Acquired - Season 3, Episode 9: Netflix (Part 2)

Episode Date: November 25, 2018

We complete our two-part Netflix special with the company’s bold transition to streaming, including of course the most (in)famous spin-out in business history. Rising from the ashes of Qwikster, we chronicle Netflix’s rebirth as a media company and long journey back to the top of the FAANG mountaintop!Sponsors:ServiceNow: https://bit.ly/acqsnaiagentsHuntress: https://bit.ly/acqhuntressVanta: https://bit.ly/acquiredvantaMore Acquired!:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Merch Store!Links:Netflix’s Qwikster apology video: https://youtu.be/c8Tn8n5CIPkSNL parody of the apology video: https://bit.ly/2PWEyyZEvolution of Netflix home page: https://read.bi/2KvHdteThe Chaos Monkey: https://bit.ly/1qkqDxZ Benedict Evans’ chart of FAANG stocks: https://bit.ly/2r3D72A Carve Outs:Ben: Kevin Rose interviews Matthew Walker on sleep: https://bit.ly/2LpIl5vDavid: Justin O’Beirne on Apple’s new Maps: https://bit.ly/2zrQ76Z

Oh my god, David, look at that podcast room you are in. That foam padding. Welcome to Season 3, Episode 9 of Acquired, the show about technology acquisitions and IPOs. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today we are back with the acquired version of Terminator 2, the second part of our Netflix episode. You like that, David? It's just for you. Oh man, that's great. That's great. Love it. Listeners, now if you remember the last episode we did covered the DVD saga of Netflix and where we left our heroes in 2009 shortly before the epic launch of Quickster. So today we're going to dive in on the era of streaming and later original content. So David, I wanted to have

a fun fact to start us off on Netflix. So as you remember, they were once a plucky startup mailing DVDs to customers and a remnant of the pre.com bubble starting in 97. And they were once a plucky startup mailing dvds to customers and and a you know a remnant of the pre.com bubble starting in 97 and they were doing this you know even before most people had dvd players they were waiting for the dvd wave to crest this company now accounts for 15 of all internet traffic i know that's in my show notes. And at peak times, it can even account for 40% of the US's concurrent internet traffic. So you could imagine maybe like 8pm Eastern or something like that. Absolutely incredible. Yeah. And this is with some of the best compression and optimization technology that like humans

as a species have figured out how to do. The last episode was about a company fighting to get its first 500,000 customers. And this episode is very much about sort of global domination. All right, listeners, we announced on the last episode that we had formally launched the acquired limited partner program. And we've been just totally floored by how many of you have have joined our LP community, and are listening to the bonus show and are sending us really great questions for doing q&a on the show. David, last week's episode was like very fun. So I'm pumped I got to meet Dan and thanks for bringing him on.

Yeah, it was super fun. We had Dan Hill, who in addition to being the CEO of Wave's first portfolio company, Alma, co-founder and CEO, he was Airbnb's head of growth for a long time and had just great stories about growing Airbnb from, you know, series B days to $30 billion plus and just so much to learn from him. So really fun to have him on the LP show. Anyway, listeners, if you want to hear Dan talk about why Airbnb was successful, sort of in the space and how they chose their metrics and a bunch of other great stuff, you can click the link in the show notes to support the show for $5 a month or go to kimberlite.fm slash acquired. That's K-I-M-B-E-R-L-I-T-E.F-M slash acquired. I feel like we really need a jingle for that.

We could just play that every time. Yeah. Acquired needs better jingles, period. That might be one of my holiday uh holiday projects yeah back to the show okay listeners now is a great time to tell you about long time friend of the show service now yes as you know service now is the ai platform for business transformation and they have some new news to share service now is introducing ai AI agents. So only the ServiceNow platform puts AI agents to work across every corner of your business. Yep. And as you know from listening to us all year, ServiceNow is pretty remarkable about embracing the latest AI developments and building them into products for their customers. AI agents are the next phase of this. So what are AI agents? AI agents can think, learn, solve problems, and make decisions autonomously. They work on behalf of your teams, elevating their productivity and potential. And while you get incredible productivity enhancements,

you also get to stay in full control. Yep. With ServiceNow, AI agents proactively solve challenges from IT to HR, customer service, software development, you name it. These agents collaborate, they learn from each other, and they continuously improve, handling the busy work across your business so that your teams can actually focus on what truly matters. Ultimately, ServiceNow and Agentic AI is the way to deploy AI across every corner of your enterprise. They boost productivity for employees, enrich customer experiences, and make work better for everyone. Yep. So learn how you can put AI agents to work for your people by clicking the link in the show notes or going to servicenow.com slash AI dash agents. All right, now onto the show. On to the show, indeed. David, I texted you before this.

We have a little bit of follow-up from the last episode. We have some awesome listeners that wrote us in about Netflix part one. And since this is a two-parter, we do get to actually go back and make a few corrections. The first one is actually on my carve-out from last week, where I mentioned that The Good Place was a Netflix show. That is a classic millennial mistake. It is completely not a Netflix show. It's an NBC show that just got syndicated on Netflix. But my cord cutting had blinded me from that. And Netflix originals have just gotten so good and plentiful that I just assumed that I was watching a Netflix show. So that mistake. What foreshadowing for part two. I know.

The other one is that we discussed that Blockbuster had an incredible business model where they only had to pay rack rate for DVDs, and then they could rent them as many times as they would like. Thanks to, on Twitter, Jim underscore Brown, we have a correction. It's difficult, actually, to track down the exact number. It's sort of buried

in some academic papers. And I think it came out in some court case filings that I gave up on trying to actually find it out. But it's somewhere between $50 and $100 that they actually had to pay for every DVD rather than just getting to sort of buy them at store price in sort of a special deal that they'd orchestrated so that they could generate the sort of high rental revenues that they got from each one of those DVDs. So good to know there. And thank you to Jim for correcting us. And the third one is we had an anonymous listener send us some amazing facts about Redbox after we briefly touched on it in the last episode. So Redbox, as you know from the last episode, was actually originally a project at Netflix

that an executive quit to go and work on full-time. So Outerwall, which was Redbox's once parent company, was acquired for over a billion dollars in 2016 by the private equity firm Apollo Global Management. And Redbox is now a standalone company inside of Apollo. Turns out it's wildly profitable. They're actually working on starting a streaming service of their own, standing up a second attempt of that.

But looking at their core business, it's not hard to figure out why they're wildly profitable. It turns out running a retail footprint of six feet by six feet that rarely requires human intervention can be wildly profitable. No surprise there. They have like the, you know, if you think about sort of like the dollars per square foot per month at retail establishments, like one way people always focus on improving the numerator there, but you could also lower the denominator. Yeah, they've sort of gained the system on that metric. But here's another crazy thing about

Redbox right now. So in Disney's attempt to build their own relationship with customers through the, in my opinion, very dumbly named Disney Plus, they do not have a distribution agreement with Redbox. So what does Redbox do to get the Disney titles on their machines? Well, we heard a great story. It is official company policy to send employees store to store when new Disney movies come out to buy retail copies of the DVDs, I guess Blu-rays, and bring them back to stock the machines. This is actually how Redbox acquires Disney movies to put onto their platform. Wow.

