The Netflix Story

from view today. As per text Stuff listener Kevin's request, I'm going to begin to talk about another company, Netflix, one that has been frequently cited as the giant killer when people talk about Blockbuster. But this is a very interesting and surprisingly deep story, the story of Netflix and rise and where it is today. So this is actually gonna be a rare four part episode. The founding of Netflix, just by itself is a pretty fascinating tale, and that's

what this episode is really going to focus on. So where did Netflix come from and how has it evolved? Well, first, the origins of Netflix are a matter of some debate, or at least there are contradicting versions of the origins of Netflix. Read Hastings, the co founder of Netflix, once said that he came up with the idea after he incurred a forty dollar late fee from the aforementioned Blockbuster.

The video he had rented was Apollo thirteen. No word on whether or not his response to getting hit with the fee was Houston, we've had a problem. Actually. In an interview in Fortune magazine, Hastings said, quote, I remember the fee because I was embarrassed about it. That was back in the vh just days and it got me thinking, there's that there's a big market out there. So I started to investigate the idea of how to create a

movie rental business by mail. I didn't know about DVDs, and then a friend of mine told me they were coming. I ran out to Tower Records in Santa Cruz, California and mailed CDs to myself, just a disk in an envelope. It was a long twenty four hours until the mail arrived back at my house and I ripped them open and they were all in great shape. That was the

big excitement point. End quote. So later on he would change the name of the video store from Blockbuster to a little mom and pop video rental store that had gone out of business several years later. In a future episode, I'll explain why that story changed. But then there's another version that Hastings has shared at the Mobile World Congress convention. He said the idea spawned from a theoretical scenario he

encountered in graduate school. So a math problem, if you will, And the math problem goes something like this, what is the bandwidth of a station wagon loaded down with tapes? I'm talking about tapes that have magnetic storage on them, that kind of tape. To answer that question, you have

to know a lot of different variables. You need to know how many tapes you can load into the station wagon using the most efficient method possible, sort of Tetris style, so that you can fit the maximum number of tape tapes in the in the carrying capacity of the station wagon. Two, you need to know how much data can each tape hold individually. It's for you to be able to know

what the band with is. And three, you would need to know how long it would take for the station wagon to get from its starting point to whatever its destination is. And that would allow you to answer that question. And this got him into thinking about how much data a DVD could hold and how quickly you could distribute the information on that DVD by utilizing the postal service,

and that the Internet would make delivery services faster. But another version of this story was shared by Mark Randolph, who was the other co founder of Netflix, and he said that he and Hastings were racking their brains to come up with a way to build the Amazon dot Com of something, and this would be back in now. In those days, Amazon dot Com was still only an

online bookstore. That's all they dealt with was books. Also, it's interesting that they wanted to build the Amazon dot Com of something because at that point Amazon dot Com had been operating at a loss and it would continue to do so until two thousand three. It did have a profitable quarter at the end of two thousand one, but two thousand three was its first profitable year. Still, Amazon dot Com got a lot of investment money poured

into it, so maybe that's what they meant. Plus, in those days, the way that startups typically worked was that you would get a business going. Maybe you would figure out a way to generate revenue, but that wasn't really

that important. What was more important was that you showed yourself to have a really valuable idea, one so valuable that a larger company wanted it, and then they would acquire your company for a princely sum, and then you could go and do it all over again and continue to make startups and sell them till the cows came home. Remember this is in the days well before the dot com bubble burst. But let's take a step back for

just a second. Who are Read Hastings and Mark Randolph. Well, first we'll start with Wilmot Read Hastings Jr. He was born in Boston, Massachusetts, in nineteen sixty to a well to do family. That's putting it lightly. His mother's family were founding members of the Social Register. And for those who do not know, I certainly do not move in these circles, So I would not be one to know about this if I had not read extensively about it before.

