Moviegoers once devoted substantial chunks of their Friday evenings to perusing the aisles of video stores. You’d go in with one movie in mind, but the latest releases had been picked over. Still, you leave with two or three—and Twizzlers and microwave popcorn—because why not? You went all the way there and had the weekend to watch.
That was before April 14, 1998, when a small startup in Scotts Valley, California, launched a website called Netflix.com. Instead of physically going to the video store, you could browse the virtual aisles on Netflix, rent a movie for a few bucks apiece plus shipping through its e-commerce platform, and, within two to three business days, a red envelope with a DVD would arrive in your mailbox. After seven days, return it via the mail in the same packaging.
This may sound archaic now, but most people didn’t even have DVD players 20 years ago. The format was adopted by major manufacturers like Philips and Sony in the mid 1990s. The ubiquitous VHS tape, however, was tougher and costlier to mail safely. Co-founders Reed Hastings and Marc Randolph tested the durability of the burgeoning disc format by mailing a CD in a blue greeting-card envelope to Hastings’ home when Netflix was still a seed of an idea.
The 30 or so employees that were with Netflix when it debuted never expected the server to crash on day one from traffic overload, Gina Keating wrote in her book, Netflixed: The Battle for America’s Eyeballs.
By fusing Silicon Valley technology with nearly every aspect of Hollywood, Netflix became the world’s TV service and video store. It has more than 117 million subscribers across nearly every country in the world, and employs more than 5,500 people now. It generated more then $11 billion in revenue in 2017, and is worth around $135 billion, more than most of its major media rivals.
Ironically, it did all that by revamping the business model it first killed—the video store.
Netflix, the video store
For much of movie history, a film played in cinemas and then disappeared from public view. The most popular movies like E.T. Extraterrestrial stayed in theaters for more than a year, were re-released in cinemas, or aired on TV. It wasn’t until video stores took off in the 1980s and 1990s that audiences could experience those movies again at home. It created a market for old releases.
Netflix did the same when it burst onto the scene in 1998, reportedly with about $2 million in startup cash from Hastings, who sold his first company, Pure Software, and additional funds from Randolph’s parents and Integrity QA founder Steve Kahn. It launched with less than 1,000 titles. The most notable were the 1997 releases L.A. Confidential and Boogie Nights, which then-buyer Mitch Lowe said he convinced a friend at Warner Bros. to sell him 230 copies of each. Netflix would need a lot more than that to reach critical mass, but it was a start.
In the years to come, it loaded its library with all the titles it could, buying TV repeats and old movies from classics, to indies and documentaries. New releases were the hardest to come by, as studios held back movies from Netflix to maximize the revenue that came from releasing a film in theaters. Hollywood sustains itself by making sure the people who want to watch a title the most have to pay the most. The others have to wait, as Ben Fritz described in his book, The Big Picture: The Fight for the Future of Movies. Movies hit cinemas first, then home video, and, later, TV and subscription streaming.
Even without the latest releases, studio and network executives started to notice that the platform was eating up more and more of viewers’ time after Netflix launched on-demand streaming video in 2007.
Not only was Netflix acquiring more content to rent and stream, it was getting really good at putting the right titles in front of the right people so they spent more time on the service. Like a helpful video-store clerk, it recommended titles viewers might like based on others they’d seen. Todd Yellin, Netflix’s vice president of product, had the idea to break each title down with tags like “dark,” “cerebral,” or “irreverent,” that captured the nuance of genre, tone, or character. That created tens of thousands of microgenres with combinations of tags, and fueled Netflix’s algorithms.
“Netflix’s great breakthrough was that there are many, many more components of a film than genre, actor, director, time period that go into why you might like or be interested in seeing a film,” said Lowe, the former Netflix executive and current CEO of MoviePass. “I have some weird quirk where a film that’s filmed in the winter, no matter what it is, for some reason I want to see it. Those are the nuances that Netflix understands.”
The recommendations got better the more people used the service, because they were personalized to each user based on their viewing habits and the habits of viewers like them. Netflix now says that 80% of shows watched on the platform are driven by its recommendations, as opposed to someone searching for a particular show and watching it.
As Netflix’s subscriber base passed 20 million (pdf) in 2010, the Hollywood studios that had been happy to rent titles through the fledgling service worried about the competition it had introduced.
Blockbuster, the nation’s largest video-store chain, filed for bankruptcy that same year. (Only a few remain today.) New subscription streaming services like Hulu and Amazon Prime were cropping up, inspired by the Netflix model. With DVRs and on-demand video, more people were watching TV on their own time, sending TV ratings into a downward spiral. People were ditching cable for cheaper, on-demand offerings. And US cinema attendance was slipping (pdf).
Netflix, the studio
Premium TV-network Starz, an HBO competitor, ended its streaming deal with Netflix in 2011 to keep from cannibalizing its own revenue. Sensing the changing tide, Netflix licensed its first “original” series, House of Cards, that year. It was in a unique position because, unlike movie and TV studios that required mass appeal to fill cinemas and sell advertising, Netflix needed consistent, fresh, and wide-reaching content to keep subscribers coming back month after month. Box office takes and ratings didn’t matter. It was also expanding around the world in places like Canada, and Brazil, other parts of Latin America, and Europe, and needed the rights to programming globally.
In the golden age of TV, series offered Netflix the most bang for its buck at first. But no matter how many TV shows Netflix released, it found that movies were consistently one-third of viewing on the platform.