Which I kind of imagine are some of the most popular titles on Redbox machines. I just think in general, think we we sold the company short last episode um they deserve some of the credit also for destroying blockbuster because while netflix was hard at work hammering them on the online front redbox was also doing for one dollar what they used to do for three dollars and in many ways easier because they sort of had more endpoints at more stores blockbuster's main business was sort of under under attack there as well so lots of kudos to Redbox

for being a major player in this industry. Indeed, indeed. All right. So David, can you take us in to what year 2007 rewind a little bit and start with with streaming? Are you going to like find some way to go to like early 30s? Not that far back this time. But we will pick up the story in part two. As listeners remember, in part one, we covered the story of Quickster. I mean, Netflix from founding to 2009. Once again, also in part two, I want to shout out the really excellent book Netflixed by Gina Keating, which provides a lot of the history and facts. And really, for anyone who's more deeply interested in this company, and this history, can't recommend enough that you go read it. So we ended last time in 2009. Netflix, not yet Quickster, had basically, you know, snatched victory from the jaws of Blockbuster. Do you keep calling it Quickster?

Because like their whole business basically was Quickster? Yes, this was Quickster. Everything we discussed in the last episode was Quickster. They just reached 10 million subscribers. It's 2009. The recession has beset the US and the world recently. And Netflix is one of the few companies that is thriving during the recession. They're basically on top of the world. But the waves are shifting. Streaming is coming and like any good you know sea captains uh at sea reed hastings and the netflix management team uh they

see this and they know that they're going to have to adapt and they're going to have to embrace this uh this new tidal wave of streaming that they see coming so So to rewind a little bit, how did streaming kind of come about? So really, I mean, I think you can point to this was our first episode. It was our first acquired episode, right? Disney Pixar. Yeah, first or the second. I can't remember Instagram or Pixar was one of those. Yeah, those are one and two. But anyway, Disney in 2006 had acquired Pixar. And that, of course, brought Steve Jobs became the largest single shareholder in Disney and Steve Jobs joined the Disney board. And after that happened in a couple years following, Disney made a made a pretty unprecedented move. They brought all of their video content to the iTunes store. And so for the first time, all of a sudden, I remember doing this in college. And right after you could buy digital copies of Disney movies and ABC TV shows. I remember doing this with Lost and you could buy a whole season at a

time. Now this was not streaming. This was downloading. You would buy it on iTunes, download the entire file to your computer. In the beginning, there wasn't even a video iPod. I like the disdain that you say for computer. the entire file to your computer um in the beginning there wasn't even a video ipod i like the disdain that you say for computer like you're as if some like archaic device it is it is i say as i'm talking into one but i'm rapidly trying to move everything to ipad but and so that really kind of started to open the industry's eyes this was the first like this was real content mainstream content that that now could be available digitally The other thing that happened right around this time is U.S. broadband penetration finally passed, you know, 50% and then kept growing and became really

ubiquitous. You know, this whole business, whether downloads or streaming would have been impossible in the dial-up days, but Budband finally enables it. So Netflix, of course, and Reed Hastings and the management team, they see all this happening and they know they need to do something. So in 2007, they make a pretty key hire onto the team. They hire a man named Anthony Wood. Now, Anthony had been the founder of a successful DVR company. So you know those like set-top boxes that were like TiVos? So he had founded a competitor to TiVo called Replay TV that had been successful. And so they hire him to come and be a VP at Netflix and to work on what they're calling the Netflix box. And the idea is that this would be a set top box made by Netflix that people would would buy and put in their homes next to their DVD players. And initially, the vision was it

would have a hard drive in it. And just like when you would download a Disney movie via iTunes on your computer, you would download a movie from Netflix onto this box and it would play it off the hard drive hooked up to your tv i think i glazed over that at the research like but that before streaming it really was like it was it was basically a nas like a a network store you know i just keep a bunch of stuff at at home well it was it was a replay tv it was a dvr that's what it was uh it was a hard drive um they realized though that that actually with broadband like you know you have to wait to download the movie when you're um in in this old paradigm that actually just streaming they had the

technology to do that and that would be better so they pivot the project into that the the box is is coming along but reed and the management team they started to get worried though uh this is late 2007 they they worried that if they release their own box, they see that there's fights coming in this new paradigm. They're going to have to fight with the cable companies. They're going to have to fight with the content companies. And they realize that if they release their own box, they're also going to have to fight with the consumer electronics manufacturers. And Reed's like one of his main jobs at this point is sort of going door to door with Xbox and with I think PlayStation and like really lining up these partnerships saying, hey, we think streaming one of his main jobs at this point is sort of going door to door with xbox and with i think

playstation and like really lining up these partnerships saying hey we think streaming is going to be a thing we're working on a way to get that delivered through the browser on computers but we know that a lot of people are going to be reticent to you know when we do this watch on computers so they probably want to do on tvs you guys are plugged into tvs and and he's realizing like boy these negotiations are are not going to go well uh if i have my competitive device to you guys what does he do we've seen this before he tells anthony yeah we're gonna have to cancel the project just like they did with redbox and and he says oh okay well you know we've basically built this thing how about we do something a little bit different i think they're two weeks from shipping from people who who know sort of how this process works,

they're in the third phase. So it's DVT, design and validation testing or verification testing. The whole team has been over in China, like manufacturing these things. They've done several revs. They're coming off the line. I think they have 100 or 50 units made that are done and perfect. And they're taking those on the roadshow to show sort of demos to potential partners. Yeah. This thing's baked. It's baked. Yep.

And in a classic Netflix management team, Reed Hastings move, it's, nope, we're changing our mind, as we will see. But Wood convinces them, OK, rather than killing the whole project, how about we spin this out as a separate company we've already built this device it will behoove you netflix to have this device out there to be the initial you know device streaming partner for this netflix streaming service you know we can have a win-win here and i get to run you know my own company here well they talk it over they decide okay they spin the company out and they name it roku roku actually um was a name so wood had had a essentially a shell company after the after selling replay tv and uh or moving on from replay tv it started a company called called roku which

i believe in japanese means six is the number six and uh it was that this was his sixth company that he had started something like that yeah exactly that and uh and so he essentially restarts this company leaves netflix and takes this box that they've built within netflix and rebrands it as roku and launches it in early 2008 and it is um you know it goes on to great success and is now its own public company uh ipo earlier this year but they are the first device streaming partner for this netflix streaming service and just like netflix wanted following this this is sort of the proof of concept they sign up microsoft and xbox as a device partner streaming comes that summer to xbox 360 um netflix streaming and then they start you

know going to playstation they go to all these devices, knocking them down one by one. Can we just pause and reflect for a moment? What an unbelievably gutsy management decision that is like you have this whole like arm of your company for, for listeners who are interested, we'll put a link in the show notes, the team like a month before canning it, or maybe a couple of weeks before canning it did an all hands where a group of employees did a parody video of the dharma initiative from lost which was huge at the time of of the sort of like secret project to build i can't remember what they called what the sort of secret project name was um all i remember about lost is that it was it's like such a period piece now oh the code name was griffin so it was it was like such a period piece now. Oh, the code name was Griffin.