The Social Registered tracks things like marriages, births, other big life events among the well to do in high society. So we're talking old money typically, and it's a relatively small list of families in the grand scheme of things. These are movers and shakers and business and politics and

in finance. And there's no way I would ever be listed in there, not that I have any great desire to be, but his family on his mother's side founded that his great grandfather was Alfred Lee Loomis, whom I covered in a previous episode of Tech Stuff, and he would go to college. That that is, Hastings would go to college in Maine at Bowdoin College. He graduated with a bachelor's degree there, and then he entered the Peace Corps for a few years, spending much of that time

in Swazila and in Southern Africa teaching mathematics. When he got back to the States, he first attempted to enroll in m I T. He wanted to study computer science, but M I T wouldn't accept him, so instead he enrolled over at Stanford University and he would graduate nineteen eight with a master's degree in computer science. He got a job as a software developer, and in nineteen ninety

one he founded his first company, called Pure Software. In nineteen Pure Software merged with another company called Atria Software in a stock transaction deal worth nearly a billion dollars, and Hastings would become the president and CEO of this new company called Pure Atria. One of the company's services was to work on solving computer bugs that would pop up when multiple developers would all work on the same

computer code. Atria's former CEO would actually become the chairman of this new company, and in August nine, another company called Rational Software made a move to acquire Pure Atria, which meant that Hastings got a handsome payout an enormous amount of money, made him a millionaire and a multimillionaire, and it gave him the money he would need to found Netflix. He was essentially the source of the seed

money for the company. Mark Randolph was born in Chappaqua, New York, in nineteen fifty eight, also to a wealthy family. He had famous relatives of his own. His great uncle was Sigmund Freud, and he was also the nephew of Edward Burnet's, a public relations and propaganda genius some might say, the master of misdirection. You can learn more about Burnet's and episodes from shows like Stuff You Should Know and

Stuff They Don't Want You to Know. They've both done episodes about Edward Burnet's and his is a fascinating story. Randolph would go on to attend Hamilton's College in New York, where he earned a degree in geology, which totally rocks. When he graduated, his dad helped Randolph get a clerical job at a company called Cherry Lane Music Company, and Randolph worked in the mail order side of the business and learned about catalogs and mail order strategies and marketing

strategies and about direct mail. He began analyzing customer behaviors and learning which products were performing best and the types of customers who were likely to buy a future product based upon past purchases, and so he started to redesign the UH, the company's approach to this and make it

more effective. He was then asked to design the computer inventory and processing system for the company when they decided to move to a computer system, and he would co found the American version of Mac User magazine, and then he was tapped to launch two new mail order businesses.

They were called mac Warehouse and MicroWarehouse. After those jobs, he worked for a software company called Borland International for seven years years and after that he worked at various startups in the dot com boom and became a founding member and chief product marketing officer at Atria, in which, as I mentioned, Pure Software had acquired. So Randolph then became the head of corporate marketing at the new company

of Pure Atria. But just a few months after he took that position, they had the announced merger with Rational Software, and that meant his job was already on borrowed time. He knew that his job was going to be eliminated upon the completion of that acquisition, so he and Hastings

started talking about a possible business venture together. And I've heard it said that Hastings is sort of the engineering and numbers guy, and it makes very cold and calculated decisions in many ways, and Randolph was more of a people person in creative type now, according to Randolph himself, as the acquisition neared, he would talk to Hastings about various ideas. He had to launch the next Amazon dot Com of something, and they were going back and forth

on what that something should be. Early on, they talked about the possibility of video sales and rentals using the Internet as a way to connect customers with video titles. But this was still in the day of VHS tapes, and the cost on a per tape basis would be between fifty five dollars per title. That's how much a lot of these video rental stores were paying, and then you had the expense of shipping tapes in the mail and the question about whether or not they would remain

in good condition. How long could you do this per tape before they wore out? Presumably the wear and tear would be much greater than you would see in your typical store, And eventually that made them decide that this particular idea was impractical. But then again, according to Randolph, he came across something interesting while reading about new technologies. He heard about the DVD format, and in the DVD

