVEN

  THE INCREDIBLES

  (2006–2009)

  CHAPTER TWELVE

  HIGH NOON

  (2007–2008)

  CHAPTER THIRTEEN

  THE GREAT ESCAPE

  (2007–2009)

  CHAPTER FOURTEEN

  TRUE GRIT

  (2009–2010)

  CHAPTER FIFTEEN

  CINEMA PARADISO

  (2011)

  EPILOGUE

  AFTERWORD

  ACKNOWLEDGMENTS

  A NOTE ON SOURCES

  BIBLIOGRAPHY

  INDEX

  PROLOGUE

  IT IS EARLY MORNING ON a workday in the spring of 1997. A dusty maroon Volvo station wagon pulls into a commuter parking lot in Scotts Valley, California, in the foothills of the Santa Cruz Mountains.

  The dot-com bubble is on the rise and the parking lot is lousy with twenty-something computer geeks, male and female, gathering in carpools to take them “over the hill” to Silicon Valley.

  They carry canvas cases with logos: Apple Computer, Sun Microsystems, Oracle Corp., and other hot technology companies. Most wear the Valley uniform of board shorts or Levis with a wrinkled T-shirt, a fleece jacket, and some form of Teva footwear. Several have “bed head” from not showering and a dazed look from long-term lack of sleep.

  The Volvo pulls toward a space on the deserted far side of the lot, where a shining steel blue Toyota Avalon is the lone occupant. The Toyota driver sits in the driver’s seat, door wide open. At the sight of the Volvo, the Toyota driver jumps out of his car.

  He is Reed Hastings, a tall lean man in his midthirties, wearing pressed Levis, a white T-shirt under a worn corduroy button-down shirt, brilliant-white running shoes, and black socks. He has close-cropped brown hair, a neat goatee, intense blue eyes, and a perpetually guarded expression. His normal posture, slightly forward and a bit hunched in the shoulders, reflects years of staring at computer monitors in pursuit of “beautiful” mathematical algorithms to define all manner of natural and man-made phenomena.

  Hastings paces impatiently, his hands jammed into the pockets of his jeans, as he watches the Volvo approach, park off-kilter, then vaguely repark.

  Finally satisfied, the driver of the Volvo, Marc Randolph, gets out, stands up, and greets Hastings over the roof of the Volvo.

  Randolph, in his late thirties, is as happy-go-lucky as Hastings—who is his boss at a soaring software company—is intense. Loose-limbed and lanky, with thinning dark hair, Randolph has engaging brown eyes, a bemused, wide mouth, and an easy laugh. Randolph is Hastings’s mirror opposite, a “people person,” exactly the guy you want to be your marketing manager when you are not.

  Despite their differences, there is an obvious ease, trust, and camaraderie between them: They share that confidence conferred by privileged upbringings and a passion for spinning ideas into businesses.

  Randolph, clad in a fleece jacket, T-shirt, torn jeans, and flip-flops, circles the car and stands next to Hastings.

  “It came,” Hastings tells him.

  Hastings reaches into the Avalon, digs an oversized rose-colored greeting card envelope out of a Pure Atria briefcase on the passenger’s seat, and holds it up. Randolph swallows hard, and nods for Hastings to go ahead and open it.

  Hastings takes an antique monogrammed silver penknife from his shirt pocket and slits open the envelope. He pulls a silver compact disk out of the envelope and turns the disk in his hand, minutely inspecting it. It is in perfect condition.

  “It’s fine,” Hastings says flatly.

  A huge smile spreads across Randolph’s face.

  “Huh. This online movie rental thing might actually work,” Randolph says.

  • • •

  LIKE ALL GOOD stories, the one about the founding of Netflix Inc., the world’s largest online movie rental company, mixes a little bit of fact with some entertaining fiction. But the version above is closer to reality than the company’s official story—the one about how tech millionaire Reed Hastings had an epiphany for his next company after returning an overdue movie to his local video store, and later dreamed up its signature subscription model on a treadmill at his gym.