So it was like the Dharma Initiative logo with Griffin in the middle. But this video is amazing because it was shown at the all hands. It's got everyone from people who worked on it to the manufacturing team in China to read Hastings as part of this video. And they're showing it to everyone at the all hands as like a hype video for get excited about this new strategic direction the company is going to take. We're doing hardware, baby, like we're doing our own video codex, like we're going from silicon all the way up to the cloud, and we're going to own the whole thing. And then just like on a dime, boom, it's its own company,

like it's its own company that goes on to be wildly successful. I mean, it's really amazing. Like, I don't know if this says more about me and me living under a rock or just that like this history of Netflix is not told that both Redbox and Roku come out of Netflix. Like it's crazy. They've had more spinoffs than they have their own acquisitions. I think they've only ever acquired one company. I know what their first was. I don't know if there were other ones after that. And their first was quite recent. But the Roku thing, just one more note on this. I tried to do a bunch of research to figure out when they spun it out, what did the ownership structure look like? You're totally not living under a rock because I looked through the entire Roku S1

and a couple times it mentions Netflix as, obviously they have a large dependency on Netflix's business. It mentions in two places a lease that they shared with Netflix in the sort of early days, but it doesn't mention anything about Netflix is part of the founding story of the company. Reed Hastings nor Netflix appears on the cap table when they're going public of sort of major shareholders. Which is interesting because Netflix invested $6 million when they spun it off,

but I wonder if they'd just been diluted so much one other thing that's six million dollars i tried to find uh more information on that to figure out like if there was a valuation on the company if they what it looked like uh there's a form d filed on edgar which is the sec's website that you can go to that shows an investment it doesn't name name Netflix. It just names Reed Hastings. So maybe it was some kind of proxy thing because I assume it was Netflix. And it's scanned improperly. So like you get to read half the previous page and half of the next page while you're looking at this document

and scrolling through it. And none of it's in a digital format. So it's like one of these things that's like, you really have to scour to find anything. And then you can't find that much other than the fact that it was killed and spun out amazing and this is now a you know billion and a half dollar market cap public company crazy so that's the story of the genesis of the one half of the streaming business for netflix which is the distribution getting getting you know content

into people's homes but but it turns out the other half of the streaming business, the content side, quite frankly, proves to be the harder half over the coming years, or at least the more capital intensive half. So unlike DVD rental that Ben was addressing in the follow-up in the beginning of the show, at the top of the episode, unlike DVD rental, there's no first sale doctrine here. So to stream content, be it, you know, shows or films to people via service, you have to negotiate with the rights holders of that content, and you have to buy those rights from them. Now, in the early, very, very early days, the 2008 2009, when they're just getting started here, the content companies don't

really see the future as clearly as Netflix sees it here. You know, these are the days when cable network content deals are like still huge and the vast, vast, vast majority of these content companies revenues. So they view streaming as just kind of like a nice add on. So the first deal that content deal for streaming that Netflix actually does does is with stars the pay tv cable network this is a total steal so they do a two-year deal in october 2008 with stars to get all of their content for 25 million dollars so this is tv shows movies their back catalog everything that they have the rights to um stars quickly comes to regret that

but it's only a two-year term does stars does stars actually own the rights to all those movies that they're putting on their sort of like high hundreds cable channels yeah so i believe the way this works this is i'm mostly conjecturing here but i i'm recalling my old days as a media tmt investment banker around this time i believe the way it works is that stars had negotiated with the with the content production company be disney fox you know whoever nbc who had originally made the movies and tv shows um they had acquired the rights to show them on cable and i believe it also included streaming or whatever the language but it wasn't really something that was contemplated then but they had the right to then resell those rights. That's a theme between music and movies. Really all media is like you, since you don't know what the next frontier is going to be,

sometimes people can sort of slip it into the contracts. Like if, if it's like, oh yeah, we'll just bundle in forward looking like the VR rights to this thing. And you're like, yeah, yeah, whatever. But like, you don't know what what's gonna end up being huge and what's not yep totally this happens and and netflix also does a deal in 2008 with nbc universal for uh streaming access to some of their content including saturday night live i believe streaming the day after uh on sunday um once again just like we saw with netflix in in one, this is like instant product market fit. So, you know, everybody who, uh, has, is any inkling of watching video on a, you know,

computer or mobile devices are emerging any screen at this point. So, you know, mostly millennials and younger, but, um, but lots of other people too. I mean, YouTube has been around for several years at this point. They just go nuts. And this drives tons of signups for Netflix, even during the recession. It's a way better product. I mean, like, why would you, the old paradigm is you only watch video when it's on TV, you know, when you what you want is on versus you can watch it whenever you want, wherever you want. Like that's no-brainer customer value prop there and i remember in the summer of 2008 previous to that i wasn't able to do netflix's what did they call it like instant

watch or watch now feature i think it was instant q you had your regular netflix queue for dvds and then the instant queue was your queue of what you wanted to watch you know lined up uh via streaming you're so right yeah and and you could only it only worked on windows because like they just hadn't they hadn't gotten around to building the sort of mac client for it yet and then when they did you had to like use i can't remember what browser it was but it only worked in one browser and you needed silver light so like think about sort of this oh my goodness the way that this works today and the way that it used to work it was just the kludgiest way that this works today and the way that it used to work

it was just the kludgiest way that you could imagine trying to like it would take 15 minutes to get the video sort of set up on your computer so you could watch it this was the only reason i had silver light installed on my computers wow how quickly we forget this is you know 2009 2010 netflix is just but they've beaten blockbuster at this point yes they're competing with redbox but like they're the only game in town when it comes to streaming they are having a bonanza just adding subscribers uh like there's no tomorrow and so much so that by 2010 uh ben gave the stat that um today netflix is still 15 of all u.s internet traffic back then in 2010 they were 20 percent of all u.s internet traffic oh wow internet grew yeah i assume uh well think about how much more streaming video

there is now versus in 2010 um right yeah it probably wasn't 68 percent of the internet or 58 of the internet then yeah i mean of course there was youtube much smaller than it was today but you know there was no uh there was no amazon prime streaming there was no facebook video there was no you know snapchat there was no instagram nothing infrastructure wise there also wasn't gigabit to the home then yep yep yep and netflix already knew this was the future this is like not just the future this is now so they they realized they need to sign up as much content as possible and just keep this keep this train running. So they're willing, the content companies are also seeing this and saying, oh, wow, we can

extract a lot of dollars out of Netflix. Netflix says, we're happy to pay dollars. We've got subscribers coming out the wazoo. They sign in 2010, remember their first deal with Starz was $25 million. They sign an $800 million deal, five year deal with epics EPI X. Now epics was a joint venture between paramount, um, which is part of a Viacom lion's gate. Paramount was the, the film, uh, studio of Viacom lion's gate independent and MGM, which were the two remaining major independent film studios. So they get all of their content, all the back catalog, all the new content that's coming out.