format was brand new in the United States. It had launched the year before in Japan, but just made its way over to the US. In an optical disc would be much lighter and easier to ship than a VHS tape, and it looked like it would be easy to get titles much more cheaply on a per title basis, because it looked like instead of charging this fifty to eighty five dollars per title, it would be closer to fifteen to twenty dollars, and that really brought that initial startup

cost way down. So the story goes that Hastings and Randolph went to a local music store, not necessarily Tower records, and then they bought a CD. Then they hopped over to a greeting card store and they bought a card that had an envelope large enough to hold the c D. Then Hastings mailed the c D to himself and he went home and he waited for it to arrive. And then within a day or two, it got there, and he checked out the c D to see if there was any visible damage on it, and he saw that

the disc inside was undamaged. This could work, they thought, I'll explain more in just a moment, but first let's take a quick break to thank our sponsor. Hastings and Randolph pulled in Christina Kish, who had joined pure Atria on Randolph's recommendation, but then she found herself out of a job, literally on her first day of work. She comes to work on her first day, finds out that she's going to get laid off once this acquisition happens.

She would be allowed to continue to show up and draw a paycheck during this acquisition process, but she didn't really have anything to do, and she already knew that the job was strictly just sitting at a desk doing nothing until the acquisition was done. Her main job in the early planning stages of what was going to become Netflix was to look at Blockbusters business plan and determine

how did Blockbuster make money? And that was a little challenging because she saw how big the overhead was, how much the costs were to operate Blockbuster, and it became clear that Blockbuster strategy was not going to work for Netflix. That Blockbuster had largely succeeded by acquiring various video chains and growing this way and adding to their customer base in that way, but that was not really a viable option for Netflix. Meanwhile, uh they also brought on a

woman named terse T Smith. She was someone else who had joined pure Atria on Randolph's recommendation, and Hastings brought in a developer of his own named Eric Meyer, who would be responsible for designing the website. Together, they began to hash out their plan for what would become Netflix. So how do you convince people to a shoe a brick and mortar store for an online library of DVDs and then expect them to wait patiently for a movie to be packed up, shipped and delivered to their homes.

It seemed like a really big challenge. Randolph started doing research in the video rental industry. He attended a convention and held by the Video Software Dealers Association or v s d A, and there he met the president of the v s d A. It was a guy named

Mitch Low. Low initially agreed to just do some consulting with the entrepreneurs, giving information about valuable rental industry stuff, such as how to use software to simulate the experience of talking to a knowledgeable video store clerk for recommendations. This would become a key feature early on with Netflix creating a system that would recommend movies based upon your likes and your interests, something that that a video store

clerk could do. And you talked to a video store clerk and say, you know, I really like action movies, and I like movies featuring you know, a protagonist who's really the odds are stacked against them, and etcetera, etcetera, And they say, oh, well, have you seen die Hard? Let me take you over here and I'll show you and or if you have seen die Hard, I'll show you some other movies that are similar to that that

you might really enjoy. Well. Low talked about the ways that video clerks did this, so that they could figure out a way to essentially simulate that through their algorithms. Randolph eventually was actually able to convince Low to join the new company, and interestingly, Low had already experimented with a video rental method that was outside the norm, and later that method would prove to be actually really effective,

although it wasn't in the early days. So what he had done was he had installed a video rental kiosk in a Japanese hospital, and that particular venture was a failure, but it would turn out to be a pretty good idea later on A box that has read one might say more on that in a future episode. The company would grow to eight people with the addition of a couple of programmers and a new director of operations in finance, and they got to work building out the initial website

and user into face now. According to the book Netflix, which is a phenomenal book, I relied on it very heavily. When doing the research for these episodes. Christina Kish would draw out the stages she wanted customers to encounter when they would navigate to whatever the website was going to turn into. She this was sort of the experience she wanted customers to have, and it went from seeing the initial page to the point where you're checking out and paying to rent a title, and she did it all

like drawing crayon on paper. Other programmers started building out the back end of the operations, which would include stuff like keeping track of inventory. They need to know which titles were available, how many copies of each title were in stock, how many of those copies were out for rental, that kind of thing. They need to know that in order to be able to fulfill orders, So they had

