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article imagePlotting Netflix’s future: pain equals success Special

By Les Horvitz     Oct 27, 2016 in Entertainment
New York - There’s a big difference between strategy and tactics, says Netflix’s CEO and co-founder Reed Hastings. He sums it up in a simple equation: strategy = pain.
Hastings draws on a military analogy to illustrate what he means. Say that you’re a general planning to defend his position against an enemy attack. Unless you have overwhelming forces at your disposal, you have to decide where to deploy them. “Put them on the northern flank and if the enemy comes from the south you’re screwed.” That’s where strategy comes in. That’s where the pain comes in, too. “You need to have a list of things you’re not doing to derive a strategy," said Hasting while speaking recently at The New Yorker Techfest in New York. Most of the time the pain paid off for Hastings, but occasionally he admits, the enemy attacked where he least expected it.
Netflix sustained its biggest blow in 2011 when Hastings decided to split the Internet company into two — one for supplying Netflix customers with DVD’s by mail and the other for online streaming. At the same time he raised prices for subscriptions to $16 a month (double what it is now). “I was so obsessed with not getting trapped by DVDs the way AOL got trapped, the way Kodak did, the way Blockbuster did,” he told The New Yorker’s Ken Auletta in 2014. “We would say, Every business we could think of died because they were too cautious.” The result, however, was a disaster: eight hundred thousand subscribers jumped ship and the stock price sank. It took just a month to scrap Netflix’s equivalent of New Coke and rescind the decision.
The DVD imbroglio wasn’t the first time that Hastings had gone out on a limb…and fallen out of the tree. “I had a great time doing a mediocre job at my first company,” he says, which involved debugging software for a company called Adaptive Technology. “I wasn’t very effective,” he concedes, “I was uncomfortable being a CEO.” He preferred to be nice to people rather than to be honest. “I learned the value of focus,” he told Auletta. “I learned it is better to do one product well than two products in a mediocre way." In 1991, he left Adaptive to found his first company, Pure Software. As the company expanded, he was forced to learn new, even more painful lessons: "I was doing white-water kayaking at the time, and in kayaking if you stare and focus on the problem you are much more likely to hit danger. I focused on the safe water and what I wanted to happen. I didn’t listen to the skeptics." He was so overwhelmed that he says that he tried to fire himself – twice. No luck: the board refused his resignation.
Hastings was inspired to launch his most ambitious project after paying a late fee of $40 for a video cassette, which he’d misplaced (it was ‘Apollo 13.’) He was so embarrassed he didn’t tell his wife. Then he realized that there must be a better business model. Netflix, which he founded in 1997 along with Marc Randolph, was intended to be a single rental service, but one with unlimited due dates and no late fees. What set the company apart was that it would rely on a subscription service with an online queue. But once they built it they had no idea whether anyone would come.
They soon found out the answer. This time the strategy worked – much better than Hastings and Randolph could have imagined.
“We think of Netflix in terms of the Internet, not as a network,” Hastings says. That means that the company isn’t trying to compete with network or cable TV. “We’re not doing sports or pay-per-view though we get a lot of requests for it. We don’t do sports because we don’t think of ourselves as a cable replacement.” So Hastings leaves it to the networks to broadcast big events like the Olympics, the Super Bowl and the Oscars, which cost hundreds of millions of dollars to present in expectation of a windfall from advertisers. But Netflix makes its money entirely from subscribers. To keep those subscribers and draw new ones, Netflix decided that it wasn’t enough to recycle TV shows or movies. The key to the company’s new strategy was to produce its own original content. Hastings now considers his main competitors to be Showtime and HBO, which offer apps that allow their subscribers to watch their shows on any device. HBO has more than two and a half times as many subscribers worldwide as Netflix—a hundred and fourteen million. Nonetheless, Hastings says that he doesn’t lose any sleep over his cable TV competitors. “The last competitor Netflix was concerned about was (the videotape outlet) Blockbuster and that was ten years ago.”
Netflix not only invested heavily in original content, it also broke with precedent by releasing an entire season’s worth of episodes at once, ushering in an era of binge watching. Three years after the disastrous rollout of a bifurcated Neflix, the company garnered three Emmys for its hit political thriller “House of Cards” directed by David Fincher and starring Kevin Spacey. The company went all in on the production, spending $100 million for the first two seasons – a total of 26 episodes. Its fourth season is set to begin soon. It was the first time that the prize was awarded to a nontraditional medium. If it wasn’t for Netflix, there might never have been “A House of Cards” at all. Fincher and Spacey had gotten nowhere pitching several TV networks on the idea for “House of Cards,” a remake of a British series, but found a surprising welcome when they approached the fledgling Internet company. Better yet, Netflix offered to approve the project without first seeing a pilot or test-marketing it with viewers. “Netflix was the only network that said, ‘We believe in you. We’ve run our data and it tells us that our audience would watch this series,” Spacey recalled. “’We don’t need you to do a pilot. How many (episodes) do you wanna do?’”
