That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea

by Marc Randolph

We needed a way to reach people who owned DVD players. The manufacturers needed a way for their new customers to access DVDs. What if we could come up with a promotion that would link our interests?

They worked from nine to five every day and got paid overtime if they stayed late. Once a month, they came to work in khakis and polos for casual Friday. But only once a month. In other words, the ethos of a consumer electronics company was about as far from the startup mentality as possible.

What if I could, in one fell swoop, eliminate their biggest obstacle to selling more DVD players? What if they could assure every one of their customers that if they bought a DVD player, they would have immediate access to every DVD available? And then the real heart of the pitch: What if every new player they sold came with a coupon offering three free Netflix rentals? Chicken. Egg. Simultaneous! We’d get traffic to our site, and they’d help grow the DVD user base. Sounds good, doesn’t it?

Nickerson worked for Toshiba, the perpetual second banana. In the CES world, Sony was the undisputed king. They didn’t need to take risks. But for a company like Toshiba, always vying for market share, a risk or innovation could help set the company apart. Whatever his reasoning, I’m eternally thankful to Steve Nickerson for taking the plunge. In my estimation, he’s one of the single most important players in the Netflix story. Without his help, there is absolutely no way the company would have succeeded.

In every DVD player Toshiba sold, they’d allow us to include a small promotional flyer, offering three free DVD rentals through our site. All a customer would have to do would be to visit Netflix.com and enter their DVD player’s serial number, and they’d have three free DVD rentals. It was a win-win. We got direct access to DVD player owners, at precisely the moment when they needed us most. And Toshiba solved its biggest problem: convincing reluctant buyers that they’d actually be able to find something to play on their new machine.

lunch is a chance to start imprinting culture: to explain the most important aspects of working at Netflix, what we expect of people, and what they can expect of us.

Most engineers can choose where they want to work, and the way they make their decision boils down to two questions: 1) Do I respect the people I’m working for? 2) Will I be given interesting problems to solve?

“We’ll try to be a little speedier, a little more proactive,” he says to me. “We’re being careful on this because we think it can really work.” Music to my ears.

The second your dream becomes a reality, things get complicated. You simply can’t know how things are going to behave until you’ve actually tried them. Go ahead and write up a plan, but don’t put too much faith in it. The only real way to find something out is to do it.

Bezos planned to use a good chunk of the $54 million raised during his company’s 1997 IPO to finance an aggressive acquisition of smaller companies. That’s normal—most companies looking to enter a new business arena do what’s called a “make-or-buy analysis,” in which they consider the cost, timing, and difficulty of starting a new business from scratch, then evaluate whether it would be cheaper, faster, and better to simply buy another company that’s already doing it.

“Okay, Jeff,” I said, grinning. “What’s with all the doors?” “It’s a deliberate message,” he explained. “Everyone in the company has them. It’s a way of saying that we spend money on things that affect our customers, not on things that don’t.”

Bezos was notoriously frugal—even cheap. He was famous for his “two-pizza meetings”—the idea being that if it took more than two pizzas to feed a group of people working on a problem, then you had hired too many people. People worked long hours for him, and they didn’t get paid a lot. But Bezos inspired loyalty.

“if we elect to continue down this path, we’re probably going to land somewhere in the low eight figures.”

When someone uses “low eight figures,” that means barely eight figures. That means probably something between $14 million and $16 million. That would have been a pretty good outcome for me, since at the time, I owned about 30 percent of the company. Thirty percent of $15 million is a pretty nice return for twelve months of work—particularly when your wife is broadly hinting that it might be time to pull the kids out of private school, sell the house, and move to Montana. But for Reed, it wasn’t enough. He owned the other 70 percent of the company, but he’d also invested $2 million in it. And he was fresh off the Pure Atria IPO. He was already an “eight-figure guy.” A high-eight-figure guy.

if we didn’t sell to them, we would soon be competing with them. So long, DVD sales. So long, Netflix. Selling to Amazon now would solve all those problems—

Eventually, they decided to fund us. But that had less to do with my pitch than Reed’s presence. Reed was a known quantity, venture capitalist catnip.

