Startup Stories, The Netflix Special Ep.1
How the most popular movie streaming service got its start
This story reads like a Blockbuster video. Imagine a scene that takes place in a classroom in the 1980s. Written on the blackboard is a problem titled Wagon Bandwidth Calculation. The problem details are faded, but you know they will be important later. Now, we zoom in on a male student. Fast forward after graduate school and that student is in the peace corps teaching math. In 1991, the math wiz founded a company that created a debugging tool for engineers. For 4 years, the company grew its revenue and was sold in 1997. At that point, it was the highest corporate acquisition in history. You see a flashback to the elusive math problem then we’re back to 1997.
The student sends himself a VHS tape in the mail to see how it would fare the journey. The tape looks like it was sent though space and didn’t survive the journey. After that, the gentlemen sent himself a new type of media, called the DVD, through the mail. It returned without a scratch. Cue the hopeful music.
In 1997, inside the tech bubble, there were whispers of a rumor involving this student making it’s way around northern California. This rumor had a riveting plot that helped it eventually engulf the entire United States. This rumor helped to topple a giant and drive the video rental business into creative destruction. Let me set the scene, if you’ll indulge me. Renting a movie from Blockbuster at that time might cost around $5, but if you returned the movie late, you were charged a penalty, usually a few more dollars. Even at that price, the late fee incensed customers. Blockbuster made them feel regulated. It was common water cooler talk to snivel about the negligible late fee you received from the video chain for returning a movie a day late or even on the same day after closing hours. But this gentleman, Reed Hastings, was charged an exorbitant $40 fee from Blockbuster video for returning the movie Apollo 13 too late. It was a good movie, but that fee was out of this world. I would have been mad too if I was him, because he had to go home and face the scorn and derisive looks from his wife. This included long stares, eye rolling, and under the breath muttering. Millions of people across America lived through that scenario. Someone would lament the lost few dollars from their last video, and another person would interject, saying, “Did you hear the one about the guy that was charged $40?” Customers already resented Blockbuster for charging the fee, but $40 levied against someone was cause for pitch forks and fire sticks.
The rumor was started by Reed, and the story is unverified. Blockbuster was the draconian antagonist, taking full advantage of their stranglehold on video rentals, until a hero emerged decrying no more late fees. But this was no movie; the hero was a company called Netflix and a real life nightmare for the customer-bullying Blockbuster video.
In 1997, DVD players were expensive, so few people had them. Because of that, Blockbuster didn’t choose to stock many DVDs in their stores, opting instead to keep a plentiful inventory of VHS tapes. Various stores didn’t stock many DVDs on their shelves because the demand was too low. This was a classic chicken and egg problem with DVD. The DVD players weren’t selling because DVD movies were hard to find, and DVD movies were hard to find because there weren’t many people with DVD players. If you were one of the passionate early adopters who purchased a DVD player anyway and rented a DVD that you wanted from blockbuster, you couldn’t keep it for long because of the despicable late fee. This meant you probably wouldn’t have had a chance to enjoy the deleted scenes, commentary, or outtakes that were exclusive to DVDs.
If the tag line, no more late fees, made it to you, and you were a serial DVD renter, you would have felt as if the protagonist of a story has just arrived to give you new hope. Netflix, at that time, was a DVD-by-mail service. You paid a flat monthly fee and received a DVD through the mail. After you were done watching your DVD, you put it in the mail and Netflix sent you the next one in your queue. That way, you were able to watch the movies you wanted at your own pace. Also, because the movies were stored in warehouses instead of stores, you had many DVDs to choose from. Netflix grew a small but passionate number of subscribers for this service. However, the new concept lost money for the next 3 years. Just like Rocky in all 6 of the eponymous movies, Netflix was on the ropes. In the year 2000, Hastings offered 49% of Netflix to Blockbuster to act as the online arm for the video Goliath. Blockbuster turned them down, betting this would be a knockout blow to the struggling startup. This short-sighted decision by Blockbuster Video would haunt them more than an episode of Stranger Things. Remember the problem from the blackboard earlier? On the blackboard was an exercise that required students to figure out how many tapes could fit in a wagon, how much data the tapes could hold, and then how fast the station wagon could get to the destination. In the 80s, it was faster to drive the data across town than to deliver it though most other means, but that was changing. The internet was becoming faster.
What would any (hopefully) good series be without another episode? In the next article, I’ll give you a front row seat into Netflix’s transition from DVD-by-mail to streaming and how the Blockbuster empire tried to strike back against Netflix’s original ideas.
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