Investors continue to snap up the company’s shares – it tripled in value in 2013 alone — even though the company barely breaks even. Like Amazon, Netflix is investing for the long term even though that can mean a negative cash flow of up to $10 billion a year. “We don’t focus on short term gains,” Hastings says, “We focus on better service and content.” The gamble seems to be paying off. In October, Netflix shares jumped more than 20 percent after the company announced that it had gained more subscribers than expected in its third quarter – 370,000 new users in the U.S. who were attracted in new offerings such as “Stranger Things,” “Narcos,” and “Luke Cage.” Its total revenues reached two billion dollars for the first time in its history. Overseas, Netflix added 3.2 million new subscribers, easily beating forecasts. The company can now be seen in 130 countries.
After some hiccups, Netflix has made inroads in Latin America and has become even more entrenched in Europe and Asia with one major exception: China. The precedent there isn’t reassuring, Hastings says, noting that both Disney and Apple have both had to shut down their movie businesses in China because of red tape and ideological concerns. As Netflix expands internationally the company has also begun to showcase foreign series like “Marseilles” from France and “The Killing” from Denmark.
There’s certainly a lot of content to go around. Original productions debuted by cable networks like Fox and networks like ABC have doubled over the past five years to about 500 new shows. Hastings isn’t worried about a bubble where consumers are so overwhelmed by new shows that they tune out. “The ecosystem is healthy,” Hastings says, and because the distribution system is improving, viewers have more opportunity to choose among an ever expanding menu of shows. And they’re watching on a variety of devices. About two-thirds of Netflix viewing now occurs on TV; the rest takes place on mobile phones, laptops and tablets. The quality of HDTV is now so superior to movie screens that Hastings wonders why people bother going to the movies at all anymore, especially because in his opinion, there’s less of interest to see. He says that he’s worried about the future of the traditional movie business because he believes that it’s being ‘strangled’ by the theater chains. NATO – the National Association of Theater Owners — constitutes an oligopoly, he says, controlling the pipelines so tightly that if a movie isn’t distributed by a major studio like Sony or Time Warner it has a hard time reaching audiences. Hastings also notes that whereas major Hollywood movies can cost upwards of $100 million, an episode of HBO’s “The Game of Thrones” can be produced for $10 million. “Think what we could do with $20 million for an episode.”
The future is sure to bring tectonic changes to the media industry. “Look what happened to print,” he says, well aware that that’s something that faithful New Yorker readers at the TechFest didn’t need to be reminded of. To be fair, the magazine also has a digital edition. Kodak, he points out, was replaced by Facebook and Instagram. Will TV become like opera, which has a lot of trouble attracting younger audiences? Maybe there will be a new, as yet unimagined form of entertainment, he speculates. Maybe one day you could take a blue pill, he jokes, and the movie will automatically unspool in your mind. However, he doesn’t believe that virtual reality will be the means with which most viewers get their content. “I can’t see people wearing 3D glasses when they sit down to enjoy a show.” VR will more likely be limited to gamers. Whatever the device people use to access their entertainment and news, Hastings has no doubt that the Internet will remain as ubiquitous and commonplace as electricity. “DVDs come and go but electricity remains.” He also predicts that HDTV screens will continue to improve – a fairly safe bet – and come way down in price.
While Hastings still expects viewers to turn on their TVs, Internet entrepreneur and venture capitalist Marc Andreesen is convinced that in ten years TV as we know it will be finished, declaring that content will be “one hundred per cent streamed.” Although he admits that the television industry managed the transition to the digital age better than book publishers and music executives, he told The New Yorker’s Auletta that “software is going to eat television in the exact same way, ultimately, that software ate music and as it ate books.”
How people watch Netflix isn’t Hastings’ major concern, though. “If we create shows you love you’ll keep paying us.” This isn’t a strategic dilemma, he notes. The question these days is more tactical: how well can the company execute its plans? “I don’t know how big Netflix will be. I don’t try to see the future. We try to invent it.”
More about Netflix, Reed hastings, new yorker magazine, Techfest, HBO
 
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