And MGM at the time, I remember I was working on Wall Street. They were facing bankruptcy, and so they desperately needed this cash. And it was this Netflix deal that Between Epics really keeps a lot of these companies alive through the recession. Everyone else sees this, and they start coming back. Two stars in NBC come back. They demand much more money. And Netflix realizes they need to get really smart. So they spin up a whole content acquisition department and they start spending a lot of money acquiring all this

content. So there's foreshadowing there. Netflix spending a lot of money on content. Okay. All right. It's coming back. But a quick, real quick detour about the media industry. So all of these content production companies, the media industry has been around for 100 years in the US. There has been tons of consolidation. They are either under the same parent company in the case of like Time Warner or very closely tied to the cable companies, to the distribution. Like content and distribution are all within the same house. If not directly, then at least they're in bed together. Also going on as a result of this cord cutting starts becoming a thing. Consumers are saying like, man, I'm getting so much great content from Netflix, from YouTube, from streaming. And it's the recession. And you know,

cash is tight. Do I really need to be paying 100 bucks a month for my cable subscription? So so you've got the the content side of the house then you're saying is like very incentivized to do these deals but the distribution side of the house is like wait a minute yeah this is the thing accelerating our death like can we have a conversation for a minute yeah exactly so they the distribution side of the house the cable companies they start getting very protective versus net. Now, what do the cable companies also own most of in the US? They own the broadband pipes to people's homes. Most people in the US at this point in time, and really still to this day, I would assume, are getting their internet connections in their homes that they're using to stream from their cable company, from Time Warner Cable, from Comcast, from whatever, from their cable modem. Quick side note, do you know about fast.com vaguely but so forever i use speedtest.net to test my sort of upload and download netflix was having all these issues through all the net

neutrality stuff where as you're about to suggest the pipes did not like them because they were taking up most of the bandwidth but not paying anything special to be on them. So Netflix was getting throttled. So what did they do? They created fast.com and put it on the same IP block and on the same CDNs as their content. So then they were in a big campaign and encouraged users. By the way, fast.com is a great way to check your upload and download. It is far sort of like simpler and lighter than speed test. They encourage consumers, hey, if you ever feel like, gosh, it might, why is my Netflix slow? Go to fast.com and compare that against however fast you think your internet should be. And you'll get a reading of, you know, what your ISP is actually treating us as in terms of upload and download speed. Interesting. Well, of course, Ben, what you are referencing here is throttling the the cable

companies the the isps they start throttling netflix because it's a competitive threat to their whole business model so what does netflix do reed hastings is like i can play politics i know how this works remember back to part one uh and his days on the california board of education he starts a pack a political action committee committee, called not to support a particular political candidate. It's called FlixPAC, and it's to lobby the FCC to set up net neutrality rules. So if we all go back in the time machine a little bit here and start remembering,

when did net neutrality start becoming a thing? When did we first start hearing about this? It was in 2010, and it was because of this. And it was because of Netflix that really, remember all these campaigns about net neutrality and Stop SOPA and all this stuff? Who's behind it? David, some of us wrote a big 40-page thesis paper

on network neutrality in 2007. So like, you know, hipster net neutrality. You were just ahead of the curve. I was. It's the only time in my life I can ever claim that. And I remember these big, huge, huge fights. And then finally, at the end of end of 2010, Netflix wins and the FCC approves rules essentially preventing ISPs from from blocking content. That's under attack again today. I don't know actually the details of the latest fcc ruling um this year last year in the trump administration uh i believe reversed a lot of this this is one of those things i followed and then the rest of the world's news

got so insane that i lost the thread yeah yeah me too so i cannot speak authoritatively on this anymore anyway um so 2010 basically goes really well for netflix they're spending a lot of money but they're they're growing hugely 2011 also starts on a very positive note they finally launched international expansion now international was hard to do with the dvd rental business because you needed you know basically cooperation of the national post office and all this infrastructure and everything um but streaming you know it's just it's just bits. It's not atoms. And turns out a lot of the world speaks English, too, and watches US made Hollywood video content. So first, they expand first in Canada, naturally, and then before the end of the year in Mexico and Latin America. And this becomes a huge, huge growth driver for them over, you know, the subsequent

throughout the 2010s. Now now international is a bigger business for netflix than their than their u.s business um so all going well they're you know still kind of on the top of the world here and this is 2011 2011 yep i don't think we talked about the chaos monkey on the last show correct no i don't know we didn't talk about the chaos go for it all right so this is the the time that netflix decides we're fully now an internet company in a bigger way you know that we're a streaming company and so we need to be world-class at technology and anybody that has that watches netflix today sort of knows like it is remarkably bulletproof like that it kind of always works and how is that well netflix invented something that you can find

on github now that's part of a larger suite of software that's open source in 2011 called the Chaos Monkey. And what the Chaos Monkey in its original incarnation did was it was a software package that you would turn on on the server, sort of on your whole infrastructure, and it would just start pinging around all the different internals of your system and just kill random processes at will. It was literally a chaos monkey. Yeah. And what it would do and the philosophy behind the whole thing was what better way to prevent failure than to always be failing and be able to construct systems that are extremely resilient and sort of fail gracefully

instead of failing in a catastrophic manner. And so some of the original things that they did were the experience could degrade where the resolution would get worse or where your recommendations weren't available or your profile wasn't available, but you could always do the number one thing that people want to watch on Netflix, which is search for a thing and then watch it. And it's just crazy impressive mentality that, you know, back in 2011, they're pioneering sort of like a, it's actually, it's used in a ton of companies now. There's that book famously named Chaos Monkeys about Silicon Valley in general. It's sort of a brilliant infrastructure decision and just showed the sort of level of talent in the

engineering department there. they still run it now like nine to five or something so they don't have to wake people up in the middle of the night because the chaos monkey tipped something over that that you know was still sensitive it's very humane it's a humane chaos well an apt analogy for what's about to happen here i feel like this is also the story of the business side of the netflix house which is like there's a chaos monkey running amok and they keep shooting themselves in various body parts but managed to persevere uh and are very very robust uh as a business so summer 2011 now this is when the dominoes start to tip the other way they make an announcement so again we're now a couple years

into this streaming business it's again instant product market fit people love it it's 20 of the internet they know this is the future so up until this point everybody who was a netflix subscriber to the dvd rental business just got the streaming baked into it like you just subscribed to netflix it's just one product it's like prime we're just going to throw stuff in to sweeten the offer exactly summer 2011 they change the pricing structure or they issue a press release and they're a couple there are a few things in this press release what gets all the attention is they come out they build this as a price cut it's anything but in reality. Come on, don't bury the lead. Like PR rule number one,

if you're about to announce something that consumers hate, do not make the title, you're going to love this. I thought you were accusing me of burying the lead. No, the lead comes later. No, no. Separate press release, but yes. Yeah, no, totally. No, no, no, I'm saying yeah, that press release,

hardcore bury the lead. Yeah, this is gunshot wound, self-inflicted number one. So what did they do? They changed the pricing, their pricing tiers to, so they now have three options. You can subscribe to just DVD rentals and they bill that as a price cut. So cheaper than what just subscribing to Netflix was before. You can subscribe to. Meanwhile, they know the greater usage is on the streaming side.

Yeah, right. You can subscribe to just streaming for also cheaper than the price of the old bundled Netflix plan. Or you can have the bundle. You can have both. And that goes up, I think, like 20% of price or 20 or 25% or something like that. People react very negatively to this quote unquote price cut. So negatively, they lose a million subscribers basically instantly

now they've grown a lot so it's not like you know losing a million subscribers back in part one was like losing you know 20 of their business um but still like it's the stock price takes a beating yeah it's still very significant people people are very upset my father was one of them and i don't know if he still listens to the show but i distinctly remember him like boycotted netflix for a year or two before he signed back up and he was furious about this again this is the recession like it's just so tone deaf like people loved netflix like people were losing their jobs and cutting the cord on their cable company but keeping netflix because this was like their you know their happiness like it was like one of the most high whatever the you know those brand ratings that they do netflix was like one of the most high, whatever the, you know, those brand ratings that they do.