It debuted its first film, Beasts of No Nation, in 2015 on the streaming service with a limited theatrical release to qualify for awards. It was borrowing another strategy from the video-store era: the straight-to-video release, in which movies were released first on video tape, and only got a run in theaters if there was enough interest. Usually, movies played in theaters for at least 90 days before being released on home video. But niche and budget movies could profit without ever hitting cinemas if enough copies were sold to video stores and rented to customers, who often choose two to three movies at a time based on their VHS covers, the descriptions on the back of the box, and the talent featured. Some movies were commissioned strictly to fill shelves at video stores.
The model worked for Netflix, too. One of its first big film deals was with Adam Sandler, whose recent movies like Blended and That’s My Boy bombed in US theaters. But people still watched his stuff on Netflix. The company locked him into a four-picture deal in 2014. His Netflix movies, though panned by critics, went on to become some of the most watched on the service.
Netflix shopped the festival circuit, boosted the market for indie films like Okja and Mudbound, and as revenue grew, invested in higher-profile projects, like the Brad Pitt-starring War Machine and David Ayer’s Bright. The 2017 fantasy cop thriller with Will Smith in the lead had a blockbuster budget of $90 million, but was too offbeat to land a major studio. It was the perfect straight-to-Netflix release. The threshold for clicking on a movie that was part of a subscription with a big action star and notable director in the billing was much lower than convincing someone to go the theater and pay $9, on average, to watch it.
Risk-averse Hollywood, meanwhile, was leaning on tentpole superhero movies, sequels, and reboots to fill cinema seats. Netflix developed a reputation as a studio where filmmakers could still take shots, because customers were willing to as well.
“The ability to take chances on small, obscure, oddball films by simply clicking on them … this was huge,” said filmmakers Mark and Jay Duplass, who have a deal with Netflix, in an email to Quartz. “Maybe a 14-year-old kid in the suburbs wouldn’t have spent $3 renting The Puffy Chair from Blockbuster, but clicking on it “for free” on Netflix garnered us a slew of viewers that wasn’t likely to come our way in the traditional movie rental model. … If we had to fight our way through the standard development process of the studio system we would either be retired or dead by now. Sincerely.”
Netflix has $8 billion earmarked for content this year, and analysts expect that budget to continue growing at a steady clip. The web-video giant is developing more programming to appeal to its increasingly global audience. More than half of Netflix subscribers are now overseas.
It’s also snapping up the rights to intellectual property to hedge against studios like Disney pulling licensing from the platform. It acquired its own mini-Marvel in the form of comic-book publisher Millarworld, and signed mega-deals with TV hitmakers like Ryan Murphy and Shonda Rhimes in the last year. It’s spending more on marketing to push Netflix originals to people outside the platform. It plans to spend $2 billion this year (pdf), up from around $1.3 billion last year. And it’s reportedly eyeing a billboard company with real estate on Los Angeles’s famed Sunset Strip to cut down on costs. If Netflix’s reported $300 million bid is accepted, the acquisition would be the company’s second and largest ever.
Netflix, the disrupted?
Much of Netflix’s story thus far has been a saga of disruption. It played the David to Blockbuster’s Goliath, and drove the largest US video-store chain, and most others, out of business. It challenged cable companies with its library of TV shows and movies on-demand that could be streamed for a low, flat monthly fee. It commissioned its own programming, pitting itself against TV channels and premium networks like HBO that would launch streaming services of their own. It rivaled cinemas by sending movies straight to streaming, and releasing more movies this year than most major studios. And it’s using technology to make those big-budget productions more efficient.
That’s what’s driven the stock, which began trading publicly in 2002, up more than 1,100% over the last five years, making it one of the US’s fastest growing tech stocks.
As Netflix matures as a technology company, a TV service, and a Hollywood studio (the Silicon Valley company now has offices in West Hollywood where it films originals), it has to continue proving that the model from its video-store roots still works—or be disrupted itself.
They proved streaming. They proved international expansion. They proved profitability. They proved original content. And they proved pricing power,” said Mark Mahaney, analyst at RBC Capital Markets. “Those five reasons are why stock has so outperformed. And they have to continue proving that moving forward.”
It needs to keep proving all that in the face of new competition. Thanks to Netflix, every media company needs a streaming strategy now. Just this week, media giant Disney launched a streaming offshoot of its popular sports network ESPN, which was once the crown jewel of cable TV. It also has a family friendly service due out next year that has been heralded by some in the industry as a “Netflix killer.” It will be cheaper than Netflix, at $4.99, and feature the latest Disney releases—which it ripped from Netflix, leaving a gap in the streaming service’s family programming—as well as Disney’s coveted back catalog, and its Star Wars, Marvel, and Pixar brands, among others.
No one knows what the next decade of Netflix will hold. But the company’s future will largely depend on its ability to continue pushing the envelope (pun intended) in shaping shifts in consumer viewing habits, whether that’s global TV, virtual or augmented reality, interactive storytelling, or a Matrix-like hallucinogenic pill. Hastings is considering all of the above.
“Everyone is adapting to the new world,” said Hastings, speaking with reporters in March, a few weeks after signing its reported $300 million deal with Murphy. “What we’re trying to do is take many bets. Some of the content, maybe it won’t work. But that’s part of being aggressive and trying new things. We’re willing to try.”