to build the system to actually support that. They also needed to have the infrastructure in place to be able to actually ring transactions. This is in the early days of online commerce. You didn't have a whole lot of examples out there beyond some big names like Amazon dot Com. So essentially they were building out all the basic functions of online shopping that developer I mentioned earlier, Eric Meyer,

he set a very high goal. He wanted the programming team to make sure that the Oracle software they were using as a foundation for the back end operations would eventually be able to handle up to ten million customers, which seemed like a crazy number, but He was essentially talking about scaling up the back end for business before there even was a business, and he felt strongly that was better to be prepared and be ready for the eventuality than to be caught without the structure in place.

Once the need arose. They created a search tool that they would call flicks Finder that would help users find films by title, director, or actor. So if you really liked movies that featured I don't know, Bruce Campbell, for example, then you would get results like Army of Darkness or

Bubba Hotep, that kind of thing. They also added in a feature called film Facts, which included stuff like a synopsis for each DVD and included ratings for the films, and would include a rundown of the different features you could find on the DVD, because of course a lot of DVDs would ship with bonus material on them. And they created a recommendation engine, or they put the building

blocks in for a recommendation engine. They would take a couple of years for that to really take form, but this is something that Netflix is known for to to this day. The recommendation engine would suggest films similar to ones that the customer had previously rented and they might be in a similar genre, or they might have the

same principal actors or director involved. And they also included a feature that would remind customers about films they had flagged as being interested in but had not yet did. So let's say you go to Netflix's site early on and you see a whole bunch of different movies that you're interested in. You're only going to rent a couple at the moment, but you want to flag the ones you're interested in so that you remember on a future visit. Oh yeah, yeah, yeah, I did want to see that movie.

That was what that feature was all about. Meanwhile, other team members were busy building out inventory. DVDs were a novelty in nineteen seven. Not a whole lot of people owned DVD player yet by the end of that year, and they were wicked expensive when they first came out, like eleven d dollars for a DVD player when they first debuted. Towards the end of nine seven, the team had accumulated around five hundred DVDs, most of those older films.

That wasn't because the newest films were more expensive or anything. It was mostly because movie studios hadn't really started to release films to DVD yet. And this was where we get into a weird situation because from the movie studio perspective, until there was a market, right until you had enough people buying DVD players, there wasn't a huge incentive to put titles on DVD because there weren't enough people out

there to buy the DVDs. But then without the library, without the titles, there was no incentive for customers school and by the hardware. So that was a real Catch twenty two and I honestly don't know if Catch twenty two is one of the DVD is available at the time. Jim Cook, the guy who I mentioned earlier who had become the head of finance and operations. I hadn't mentioned him by name yet, but he was the finance and

operations guy in the early days of Netflix. He helped Randolph and Kish tweak their business plan, and he was really good at raising concerns about the cost of operations and the risks of getting into a business with a medium that had yet to receive wide adoption. So he would raise points of concern and it came down to Randolphin Kish to figure out, well, how are we going to address this, how are we going to answer this point of criticism, And so it became a back and

forth and it helped kind of improve the process. Before they ever launched, they also designed and tested out the postage paid mailers, the inn actual envelopes that they intended to use with the DVDs, and they ended up bringing their friends and family across the United States in on

this to try and test out the system. So they would mail disks to their friends and family across the US that the friends and family would tear off the little return address or the shipping address which would have the return address underneath it, and then they would put

it back in the mail. And so most of their friends and family didn't actually own DVD players, so they would get this envelope with disks in it, and they would take the little label off and then they would pop it back in the mail without ever having watched anything because they didn't have anything to watch it on.

So the real purpose was really to see if the mailers adequately protected the disks and if they could hold up to the trip of being sent across the United States and back again and still be usable for future rentals.