Netflix was like up there with Apple and Amazon and like the very, very best, best brands in America. And this just did huge damage. People felt betrayed. Their stock plummeted too. I mean, I think Netflix has always sort of been valued on their subscriber growth and actually more recently really on sort of what their uh projected subscriber growth will be next quarter um and this was to to have a down quarter where they actually lost subscribers it was like what the only time this had happened in the past is what we saw in part one when when blockbuster launched uh total access so what are they going to do

hastings has a plan of course now we should know i forgot to mention earlier um at the end of 2010 also something you know long time coming foreshadowed that we knew happened but sad for netflix their great hero barry mccarthy uh retires and leaves the company he decided not to leave his friends in the knife fight against blockbuster i'm sorry against amazon when they thought that amazon was coming in and so uh now now, now, now they're safe. So he can leave. He leaves. And, uh, he takes some time.

He, he becomes an investor with TCV and, um, then does his short stint at clinical and then joined Spotify, uh, as, as we talked about in that episode, but back to Netflix.

So there's no, no Barry McCarthy read, you know, he has a plan to address this issue. He thinks that the way to do it is, you know, he knows the future. It's the public that doesn't get it. is, you know, he knows the future. It's the public

that doesn't get it. They don't get that streaming is the future. He is going to open their eyes to this. He just needs to push harder. In that first press release about the price cut, quote unquote, that got so much negative reaction, kind of at the end, he said, you know, and this is a precursor to we are going to spin off the DVD rentald rental as a separate business eventually he decides that the way to fix all of this is explain that this is really part of the bigger strategy and to do this spin-off and execute it and show america like the path forward so he decides the way he's going to do this so so the plan is that they're spinning off the dvd rental business into quickster and a long time netflix um executive who we didn't talk about in the last episode andy rendich who who ran um i

believe ran all dvd operations he's going to be the ceo now now quickster yeah and he'd been there for like 12 years or something he'd been there for a long long long time how are they going to do this they're going to do what you know all the hip kids are doing these days they're going to make a video and they're going to post it on youtube and it'll go viral and everybody will understand you know the vision great it's gonna be this is like the 7-eleven dude at blockbuster coming back and be like the kids they're gonna come they're gonna eat pizza the blockbuster stores was it was it party on the block uh rock the block rock the rock the block this is the rock the Block moment for Netflix. They're going to post a viral video on YouTube.

Well, they make a video. Reed and Andy, they make a video. And it does go viral in September 2011. Hashtag winning. Hashtag winning. But it goes viral for the wrong reasons. We will link to this video in the show notes it is still on the netflix youtube channel i think this might be the most painful

thing i've really ever yep it's still there i so i i thought it would be you know on youtube somebody else and many people have mirrored it and you know copied it on on their accounts it's still on the netflix account this is amazing they're proud they're proud oh my god this is the one of the most painful videos i've ever watched in my life imagine the least like cool most fake like corporate like dad thing you could ever imagine and and then multiply by 10 that's this it's so bad and it's a three and a half minute video the two of them basically like it's like scripted so like they're trying to be hip and cool they're on like patio furniture outside the netflix headquarters and reed is wearing like a like a teal like shirt he's got his goatee and like most people never

seen reed in person at this point listeners if if if this is ever us and like we are we become like tone deaf like maybe we are already please write us emails please acquired fm at gmail.com oh don't worry if we do something like this i wouldn't be worried about getting feedback because within like days of this getting posted read on his personal blog he gets 30 000 comments on his blog basically just trashing him for like how bad this is so saturday night live they it's so this goes so viral they parody the video on saturday night live they've uh fred armisen the um uh you know the portlandia guy he's andy i think and i forget who does uh does read we'll link to this in the show notes too and it's just like it's so funny you know the stock

price got crushed the first press release this time it gets crushed even for like netflix and quickster basically become the laughing stock of the internet um hey a lot of their big bets pay off a lot of them don't but they take big bets they take they take big bets this is one they really should have thought through a little more before the july press release they were trading at 305 a share after the quickster announcement they're down to 65 a share so they lose like what is that 80 of their value as a company in like a couple months here and and the quickster thing itself like part of it is a big part is the way they announced this and how this went down it's also just like it's half-baked like this is not a good product this is not well executed this is not well thought through so customers when they announce the spinoff and do it you have to have a separate account on quickster

and netflix separate billing separate queues that you manage separate customer service like separate company man what do you expect yeah talk about like a terrible experience this is this is like the kicker here netflix didn't even grab the quickster twitter handle so there was some dude out there who had the quickster twitter handle and uh fairly he was like a pot smoking like soccer player guy and he's like just starts trolling netflix and is like publicly extorting them and like you know oh so bad so bad what is the net of this what what all happens within one month it was september when they do this ill-advised youtube video announcing quickster within a month they cancel quickster they completely unwind the whole company andy uhed you know the the 12-year next Netflix veteran who'd been tapped as CEO like he's gone he resigns he leaves the company uh everybody you

know like half the people who'd gone over to Quickster they get laid off they're gone like they just completely like I mean this is one thing about Netflix and and and Reed is like they make big decisions they make them confidently and um you know if they're the wrong thing then they pull the plug so they they pull the plug on quickster another bad thing for netflix oh well bad thing at the time i think good thing in the long term happens for them in 2011 amazon they didn't launch the netflix competitor in the dvd streaming and the dvd rental era they launched the netflix streaming competitor amazon instant video and they launched the Netflix streaming competitor, Amazon Instant Video, and they get into the streaming game. And then early in 2012, they also do a deal with Epix,

the joint venture that Netflix had done a deal with, spend, I think, about the same amount of money, about a billion dollars, get all the same content. And so now, not only has Netflix just shot themselves in multiple body parts with this Quickster thing. Now they have Amazon out there, which is offering Amazon instant video bundled with Prime. If you're a Prime subscriber already, like Netflix is like, Oh, yeah, you were paying for Netflix. Like now I'm gonna make you pay twice for this. Amazon's like, Oh, great. Oh, yeah, you want this entire company's value prop for free? Yeah, yeah, yeah. Do you know sweetens our offering a little bit? Yeah, here you go go so the net result of this is 2012 is a tough tough year for for netflix i didn't go back and verify every quarter

but i believe they missed their subscriber targets every quarter of the year um the stock price is totally languishing uh still around the 60 a share you know one thing they do start in 2012 though that uh is a name no one will recognize but foreshadows everything to come is uh netflix produced their very first show called lily hammer yes they do which was a sopranos clone um i don't think it does i mean i don't never seen it um i never watched it yeah yeah but uh harbinger of good things to come uh but one more bad thing in 2012 this is wait let's go back to the let's go back to the bad parts go back to the bad stuff let's keep ripping on netflix it'll just make their rise

so much better this was another unbelievable thing that uh i i again i didn't know about the first part in part one and i didn't know about the second part here you cannot make this stuff up even if you did a netflix special carl eichen who comes in to you know the stock price is languishing by the end of 2012 who returns but acquired super villain he's like barry mccarthy's gone great but take another go at this one take another go at this one he is back in the movie business game he announces that he has accumulated a 10 equity stake stake in Netflix on the public markets. I believe this is October 2012. And, you know, he's going to start getting involved. I love how this happens to like in public companies, you can just slowly buy and buy

and buy and buy. And then, you know, you don't want to announce that you're buying, so it'll move the stock price. And then like, suddenly, you just say, Hey, guys, you may not know this, but through various sources, I have a 10th of your company. Yeah, incredible. You know, he thinks that that really what Netflix, guys, you may not know this, but through various sources, I have a tenth of your company. Yeah, incredible. You know, he thinks that really what Netflix should do, you know, there's been so much mismanagement here, you know, but there's so much value and streaming is the future. They represent strategic value. They should sell themselves to a media company or to another tech company.