The life span of a startup is often so short that by the time people notice what you’re doing, you’re hanging on by a thread. That’s true of most things, really. When you’re busy making your dream into reality, no one praises you until the work is done—and by that time, you’ve long since moved on to other problems.

success creates problems. Growth is great—but with growth comes an entirely new set of complications. How can you preserve your identity even as you include new members on your team? How do you balance continued expansion with coherent identity? How do you ensure that you continue to take risks, now that you have something to lose? How do you grow gracefully?

I was trying to manage the growth of that team—to make sure that the culture we’d forged over the previous twelve months survived a scale-up. We’d built a company where freewheeling discussions sometimes turned heated—and it was okay. Where ideas were more important than chain of command. Where it didn’t matter who solved a problem—only that it got solved. Where dedication and creativity mattered a lot more than dress codes or meeting times.

nothing forces people to bond like shared embarrassment.

There’s a speaking tactic in business, useful for breaking bad news. It’s called a shit sandwich. You open up with a string of compliments, praise for work well done. That’s your first piece of bread. Once that’s done, you pile on the shit: the bad news, the less than glowing report, the things your audience doesn’t particularly enjoy hearing. You close with more bread: a blueprint for moving forward, a plan for dealing with all the shit.

I have a pretty good sense of my skill as an entrepreneur. I don’t think I’m tooting my own horn to say that I’m in the 98th percentile. I knew, even then, that I could lead the company as it grew. But I also knew, even then, that Reed was in the 99.9th percentile. He’s one of the all-time greats. And he was better at this stage of things than I was. More confident. More focused. Bolder.

Officially that spring, my title was “president.” Day-to-day, little about my job had changed. I was still in charge of the aspects of Netflix that I loved (and was good at): customer relations, marketing, PR, web design, all the movie content, and our ongoing relationships with DVD player manufacturers. Reed took over the back end: finances, operations, and engineering. As far as I was concerned, the job titles were irrelevant. But titles mattered to VCs, and I wasn’t stupid: I knew that when it came to raising money for a rapidly growing (and still not profitable) startup, having Reed as CEO was one of our best assets. Reed’s presence calmed the board and reassured potential investors.

Netflix’s culture, at least originally, wasn’t the result of careful planning—of aspirational principles or cultural manifestos. How it was a reflection of the shared values and behaviors of the founders. How we trusted each other, worked hard, and had zero patience for traditional corporate bullshit. All of that is true. But what happens when the team grows? When a company is small, trust and efficiency go hand in hand. If you’ve got the right people on your team, you don’t need to tell them exactly how you want them to do things—in fact, you often don’t even need to tell them what you want them to do. You simply need to be clear about what you want to accomplish and why it’s important. If you hired the right people—smart, capable, trustworthy—they’ll figure out what needs to be done, and they’ll go ahead and do it. They’ll solve problems on their own before you even know the problems exist. And if you didn’t hire the right person? It’ll be apparent, really quickly.

one of our engineering managers came to me with a peculiar request. His girlfriend had moved to San Diego and he was trying to keep their relationship on stable footing. “How would you feel,” he asked, “if I left work early on Fridays to fly down to San Diego?” He explained that he would work from there on Monday, fly back home Monday night, and be in the office Tuesday morning. My answer probably surprised him. “I don’t care where you work, or what hours you work. Work from Mars, for all I care. If all you’re asking me is about when you work and where you do it, that’s an easy answer: it makes no difference to me. “But,” I continued, “if what you’re really asking me is whether I’m willing to lower my expectations for you and your group so that you can spend time with your girlfriend? Well, that’s an easy answer, too. No.” He looked at me uncertainly. I could see his dreams of San Diego weekends fading away. “Look, where and when you work is entirely up to you. If you can run your group effectively on three and a half days a week in the office, all power to you. Go ahead—I’m envious. Wish I was smart enough to do that. Just remember: You’re a manager. Part of your job is making sure that your team knows what you want them to accomplish and why it’s important. Do you think you can do that without being around?” Needless to say, his girlfriend was a free agent shortly thereafter.