One thing that the team. Included was a special barcode on each of those envelopes, and this was really important because the barcode allowed the envelopes to skip certain steps in the mail sorting process at postal services, at post offices, and otherwise those envelopes could be really badly damaged and the discs could be crushed inside. So Randolph learned about a service that would allow him to skip mail sorting automation.

All they had to do was pre sort the envelopes on Netflix's side, So he created a system that used a barcode scanner, just the kind that you would find in say, department store a grocery store, and they would print these barcodes on the envelopes and in the warehouse you would scan each envelope and it would tell you which bag out of like twenty seven bags you should

put the envelope. And then you had all that pre sorted before it ever got to the post office, and it could skip the sorting stage there and go straight to wherever it need to go for that particular zip code. The original mailers were made out of cardboard and they had a little bit of stiffness to them. They could

hold up to three discs at a time. Originally, and like I said, they had that removable address flap on them that when torn off, would reveal Netflix's return address and that could be used as the return envelope for the discs. The original DVD storage vault, as in the place where they would actually hold the DVDs they would use for rental, was initially a room in their office space.

It wasn't a warehouse or anything um. In order to hold all the DVDs, they were maximizing the use of the space so much that the aisles were only wide enough for one person to go down the aisle at a time, and after testing out numerous configurations to find which way was the most efficient, they eventually landed on a an arrangement that essentially copied the way Blockbuster stores were laid out. It seemed to work best. It made

finding the relevant copies faster and more efficient. The team also worked on pricing models for rentals and ways to promote the service, including users getting their first rental free, though they were still charged shipping and handling fee. But one thing they did not yet have was a name. I'll explain how they came up with that name in just a second, but first let's take another quick break to thank our sponsor. One of the original names the

group debated on using was Kibble Incorporated. Now this goes to the concept of, and I hate this phrase, eating your own dog food, the idea that the people who build the business or service will want to use whatever that service or product might be. And you hear this among developers frequently, that you're eating your own dog food means that you actually make use of the apps that

you develop. The team gravitated towards finding a name that would consist of two short words, ideally words that are one syllable each. They wanted one of those two words to reference the fact that the service was all about movies, and they wanted the other word to reference the fact

that the service was web based. And so they eventually made a list that had two columns and down one column were terms and slang that were related to the web, and down the other column was a similar list, but it was slang in terms all about the movie industry. And then they started matching up different names to come up with a potential name for a company. So some of the early suggestions included replay, dot com, direct, Picks dot com, Cinema Center dot com, and e flix dot com.

But as we all know, the eventual winner was Netflix dot Com. That was the one that people I guess objected to the least they I don't know that there was anyone who was passionately advocating for the name, but there was no one who was in great opposition to it, and so that became the name of the company. The original logo was in purple and white. It's easy for

us to forget that that was the case. That the Netflix is branding is so um so powerful now with the red and white scheme that it's easy to forget that originally was purple and white. It had an unspooling reel of film as part of the logo design. The red and white color scheme would come much later. They brought on a guy named Corey Bridges to work in customer development, and Bridges had previously worked for Netscape and

helped launch their internet browser. Bridges secretly reached out to influencers and use net groups because this was before stuff like YouTube and Instagram and other social media platforms. But he saw those folks and use net groups as being really passionate community members, and by tapping into people who were really big users in and use net groups that were focusing on film discussion and asking them if they would participate in a beta program that Netflix was going

to hold. He got a lot of responses, especially when he said that they would be allowed to be the first people to write about this new service once it was ready to launch, that they would essentially have the scoop on everyone else, and his promotional plan worked like gangbusters. They signed up eagerly to test out this service. On April fourteenth, the company was ready to go live. They had built up a library of DVDs and they had

tested the features with their beta testers. Read Hastings, who had provided the seed money, had mainly stayed out of the actual development process while all of this creative work was going on. This was Mark Randolph's show for that initial few months setting up the company, but read Hastings did arrived at the company and watch as they actually went online, so he was there on hand for launch day. In fact, the story goes that some of the other

employees didn't even know who read Hastings was. They had never even really chatted with him at this point. So while this team was working on Netflix. Hastings had actually gone back to pursue more graduate studies at Stanford. And here's one way that Netflix was a very different service when it first launched then it would become later on, and why the story about Hastings and those late fees doesn't ring terribly true even before we heard about Mark

