Reed Hastings on Industry Transition

Hastings had told the producer Mynette Louie in the late 1990s that streaming was always the goal, with DVDs merely a way to build the customer base for the eventual service. By the mid-2000s, data speeds and bandwidth costs had improved enough for customers to download movies from the internet. The first concept was a Netflix box that would fetch movies overnight so they were ready to watch the next morning; by 2005 the company had acquired film rights and designed both the device and the service. Then the plan changed. Once it became clear that a streaming service like YouTube could win huge audiences even without high-definition content, the hardware concept was scrapped and replaced with a pure streaming service. The decision is one of the quiet pivots that made Netflix what it became: rather than defend a proprietary box business, Hastings chose to be everywhere the internet already was, a strategy that would later make Netflix a layer on every connected screen rather than a gadget maker.

On January 16, 2007, Netflix launched its streaming media service, introducing video on demand over the internet. At launch it offered only one thousand films, compared with seventy thousand available on DVD, and the service, then called Watch Now, at first required Internet Explorer on a computer. Hollywood studios, including 20th Century Fox, Sony Pictures, MGM, Paramount, Universal, Warner Bros., New Line Cinema, and Lionsgate, licensed their second-run content, never expecting the upstart to endanger the lucrative relationships they already had with cable television. The modest catalog was a deliberate artifact of that licensing caution: studios sold Netflix their older libraries, comfortable that the internet upstart would stay a niche convenience. Hastings treated those constraints as an incubation period, using the thin catalog to prove out streaming technology, collect behavioral data, and build the viewing habits that would later justify billion-dollar originals budgets and renegotiate the economics of Hollywood once subscriber scale gave Netflix bargaining power no cable network could ignore.

The transition years between 2007 and 2008 supplied Netflix's foundational infrastructure stories. In February 2007 the company delivered its billionth DVD, a copy of Babel to a customer in Texas. In April 2007 it recruited ReplayTV founder Anthony Wood to build a Netflix Player that would bring streaming to televisions; Hastings eventually shut the project down to encourage other hardware manufacturers to build in Netflix support, and the effort was spun off as the digital media player company Roku. In January 2008 all rental-disc subscribers became entitled to unlimited streaming at no additional cost, a response to the introduction of Hulu and Apple's new video-rental services. In August 2008 the Netflix database was corrupted and the company could not ship DVDs for three days, leading it to move all its data to the Amazon Web Services cloud, a migration that became a textbook case study in cloud architecture and incidentally tied Netflix's fate to the infrastructure of its eventual competitor's parent.

The years 2009 and 2010 marked the crossover. In 2009 Netflix streams overtook its DVD shipments for the first time. In January 2010 the company agreed with Warner Bros. to delay new-release rentals by twenty-eight days after DVDs became available for sale, an attempt to help studios sell physical copies, and similar deals with Universal and Fox followed in April. In August 2010 Netflix reached a five-year deal worth nearly one billion dollars to stream films from Paramount, Lionsgate, and MGM, adding roughly two hundred million dollars a year in costs; it spent 117 million dollars on streaming content in the first six months of 2010, up from thirty-one million in all of 2009. In September 2010 Netflix launched in Canada, its first international market, and in November 2010 it began offering a standalone streaming service separate from DVD rentals. Each step converted the free bonus feature into the core business, and the content budgets made clear which side of the company management intended to feed.

Hastings said that when he founded Netflix he had no idea whether customers would actually use the service, but he was a committed proponent of internet television and saw it as the future. He credited YouTube with his shift in strategy toward developing a video streaming service, reasoning that if audiences would watch lower-definition video online in those volumes, a licensed catalog could scale. Netflix accordingly launched a service in 2007 to stream movies and television shows to computers, and under his leadership the company amassed a collection of one hundred thousand titles and more than one hundred million subscribers. The trajectory vindicated a bet he had held since the DVD era: the red envelope was always a transitional technology, a way to build the customer base, the data, and the content relationships that a streaming business would eventually require. His willingness to run Netflix's most profitable business as a bridge to be crossed, rather than a fortress to be defended, became the defining strategic pattern of his tenure.

The Qwikster affair was the fall of a company that had seemed to solve the innovator's dilemma. Netflix's stock had risen ninefold from the start of 2009 to peak above three hundred dollars in July 2011, and Fortune had put Hastings on its cover as businessperson of the year for navigating the company from DVDs to the digital future while keeping the two businesses blended. The breakup decision, Hastings said, was based in part on data showing a faster-than-anticipated shift to streaming: in the first quarter of 2011 DVD shipments fell year over year for the first time, leading Netflix to declare the DVD business had peaked, and very few new subscribers were choosing discs by mail. But the data-driven company had underestimated the unquantifiable emotions of subscribers who still wanted their little red envelopes even if they forgot to watch the DVDs inside. How Netflix came to be so out of touch with its customers became, in the paper's framing, a cautionary tale for every company attempting the transformation from old media to new.