Unlimited vacation days and hassle-free expense reimbursement are almost clichés now. But they were groundbreaking at the time. In Netflix, Patty saw an opportunity to redefine the role of HR departments. No longer was HR just a lonely cubicle filled with employee handbooks, sexual harassment claims, and benefits summaries. Instead, she envisioned the department as a proactive agent for culture.

This is one of the facts of startup life: change. When you’re building something from nothing, you rely on talented, passionate generalists: people who can do a little bit of everything, who buy into the mission, and whom you trust with your time, money, and ideas. But once you’ve gone from 0 to 1, and the seed you’ve planted is starting to grow, some shuffling happens. Often the person who was right for the job at the beginning is not right for the middle. Sometimes bringing in people with decades of experience and institutional know-how is the necessary thing to do.

The Home Rental Library. When we sent out an informal e-mail survey about the possibility of eliminating late fees, we’d gotten a warm response, so we’d designed a format that allowed users to rent four DVDs at a time, for $15.99 a month, and keep them as long as they wanted. As soon as they had returned one of the DVDs, they could come back to the site and rent another. Serialized Delivery. We suspected that we might have problems with the “come back to the site and rent another” part. People were busy. Once a watched DVD was in the mailbox, it would be out of sight, out of mind. So maybe, we could have each customer create a list of DVDs they wanted. That way, when they returned a DVD to us, we could automatically (Te used the term “auto-magically”) send them the next movie on their list. I suggested we call our list the “Queue.” I knew that queue meant line, but I also loved the idea that I could call the help section for this feature “Queue Tips.” Subscription. Having people hold on to our discs for as long as they wanted seemed good for customers—but we weren’t sure what the business model should be. Do you pay a rental fee each time you swap? What if you never send one back? We decided that we should test a monthly fee—that we charged you every month you used the service.

Overplanning and overdesigning is often just overthinking—or just plain old procrastination. When it comes to ideas, it’s more efficient to test ten bad ones than spend days trying to come up with something perfect.

Silicon Valley brainstorming sessions often begin with someone saying, “There are no bad ideas.” I’ve always disagreed. There are bad ideas. But you don’t know an idea is bad until you’ve tried it.

If we took the amount of effort, manpower, and mind-power Canadian expansion would require and applied it to other aspects of the business, we’d eventually get a far greater return than 10 percent. Expanding to Canada would have been a short-term move, with short-term benefits. It would have diluted our focus.

Focus. It’s an entrepreneur’s secret weapon. Again and again in the Netflix story—dropping DVD sales, dropping à la carte rentals, and eventually dropping many members of the original Netflix team—we had to be willing to abandon parts of the past in service of the future. Sometimes, focus this intense looks like ruthlessness—and it is, a little bit. But it’s more than that. It’s something akin to courage.

Moving the business entirely to Marquee almost immediately took one of our biggest liabilities—delivery time—and in one fell swoop turned it into one of our biggest advantages. Now we weren’t several days slower than going to a Blockbuster—we were many times faster!

trust your gut, but also test it. Before you do anything concrete, the data has to agree.

We’d suspected that next-day delivery was important, but we’d been myopic in our analysis of our tests, so we hadn’t understood why. It took an additional test, with a truly outside-the-box execution, to understand what we’d already intuited to be true. And once we understood it, we could refine the idea and maximize its potential—which was huge. Next-day delivery was like magic. We knew it had to be part of our plans going forward. Now we just needed to figure out a way to make it work without driving the DVDs ourselves or building enormous warehouses all over the country.

the best way to give users what they wanted was to crowdsource data from them.

If we were going to use collaborative filtering to group customers and recommend films, we needed to know what customers enjoyed rather than just what they rented. We needed a reviews system: a movie rating system. Grouping customers by ratings—by “clustering” users according to overlapping positive or negative reviews—meant that we could efficiently recommend films to users based not on what they’d rented but what they liked. Ultimately, the algorithm would become much more complex than that. But for it to work at all, we needed users to review movies—lots of them.

schadenfreude.

