How Netflix managed to survive for 20 years [Hint: Cannibalisation]

Reed Hastings founded Netflix in 1997 with one clearly defined goal, being “the ultimate online destination for movie enthusiasts”, Netflix is a delivery platform that helps people find their next favorite movies regardless of the platform and format whether it’s a DVD, online video, or using any other technology.

Netflix disrupted the movie rental industry 5 times during 1997 and 2007:

  1. Focusing on early technology adopters of DVD in 1998 (underserved / non-served market) when VHS was mainstream and DVD household was less than 5% and vertical integration with the cheap USPS as the delivery fulfilment service. Moreover, clearly defining the needs for the sub-segment: customers hunting for value vs. those seeking convenience & selection.
  2. Introducing a prepaid subscription model that solves one of the hardest pain points for the users, thanks to the no-late fee subscription model for DVD rentals in 1999. Further down the road the rival Blockbuster had to forgo $600M in revenue from late fees to stay in the game with Netflix.
  3. Pivoting their business model with a radical change, the unlimited rentals subscription plan, which helped them survive the dot com boom in 2000.
  4. Evolving their content acquisition capabilities through partnerships (e.g. Red Envelop Entertainment) in 2006.
  5. Pursuing another disruption cycle through early adoption and investing in Video-on-demand technology in 2007. Hastings plan was to create a separate profit centre (entity/business unit) for VOD to avoid cross contamination if he used the existing DVD rental team that manages 20 million subscribers. Hastings was willing to cannibalize his own revenues; this is a rare quality to find among entrepreneurs, the innovator dilemma as Clayton Christensen calls it.
Netflix vs Blockbuster DVD technology adoption
“First they ignore you, then they laugh at you, then they fight you, then you win” — Mahatma Gandhi

Blockbuster failed miserably to recognize the threat and disruption caused by online businesses such as Netflix to the industry of brick-and-mortar DVD rentals. They saw it as a niche market that does not have enough demand to deserve their attention. They were very slow to respond. It wasn’t until 2004 when they launched their online subscription service. However, the service was not successful because of the execution, what they did was mixing their sustainable business model and the disruptive model of online rentals, the results were a mess, BBO were giving in-store rental coupons to online customers, however the fulfilment was still done by the stores, and thus Blockbuster were never able to leverage the power of national distribution that made Netflix profitable in the first place. BBO were able to grow the user base but they burned a lot of cash as their customer acquisition costs were very high and their distribution process was far from being optimal.

Netflix started with a clean slate and they succeeded. BBO management did not make the right decision. They should have competed with Netflix by acquiring another startup in the same business that have culture and mindset of disruption, lean startup process. They probably should have acquired MovieLink to do that and let them operate as a separate company with no influence from BBO.

Netflix wasn’t always a smooth ride, though nothing ever is at a rapidly growing company. Despite the bumps, Netflix team utilized multiple growth hacking techniques that allowed them to scale their business with less cost and make it profitable.

Netflix used these growth hacking techniques:

  1. Using the cheap and effective U.S. Postal Service for delivery. Hastings actually created the first MVP back 1998 when he bought a bunch of DVDs and sent them to his own address and received them in a good shape after one day.
  2. Targeting early adopters of DVD players by adding a coupon in the box, this was an underserved market.
  3. 50% of the orders being shipped out were brand you. Netflix were able to shift the demand curve towards older releases by developing state of the art recommendation system that would personalize the experience and for each user based on their tastes from order history and ratings. Recommendations included older releases. In 2006, the new releases represented less than 30% of Netflix’s total rentals.
  4. Netflix were able to raise awareness about certain releases using their sate of the art technology and thus acted as an alternative channel for independent films that gets a lot of traction on Netflix although they did not get much success when shown in theatres. Hotel Rwanda became an all-time fourth most rented film on Netflix
  5. Lowering the acquisition costs of high-demand releases by signing reverse-economies-of-scale agreements with the distributers and thus having little up front costs.
  6. Using national inventory as opposed to having a local network of retail locations assured that there is no overstock/under-stock in each location and predicting future demand, Netflix were able to satisfy the demand in an area with one-third to one-fifth of inventory needed by a retail chain (Goodbye Blockbuster). Netflix later added 44 distribution locations across the country to guarantee one day delivery by USPS to more than 90% of the subscribers. The limited number of stores was still a manageable number compared to a retail chain with thousands of locations.
  7. Offering “Unlimited” rentals, which was actually limited to keeping a maximum of 3 movies at a time, but the name did wonders in terms of marketing and PR.

I will follow up with a second post about the history of Netflix disruption between 2007 and 2017.