Do you know if he held? Like, is he still a major Netflix shareholder? He held until 2015. And then he announced in 2015 that he had liquidated his whole stake. I believe it was about halfway through 2015. He made a ton of money. A ton of money. But the only, I guess, good thing for people who dislike Carl Ikener, if you're on the superhero side of the house here, is he misses out on like a ton of

gains still and like he believed in 2015 that like amazon was going to crush them and well that hasn't happened so he missed out on the majority of gains that he could have had but 2012 despite all this bad stuff that happens netflix now like they're they've really been the only player in this huge new market of streaming for the last, at this point, three plus years. They started figuring a couple things out that nobody else has figured out yet. And this is really what saves the company. They realize, they start seeing the data for how people are streaming. They're doing two things that were not obvious.

One, they're binge watching. So like when somebody sits down to start streaming Netflix, they stream for a long time. And if they're watching like a TV series or something, they watch just episode after episode. And up until this point, the media content industry operated on this assumption. I remember this of like appointment viewing you know like you know people tuned in at 8 p.m on you know wednesday to watch the latest episode of madman or whatever and like that was with linear television that is still what works all the top shows on linear tv are still exactly that and actually most of them are alive it's just

all sit around these like standalone like half an hour or one hour like get your fix and then tune in next week and and they realize that that's not what people want. They want to watch the whole thing all at once. And related to that, the other thing that they figure out is unlike the DVD rental business, the content that really works in streaming is television shows, not films, not these self-contained, you know, two to three hour films, but like really, really long form episodic content that people can binge watch. Television at this point, they're kind of like the, you know, the little sibling of the media world. Like it was the big blockbuster movies that everybody wanted to make. Yeah. So this brings back an interesting and

classic acquired fashion, jumping forward to tech themes, and we'll pull it back. But this brings back something that I think we talked about in the Marvel episode. That is, there's been a trend. I'm going to get the numbers wrong. But if you look at like in 1985 out of the top 25 movies, the number that were sequels, it was like three. And if in 2015, it was the exact opposite, like 22 were either sequels or some form of unoriginal IP. So you have this trend going on where Hollywood is spending more and more money on films. So because they're spending $100 million plus on every single production, they're taking less risk.

So they want more sort of sure things. So they're reusing IP from children you know, children's stories or bringing back movies from the 80s and 90s. So the experimentation needs to go somewhere. It's kind of the same thing as like startups, like the sort of the lean startup, where do you sort of prototype whether IP is good or not. So it sort of opens up the opportunity for this golden era of television or golden era of, you know, TV shows that attracts really top notch, both writers, directors, actors, and it really blows the doors wide open for some of the best people in the business who don't want to be part of Aquaman 7 to go and do something creative and original. And Netflix is

sort of the place where you could actually facilitate that format. Ben, you referenced Lilyhammer in 2012. You know, the one probably in and of itself wasn't that much of a bright spot, but that was what, you know, the sign that Netflix had finally kind of figured this out. What they'd learned from their customers was, hey, we need to pump more, you know, episodic series based, quote unquote, television content into the streaming platform so they make lily hammer they released it in 2012 and then in 2013 they do two things one they bring back i remember when this happened even though i wasn't a fan of the show but it was just such a

big deal they bring back arrested development yeah it was worse but better like it was more complex and crazy than the original register development, but like somehow it just, it didn't quite have the magic, but it was good enough that like you got your fix of what you felt like you'd be missing. Well, it's such a good example of giving people what they want,

you know, for this new platform. And then the other thing they do, they debut in early 2013, is their first real big swing at content, House of Cards. And this was just such a seminal moment. I did some research on this because I remember at the time, I binge watched the whole first and second seasons pretty aggressively and was a huge fan of the show. I remember at the time

reading about it and just thinking like, wow, this is so special. This company spent $100 million across these first two seasons. And I remember looking it up at the time, and I just sort of went back now to double check all that and see like what a big bet that was. So this is in early 2013. In 2012, the company had $290 million of cash on hand, and they had committed $100 million to creating just this two seasons of this one show a few more stats on this so like the even the total current assets including their entire content library prepaid content short-term investments all of that was just over two billion so like what a colossal bet for the company now if you go to today like they have

three billion dollars in cash alone close to $9 billion in total assets. You can sort of see how they're investing so much in content. But they created a cultural moment around, oh my God, Kevin Spacey and this incredibly high production value thing just dropped on Netflix. Yeah. Well, and it's crazy. I mean, one, as we've seen time and time again with this company, when they swing, they swing hard. But this was one, unlike the Quickster debacle, like this was so informed, like, of course, they couldn't know what was going to happen with House of Cards, but it was informed by all the advantages they had. So they knew, you know, Kevin Spacey,

we've learned a lot more about Kevin Spacey since 2013. But at the time, he was this like actor that everybody kind of knew about him but nobody he wasn't like a box office draw like there wasn't if you had a blockbuster movie coming out you didn't want to cast what are you talking about k-pax case in point uh you don't want to cast kevin speedo he's not leonardo dicaprio here k-pax was great don't hate maybe there was less of us that that loved it but it was great well he didn't have mass appeal to the traditional hollywood movie studios however netflix saw that people because they had all the data on what people were watching that once people watched

a kevin spacey streamed a kevin spacey movie they tended to go find all the other movies that he had been oh that's so powerful watch them and they're like okay there's something going on here and then house of cards had been a british show uh that they readapted to the u.s and the british show was on netflix and they were like man nobody knows about this thing but like people love it when people start watching it they get totally hooked and then they binge it so what do they do when they release house of cards? They release, I believe this was the first time this had ever happened. They release all 13 episodes of the season all at once. People in the content industry are like, why are you doing this?

You're completely upending the model. Like, you know, you're not going to like, you're going to miss the ability to draw out this whole thing over a period of time. Like completely like huge win for Netflix. It was David Fincher too,

right? He directed it or wrote it yeah i think something like that and this he he was super hot at the time because he had just done the social network and the girl with the dragon tattoo yep that's right that's right huge win with house of cards in early 2013 subscriptions pour in because again this is the first time there's like this water cooler moment uh everybody in america is talking about house of cards and you can get the whole season and binge watch it all at once.