Our company was successful, but it had a voracious appetite for cash in an environment where cash was hard to come by. After the dot-com bubble burst, venture capital—which had once been comically easy to acquire, if you had a “.com” in your name—had become not just hard to get but almost completely unavailable.

It’s common knowledge that things in Silicon Valley are pretty casual. There’s not a lot of room for suits, ties, that sort of thing. People have come to understand that it’s a sign of great respect if I shave for a meeting. I think the reason the Valley is so casual is because, unlike most industries, tech is about as close to a true meritocracy as you can get. In many disciplines, being a smooth talker or a snappy dresser can grease your ascent to the executive suite. But in Silicon Valley the only thing that really matters is the quality of your work. It’s a programmer’s world, with a programmer’s ethos. Every programmer is accustomed to having their code subjected to peer review, in which fellow coders evaluate its brevity, elegance, cleverness, simplicity, and ultimate effectiveness. It’s all there in black and white. It matters not at all what you look or dress like; what you talk or smell like. You don’t need to speak English. If your code is good, you’re in. If your code sucks, it’s immediately apparent to everybody.

“Barry,” Reed said, “we’ve waited months to get this meeting. We’re on track to lose at least fifty million dollars this year. Whether we pull this off or not, another twenty grand won’t make a difference.” “Yeah, Barry,” I piped up. “Twenty grand. Isn’t that what you finance guys call a ‘rounding error’?”

everyone hated Blockbuster. This, after all, was a company that had “managed dissatisfaction” as a central pillar of their business model. They knew that most customers didn’t enjoy the experience of renting from them, so their goal as a company wasn’t so much to make the customer happy as it was to not piss them off so royally that they’d never come back.

The world was going online. No one knew exactly how it would happen, or how long it would take, but it was inevitable that increasing numbers of Blockbuster’s customers would want—no, insist on—transacting their business online. And not only was Blockbuster ill-positioned to take advantage of that trend, they didn’t even seem to see that it was coming. The way we saw things, they could use our help.

It’s a maxim of startup life: You’re going to get things wrong. You just don’t want to get the same things wrong twice.

At Netflix, there was nothing wrong with disagreement. In fact, disagreement was a critical component of our culture of radical honesty. We expected disagreement, because we encouraged vigorous debate. In Netflix meetings, there was no seniority, and no one’s opinion was more valuable because of their title, age, or salary. Everyone was expected to fight for their point of view until a consensus had been reached. Still, no matter how passionate the argument, there was a shared expectation at Netflix that, once the self-evidently correct conclusion had been reached, it was time to fall in and implement it. Disagreement was collaborative, not ego-driven. It didn’t matter who was right—all that mattered was that we got it right. And that was where Kyle was falling short. He just couldn’t get over it when things didn’t go his way, and his bad attitude was infecting everyone.

Hiring and keeping star players is about much more than just quality of work, however. It’s a culture thing. When you retain only star players, you create a culture of competitive excellence. It’s more fun to come to work when you know you’re part of the handpicked elite. Plus, it’s much easier to attract other elite talent to your team when you’ve established a reputation for superstar talent.

The original crew of skilled generalists had been replaced with superstar specialists. I was glad to be working alongside some of the most brilliant minds in Silicon Valley.

we’d finally figured out a way to make our original idea of DVDs by mail work, and here we were, looking ahead to a future without either DVDs or mail.

studios and networks were terrified of being “Napster-ed.” They’d watched the music industry fall victim to widespread piracy and cratered sales, so they weren’t very keen to give up digital rights.

Like me, Neil saw the national increase in internet bandwidth as a possibility: a way to use digital means to deliver Netflix movies directly to TV sets and further shrink the time between finishing one movie and getting the next one. Instantaneous streaming wasn’t possible in 2002, and downloads would take hours—but we were betting that even so, passively downloading a movie while you were asleep or at work was still preferable to getting in the car and driving to Blockbuster. In our ideal, spitballing world, customers would always have a few downloaded movies ready to watch in a device on top of their TV,