Product Lessons from the Netflix Story
Netflix was founded during the dot com boom by Marc Rudolph and Reed Hastings in Silicon Valley, and its core business was video rental via mail instead of the then mainstream in-store rental model. At the time, Netflix’s top competitor was the behemoth of the video rental industry, Blockbuster video, which declined to acquire Netflix for $50M in 2002.
Today Netflix is a leading content streaming business worldwide, and Blockbuster video doesn’t exist, but like any other successful business, the company has gone through its share of high and low times. I found many product and startup lessons in “Netflix vs. the world” documentary, so this post has some of the most pivotal ones from my perspective.
Making unpopular long term bets
Early on, 99% of Netflix’s revenue came from Video cassette rentals and only 1% from DVD rentals. However, video cassettes are bulky and damage-prone, so most of the revenue went into operating costs — costs that would scale with the business. DVDs were very expensive at the time, but looking at the historical trend in the storage device market, Netflix managers made a bet that DVDs would get cheaper over time. In effect, Netflix doubled down on the revenue stream that was resulting in only 1% of its revenue at the time. In my opinion, this seemingly risky move paved a way for a much more sustainable business.
Addressing the main pain point in the industry
Late fee was a major pain point of the video rental business that consumers had learned to live with. And Netflix had a $0 late fee from the get-go. It should be noted that Netflix targeting this pain point is not unlike Uber targeting the cumbersome and unpredictable dispatch of taxis. For the mainstream video rental businesses, late fees were a great way to increase margins i.e. not easy to eliminate overnight. Although Blockbuster eventually did eliminate late fees, what gave Netflix a leg up was not having them from the beginning. In a busy urban world, the last thing you want to worry about is the late fee for a service that was supposed to help you relax via entertainment.
Tapping into the tail-end of the market
One of the main value propositions of Blockbuster Video was that it carried over a thousand cassettes in almost all of its stores, a number that was much higher than other video rental stores at the time. But the increased content availability was still a drop in the ocean compared to all of the available entertainment content. Also, even though Blockbuster had more cassettes than its competitors, popular rentals would always be out of stock. Netflix used sophisticated algorithms to recommend content to its users based on many signals such as past purchases, location, etc. This approach worked great because it led users to discover new content that they wouldn’t otherwise discover and it helped Netflix amortize the cost of popular rentals by tapping into the virtually infinite pool of not-so-popular but relevant content.
Customer obsession
Netflix was running a niche business of video rentals for many years, but when a market research firm interviewed Netflix customers, the firm discovered that the customers were extremely loyal to the company. Netflix focused on delighting the users it had rather than quickly expanding into new areas. In doing so, they didn’t just earn recurring revenues from those customers but also earned their trust, which basically translated into free marketing via word-of-mouth publicity.
Originals
Netflix originals started much later in the company’s history, nonetheless they are absolutely important for Netflix’s long-term success. Originals are costly, but I think Netflix is building a huge moat by creating award-winning, original, and exclusive content. Here’s how the math works out: let’s say a new original movie or a series costs $100M in production costs. Netflix already has over 190M paying subscribers, so cost-per-subscriber is ~$0.5. When a smaller competitor with ~10M subscribers decides to make the same content, its costs are a whopping $10, more or less equivalent to its monthly revenue/user. The more award-winning and exclusive content Netflix generates, the less reliant it is on traditional content production houses e.g. Disney. That is why Netflix originals are so important strategically — they are Netflix’s moat.
Netflix is a great example of doing one thing really really well in a niche market while betting that a longer-term macro trend (i.e. cheaper, faster internet) would grow that niche market into a huge one. As @stewart quotes in this post, “Because the best possible way to find the product-market fit is to define your own market”.