Randolph's version of the story. When Netflix first went live, users didn't get to subscribe to rent films indefinitely and just pay a monthly fee. Rentals had a seven day duration and after that you were expected to return the DVD in the provided postage paid mailer envelope. And the different titles even had different rental fees. Not everything was priced exactly the same. I actually used the Internet Archive wayback machine. If you've never used that, I highly recommend

checking it out. It allows you to look at uh snapshots of websites from over the years, so if you pick a website that's been around for a long time, you can see what it looked like in different years. And so I went to the earliest date available for Netflix dot com and on the Internet Archive that date would be January sevent so, not quite a year after

the company had officially debuted. This is still before Netflix would move to a monthly subscription plan for users, however, So you would rent DVDs for a week, and if you wanted to rent let's say, the film Blade starring Wesley Snipes, you would need to cough up four bucks to rent that movie. But if you wanted to rent Star Trek six the Undiscovered Country, that would cost you

five dollars. Now you could rent as many films as you liked, and there was an offer on the site saying that you could actually save money on a per rental basis if you chose to rent four or more titles at a time. About an hour and a half after they launched their service, their web servers already hit capacity. The promotional strategy had worked maybe a little too well. The use net groups were really buzzing about this new service,

and before long the servers crashed. So while programmer Eric Meyer worked on patching things up to get everything up and running again, he sent some of the rest of the programming team on a frantic trip to a nearby electronics store to buy more servers in order to boost capacity. Things were not going so hot over in the DVD storage vault either. In fact, things were pretty chaotic. The laser printer they were using to print out addresses jammed.

The flurry of activity meant the DVDs soon got out of order and it became much more difficult to track down specific disks, and every time the servers came back up, new orders would fly in, so the team was struggling to keep up. By the end of the day, they had orders to send out more than five hundred disks to more than one customers, and this was all done by hand, and it was sometime around them. They also realized, oh, shoot,

the Internet is always open. We can't close. It's not like from eight pm till six am we're shut down. So the site still has to be active. It still has to be up and available, even though we won't be completing any more orders until the next day. That was a stark realization. They soon included a message during high capacity situations that read, sorry, due to extreme opening week demand, the Netflix Store may be slow. Helping or hindering things was that while Netflix was in development, the

DVD player was a novelty right that people. Very few people had them. But by the spring of nine, when Netflix was actually launching as a service, it was a different story. The price for DVD players had come down to about half of what they had been and DVD player sales were starting to outpace VCR sales. So while in late potential customer base was small, by spring of that had changed. So it was kind of a right place, right time scenario for Netflix. Movie studios were playing ball too.

As sales picked up, studios began to release more of their libraries on DVD. Now they saw that there was a demand for this kind of home entertainment, and they saw the opportunity and they began to jump on that. New titles and old became potential revenue generators. And Netflix, which was protected by US president that had law that said a company can buy and then rent out movies. That is totally fine by law if you if you buy a product, you can rent that product out to

other people. So Netflix was taking advantage by scooping up copies of as many different titles as it could, building out its own library. By August, those initial five titles were now closer to and because VHS rental chains like Hollywood Video and Blockbuster were slow to adopt the DVD format, Netflix had a good running start on them as well. Those companies were so entrenched in the VHS world that they thought of switching lanes and moving to DVDs was

really daunting it. It represented an enormous cost for them to be able to change formats like that. So Netflix, because it had not been entrenched in another medium, was at an advantage. So it was an auspicious beginning. And

we're just getting started now. In our next episode, we'll look at how Netflix, whether the first year or two of its existence, and how it started to come up against what would become its main rival for the first decade of Netflix is existence as a company, that being Blockbuster. If you guys have suggestions for future episodes of tech Stuff, whether it's a company, a technology, a person in tech,

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