  “The genesis of Netflix came in 1997, when I got this late fee, about $40, for Apollo 13. I remember the fee, because I was embarrassed about it. That was back in the VHS days, and it got me thinking that there’s a big market out there,” Hastings, Netflix’s chairman and chief executive, told Fortune in 2009, one year before the magazine named him its Business Person of the Year.

  “I didn’t know about DVDs, and then a friend of mine told me they were coming. I ran out to Tower Records in Santa Cruz, California, and mailed CDs to myself, just a disk in an envelope. It was a long twenty-four hours until the mail arrived back at my house, and I ripped them open and they were all in great shape. That was the big excitement point.”

  As a financial journalist, I heard that story a lot in the seven years I covered Netflix along with a handful of other U.S. entertainment companies and their executives. I never gave Hastings’s story much thought back then. It was simple and straightforward and conveyed perfectly what Netflix was all about: DVD rentals by mail that you can keep as long as you want without paying late fees.

  The odds against Netflix surviving were long when I took over the Los Angeles entertainment industry beat at Reuters in spring 2004. Blockbuster, the world’s largest movie rental chain, was preparing to launch its own online rental service, and online bookseller Amazon was lurking on the sidelines, posting employment ads for software developers for a yet to be announced movie rental service. Retail behemoth Walmart Stores was making a halfhearted stab at protecting its enormous DVD store sales by offering online DVD rental, and Hollywood movie studios were belatedly forming joint ventures to test movie downloading. Netflix had just hit 1.9 million subscribers and was still showing losses as often as it booked profits.

  In the ensuing years I watched Hastings and his underdog company claim an ever-larger share of the growing online rental market with gutsy moves that defied Wall Street predictions about the size of the market and the strength of his larger rivals.

  I saw a gifted and disciplined team change the way people rent movies, not for the money, but for the challenge of disrupting a “real world” industry and taking it online. In the pursuit of elegant software and intuitive user interfaces, they created a tastemaker to rival Apple, an innovator on the order of Google, and a brand power equal to Starbucks. Netflix also became a story about how powerful algorithms perfect
ed in a Netflix-sponsored science contest spawned technological breakthroughs that influence how anyone with a product or idea to sell rounds up likely buyers. By 2010, with a long-delayed international expansion underway, Netflix had changed how half the world watches movies.

  I thought I had the story down cold when in 2010 I began to research and write a book about Netflix’s rise from a start-up with no clear path to profitability to a $4 billion movie rental titan with a stake in everything from postage rates to Hollywood movie deals to federal rules on privacy, broadband use, and Web traffic.

  I knew I would need good outside sources to solve a few mysteries about the company’s early days, because Netflix’s communications and marketing teams were excellent at staying on message with reporters and investors—and especially with consumers—on issues the company wished either to control or to avoid talking about.

  Some of the questions for which I could not get answers from Netflix included: What happened to Netflix’s other founder, Marc Randolph, and why is he never mentioned? Why was the Apollo 13 founding story initially set at a Blockbuster store in Santa Cruz, then changed in 2006 to a now defunct mom-and-pop video store in La Honda? Why did founding team member Mitch Lowe leave to start his DVD rental kiosk company Redbox, now one of Netflix’s main competitors, instead of launching it at Netflix?

  At first these seemed like minor details that had little bearing on the story that I knew so well and had watched unfold from a front-row seat in the financial press. But answering one question only led to another, and soon I was down a rabbit hole that changed everything I thought I knew about Netflix.

  What I found was much richer and more nuanced than the official story. The complete history of Netflix comprises a long and untidy striving for greatness with multiple disasters, lucky breaks, betrayal, and heartbreak.

  The company does not gratuitously mislead the public. The official story is simply more elegant and useful, and everything at Netflix, from its 2,180 corporate employees (who turn over at an annual rate of 20 percent) to the scripts followed by its executives on quarterly conference calls, must serve the company’s goals or be eliminated.

  After all, discipline and focus account for how a tiny, broke Silicon Valley company slew three giants of the $8 billion movie rental world (the Blockbuster, Movie Gallery, and Hollywood Video chains), warded off Amazon, and forced movie studios into the digital age. Netflix is now employing the same tactics to undermine cable and satellite providers, but in an outwardly nonthreatening way, the better to sneak into these new markets and disrupt the competition.