Netflix Lesson on Focus


[Photo from Vanity Fair]

In this recent a16z podcast Marc Andreessen interviewed Reed Hastings (h/t @joekoster). Ian pointed out that in that talk Hastings said Netflix spends “a very small amount of time thinking about competition. We spend almost all the time trying to improve the service. And that’s because there’s nothing we can do about the competition.”

A little back story about Netflix brings some clarity into why Reed Hastings and Netflix thinks this way. It goes back to their battle with Blockbuster in 2005. Blockbuster attacked Netflix and Reed said, “We came up with a number of ways to counter-attack, and remember that everybody’s got every DVD, so Blockbuster and us had the same content offering, cause it’s non-exclusive licensing to get DVDs. So we could differentiate.”

Netflix’s service offering was superior to Blockbusters, fulfillment levels were 98%, and theirs was 89%. Yet Hastings and his team that thought that number was trivial to most customers. Would customers really tell if Netflix was that much better and lead to a differentiation?

Blockbuster was trying to attack by discounting massively by up to 50% of Netflix’s price. Blockbuster was winning market share and Netflix decided to try three counter-attacks that turned out to be the wrong strategy.

Hastings talked about each counter-attack:

One is in the end of '05 we added Netflix Friends, which was our own social network. Remember in '05 Facebook is just on a few universities. So our own social network amongst our members, and if you enabled each other, you could see what each other were renting and rating.

And we thought, “Wow, the viral effects of this would be really powerful,” et cetera. We added ad sales. Back in the day it was like Yahoo type banners, and we sold banners above the choosing interface.

We added used DVD sales on our site to consumers. Of course we had some excess DVDs from four years ago, so we added an operation to sell them for four bucks a pop. It’s a different logistics, but we added all that. And we added Red Envelope Entertainment, which was a group that we brought in to buy films out of Sundance and similar festivals to then publish them on DVDs, so getting into content.

So we did these four efforts. And each one was a dozen people, 15 people, and made us feel great. Employees loved them because here was a tangible thing that was not just 98% versus 89%.

Here was the thing that they couldn’t do or weren’t doing, and it was a differentiator, right? And wasn’t management so clever? We went through these waves of battles in '06 and '07, and in the end we won.

They ended up closing down their online thing, and two years later going completely bankrupt.

The real lesson was that none of those four counter-attacks made any contribution to Netflix’s victory. All of them had to be closed down.

Lesson: It’s often best to retreat to focus on doing the core better and not try to broaden the surface of attack.

Hastings said, “It was a great lesson for us on focus. So now when people say, “Aren’t you getting into news or sports?” we’re like, “Absolutely not,” and we’re really confident in our answer. Movies and T.V. shows on a global basis, enormous market. And so we’re much less subject to being prone to go off and chase the shiny object to try to have something in the checklist to differentiate, and to trust. And in hindsight if we had just gone from 98% perfect to 99.9%, we would’ve done a lot more for the business. And it’s hard work. It’s operational logistics, how to get DVDs not to break, the amount of polycarbonate analysis we had to do, it was all this stuff. We would’ve beaten Blockbuster sooner than we did. And so that’s one of the great lessons out of that time.” (emphasis added by author)

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The Greatest Barrier to Entry

Reed Hastings has proven to be a really good wartime CEO.

In 2011, Reed Hastings, founder and CEO of Netflix, made the biggest mistake of his career. He made the cardinal sin of pissing off his customer base and raising prices at the same time. The equivalent of a double barrel shotgun blast to the brand. That year Netflix decided to spin out its DVD-to-mail business into a separate company called Qwikster. Everything about it was awful. The name was awful. The reasoning was awful. It was right up there with the launch of New Coke in greatest business blunders of all time.

As thousands of negative emails poured into the company from angry customers, “I realized, if our business is about making people happy, which it is, then I had made a mistake,” Hastings said.

Reed Hastings soon came out a video apology below, of which Saturday Night Live created this comedic version.

He knew apologizing couldn’t stop the fallout but still felt it was the right thing to do. Customers started to leave. Investors started to leave (NFLX fell 70% by YE 2011). Hastings said, “The situation made me nervous and very focused.” He was reminded of the battle with Blockbuster from 2004-2008 (read here or view the post above this one), and that even though Netflix won the battle, they still made some stupid reactive decisions to Blockbuster instead of focusing on customers. Now in 2011, he had to earn customers trust back and focus on them, which meant creating great content.

Netflix pioneered “Binge Watching”. For Netflix, customers binge watching other company’s content on Netflix is good, but Netflix can create real scarcity when people binge watch original content produced by Netflix. House of Cards would debut several months later and bring in millions of new happy customers, and the rest is history.

Reed Hastings customer obsession saved the company and regenerated the trust that was lost.