And people are doing this. And like the only way you can do that is if you subscribe to Netflix. So subscriptions pour in, the stock goes back up for the first time over $200. Remember it was $300 before the whole Quickster debacle. So they're finally like getting back up and then they followed,

they realized this is going to work. So then this is the beginning of going all in on this content acquisition and production strategy. Later the year they do a deal with marvel uh before marvel gets acquired by disney to create episodic tv content around marvel superheroes this is like daredevil and um was it luke cage and all the stuff you see on netflix uh this is where all this comes from in 2014 they realize man we've got this like this this flywheel effect here where the more great original content that we have original and exclusive content that leads to more subscribers the more subscribers that we get the more financial ability we have to invest

in original and acquired exclusive content, how can we start accelerating this flywheel even more? We can do this with the debt capital. Like this is, we have a very predictable subscription based business. If we can forecast our subscriber growth accurately, and Ben, you alluded to this about subscriber growth becoming the big thing for Netflix, we should be able to raise debt ahead of this and use that debt to invest in content, which we will know will drive subscriptions. So 2014, they basically changed their whole capital market strategy. They'd been, you know, like most tech companies at this point, no debt, completely equity financed and cash flow positive. They start raising debt and investing it into content to the point where now today they have over $8 billion in debt.

And for folks that sort of don't deal in the equity versus debt world, this is the perfect thing to take debt for. You as a company like it because it's non-dilutive capital, so nobody's equity is getting pushed down. The people who are issuing you debt are very happy to give it because you can provide them incredibly high certainty about what your ability to repeatedly sort of generate cash on cash returns from you investing that that again, the magic of subscription based businesses that we've talked about on acquired, like, you know what your revenues and cash flows are going to be.

Yeah, and to like way oversimplify it. I mean, if you know that you have a 10 interest rate on that debt but you know that by spending that to accelerate your flywheel you can get 20 per year it's like how how much debt can we have you know yeah so they start slowly they do uh i believe a 400 million dollar bond deal in uh 2014 and then they start getting bigger and bigger to the point where their most recent bond deal that i think they did this month in october 2018 was two billion dollars and and they have eight billion in total debt outstanding you know which is a huge amount for a tech company but but again based on the cash flow dynamics and the subscription dynamics of this business as long as they are for can accurately forecast subscriber growth yeah it

can work yeah i mean unless there's, if there's some competitive thing, I mean, as we saw with Tesla, like if there's something that materially changes, David, to go back to your thing from the LP show, the going sideways and sort of explaining what that is, when you rack up a lot of debt with a belief that you're going to have very predictable cash flows and then there's something structural

that changes in the industry, that's when you can open yourself up to a world of hurt. So that's sort of the only reason why you wouldn't want to just keep stacking it. Yep. I mean, that's the danger of debt. So far, though, it's worked really, really well. So, you know, to wrap things up and get us to today, summer of 2014, as they're investing heavily into this strategy, they passed 50 million global subscribers, uh, 36 million in the U S 14 million internationally. Then in, in 2016, in January, they make a big announcement at CES, uh, that they are launching worldwide in 150 countries. I believe literally every country except mainland China, uh, North, and one or two others.

Crimea. Yeah. Crimea and Syria. Yeah. And of course, it's all English based. They haven't actually translated Netflix into all these languages yet, although they start that project. And now I believe they have translated into many of these languages.

They passed 75 million subscribers globally. During the year in 2016, they released 126 original films and tv shows series more than any other content company out there period any other cable channel or or network now actually i don't know if that includes like the i believe it's less than the big conglomerates like disney as a whole or viacom as a whole um but of any one like division, like Netflix is the largest single content production company. And then the irony of ironies is in 2016, they actually do finally successfully execute the spinoff with Quickster. They just don't call it Quickster. DVD.com. If you go to DVD.com, that is the DVD rental business for Netflix. So you can no longer subscribe

to the online DVD rental via Netflix. You now have to go to this separate company separate login dvd.com but is it a separate company like it's different shareholders uh it is a it is a dvd.com quote a netflix company so i believe it is 100 owned by netflix and uh wholly owned subsidiary and it has something like they do like 120 million in revenue a year and like 60 million in profit or like you know cash flow so nice you know but you know classic growth stock yeah right value stock value stock um uh and and you know things just keep going from there so this year in 2018 they passed 100 billion dollar market cap there have been several stock splits uh over the last few years. So the stock price isn't quite the same. But now, you know, in October 2018, you know,

they just announced earnings, and they now have just under 60 million US subscribers. So if you go on a household basis, assume there are 100 ish million US households, that's 60% of the US market larger than any cable company in America, Comcast, Time Warner, you know, what have you, Charter, and 137 million subscribers worldwide, which is just incredible. If you look at that sort of third quarter announcement, sort of play forward what it's going to be by the end of the year, they're going to do close to $15 billion in revenue this year and over a billion in net income or profit.

And I think this will be their first year that they do a billion dollars in net income. Yeah. One of my other favorite stats on catching us up to today, in the first half of 2018, the stock doubled. So I think that was something like 70 billion dollars of market cap were created like 70 billion dollar market cap companies don't double in six months not that uh stock price is necessarily exactly value creation but um yeah it's pretty impressive well this is you know maybe something to get into here in in tech themes. It's probably the right moment to

transition into it. You know, for years, people have been talking about the FAANG stocks and lumping Netflix in with, you know, with Facebook, with Amazon, with Google. But Netflix is actually much for most of the last few years and even today, much, much smaller than those companies. And, you know, I think that's how you can get such, you know, a doubling in market cap is, you know, they are only, quote unquote, I think about $130 billion market cap company, you know, I think that's how you can get such, you know, a doubling in market cap is, you know, they are only, quote unquote, I think about $130 billion market cap company, you know, compare that to the, someone like an Amazon who has 8x the market cap, but they have 100x the employees. Compared to the other FANG stocks, they have remarkably few employees for their valuation. Because you look at Microsoft that has 130, Amazon has over 600,000, Apple has 132,000, including retail, you know, even Facebook's over 30, google at 85 i mean there's no one that's down in this sort

of like sub 10 000 employee category i sort of wonder two things one is it because their product offering is so simple that most of the sort of product and engineering work that you would you know typically have big teams on is a lot of sort of infrastructure and that they've really pared down the the product line to be pretty streamlined but i also wonder a lot of infrastructure and that they've really pared down the product line to be pretty streamlined. But I also wonder, a lot of these people that are working on these productions, those aren't employees. You staff up those productions and staff them down on a contract basis. All right, listeners.

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we're two and a half hours into history of Netflix. I think we can get into tech themes. There was a great tweet a while ago. It was from one of John Gruuber's like three and a half hour podcast on the talk show that was like i can't remember the last time i wasn't listening to the talk show it's like we hope to not quite get there but um we do actually have a pretty good meaty tech themes part because i think whereas the last episode was really more narrative this one there's a lot of good analysis to be done on Netflix. And so I'll start with some of the more sort of like things that are interesting to point

out, but not crazy analytical. So one of them is there's a great business insider page, and we'll link to this in the show notes, that shows the evolution of the homepage over the years. I was thinking about it. It seems very obvious to go to Netflix now and just start watching. Like, that's what you do. You go to Netflix, you start watching. But they had to do a ton of education over the years, both on the sort of innovative DVD model. And then on this crazy idea that you could stream movies over the internet on your computer.

And for many years there in the awkward middle, the homepage was like this cluttered mess to explain how to do all this. So there was like one half of it was like one, two, three, like we will mail you a DVD. You will will watch it you will put it in this envelope you will mail it back and these like infographics of how to do that because that that was confusing and then on top it was like or instant like click here then download silverlight and i mean there's this big hairy explanation to consumers to tell people what they did and today you go to netflix.com

you don't have any options like they've done a tremendous job number one people what they did. And today you go to netflix.com, you don't have any options. Like they've done a tremendous job, number one, doing what they needed to do to be sort of really messy, to educate people on what are these paradigms that we're basing our company around. But then also once they've sort of hit critical mass and this tipping point where now they can be incredibly simple. And there's a bunch of stuff that they've cut over time that has been really like, it's crazy looking at the Netflix today and thinking about the Netflix that that was. So the things that they've done that have been less over time, you know, DVDs are this subsidiary, they spun out the set top box, they said no defending machines, they deprecated a lot

of these things that were brands. So like search on their site used to be FlixFinder, and their algorithm used to be Cinematch. And they like, they were, it was all about having all these like, branded things that they were telling you about themselves. They in 2013, or something launched this very advanced social feature where you would connect your Facebook, and then it would make recommendations based on things that your friends liked. They've completely cut that and the only thing you can do with facebook anymore is log in with facebook i mean it really reminds me of the time the the steve jobs coming back to apple and pointing out the product matrix and saying like we're getting rid of three quarters of this netflix never really changed leaderships

but sort of spiritually they had this moment where the public now knew what they did and they could sort of drop all of the posturing and all of the education and just be we deliver this thing that has an incredible value prop and perfect product market fit and that's all we do the one that that just sparked was um we didn't really talk about amazon uh and and the history and facts other than mention that you know they they launched what instant video that became prime video. I think all that that really did, everybody was so terrified of it. And in 2012, that was part of, you know, why it was such a bad year for Netflix and the stock price in a market that is growing so big and growing so fast as streaming, you know, like

the streaming market is, is displacing the cable, all of video content consumption, you know, like the streaming market is, is displacing the cable, all of video content consumption, uh, you know, in America, that is a way bigger market than the DVD rental business. So like in a smaller market, like still very large yet smaller market, like the DVD rental business, Blockbuster and Netflix fighting it out, like eventually became like a, uh, uh, you know, a fight to the death, But still, even though these companies are so big, Amazon Video, Amazon's video division and Netflix, like the market is so big, they're just helping one another. Amazon launching even like an essentially free version of Netflix is just helping Netflix grow right now, I think. And likewise, Netflix is just helping Amazon Video

grow, because they're each adding like their own exclusive content. And people are like, well, you know, I really want to like I want to watch Man in the High Castle and I want to watch House of Cards. So like I'm just going to subscribe to both. And like they're educating the market, you know, both ways. So interesting to think about myself in that situation. Like I'm subscribed to Netflix because that's where I go to watch stuff. I'm subscribed to Amazon because of course I'm going to subscribe to Prime. Other than like the exclusives, I really just haven't gone there to watch stuff. And I don't know, I think lots of our listeners probably are like, I watch all my stuff there. But for whatever reason, like Netflix is the default for me. And it's only when I hit the wall of I can't find anything, do I go over to

Amazon? I'm not sure I would pay for Amazon if it wasn't bundled into my Prime subscription. Well, it'll be interesting to see. I mean, gonna hit people have been forecasting this but it hasn't seemed to happen yet hit subscription fatigue where it's like look i'm not gonna do my hbo now and netflix and amazon and disney effing plus um like i you know well i think we'll have to see uh yeah we'll have to see how to see where that lands and see what people's comfort number is yeah but it's interesting like to this point like it hasn't i don't think any of these companies have hurt one another amazon is definitely behind in subscribers i think that in the same research report that said that amazon that netflix was 15 of internet traffic the amount that you can attribute to uh prime video i think is like or amazon video at all it's like less than a third of that

interesting the the other quick tech theme that we talk about all the time on this show um but that this uh highlighted for me uh which dan hill on the latest lp episode talked about if you make something that people love it can kind of overcome all sins right like netflix kept screwing up so many times about the, you know, product wise, all the stuff you were just talking about, like the whole quickster thing. But like at the end of the day, like people loved the fact that they could, you know, binge watch all 13 episodes of House of Cards. Like how amazing is that? Of course, they're going to tell their friends. And if you can make something that people love that they will tell their friends about,

like that is a recipe for success, you know, despite many other failures along the way. All right. Drifting toward business model, the magic of zero distribution costs, and particularly when you don't have a rev share in place is, you know, worth talking about here where this is, you know, if you compare Netflix to like a Spotify, for example, Netflix licenses all of this content upfront or creates it. So they don't even have any licensing fee. They just sort of create it and take all the risk or spend to create all that risk. So then all

the marginal revenue goes to them. But you know, they have high capital costs, high operational costs, very high fixed costs to create this content, but like little marginal costs. So then the game for them becomes like, okay, how much can we blow it out? Once we have this thing, how can we get the maximum utilization out of that asset? This kind of dives into two points that Ben Thompson of Stratechery talks about these and they're fantastic points. And I'd say he talks about them so often and makes them so well that we would be remiss not to sort of credit him with this thinking when we talk about it. You know, now that Netflix has this huge subscriber base, as I sort of mentioned, how big can we blow it out, they can dump 100 million into things like House of Cards without

batting an eyelash, since the cost of producing a show is spread across a massive amount of subscribers. So their strategy to produce a broad set of shows for a broad audience is the winning strategy in this market. And compare that against what HBO was thinking a few years ago and some others have done this too of we want to produce amazingly well-produced content that really hits home for a narrow audience you just can't amortize the cost of that across nearly as many people and so over time like you just can't afford to spend to create the best content because you just don't have as many people to deliver it to. You know, you can find yourself between a rock and a hard place if you're not thinking about the same thing that Netflix is thinking about, which is more subscribers to sort of reduce the per person cost of producing expensive content. For sure, that is a winning strategy. They've

also done both, right? Like there's a tons of niche, likeflix produced niche content on netflix uh they just don't spend that much money on like i feel like they're really good analytically at understanding like what is the roi in terms of uh either new subscriber growth or subscriber retention that we're going to get for this piece of content and for something like house of cards that's going to be so broad based in in reach like they can spend 100 million dollars for something like a documentary on um uh there's actually a pretty good like documentary on um like the roots of hip-hop on netflix that i watched on a plane once and like you know great lots of people should watch it right but it's not like it's clearly low budget you know like they did

the math on how much they could invest in that there's also a pretty bad documentary on vince carter called the carter effect they make all kinds of uh way to watch that late one night well okay so i'll throw out a little counter argument to that so the thing that drives new subscriber growth for them is hit shows so when they have a quarter that tons and tons and tons of people uh come and sign up for Netflix, it's because they have an orange is the new black that draws in all the people. You know, Netflix's strategy has been to stay away from sports and live and things like that, that are not evergreen content, even though they want to create evergreen content, and they amass this really rich catalog, there is a little devil in the details that is people that sign up that quarter are probably

signing up because they have this new hit piece of content that that everybody's coming for and so uh i think your point still stands that they'll spend a bunch of money on the big splashy thing and then they'll spend a little bit of money producing sort of the long tail of niche-based stuff to make sure they satisfy all the different niches on their their platform but i felt it would be a failure not to point that out okay Okay, I have another one that I've been like almost talking about that I want to actually hit. And it's another good Stratechry thing. So Netflix is flywheel. So they focus on this content that's relatively evergreen, staying away from live. So the more capital that they amass, either through debt or equity or

earnings, the more content they can license or produce, which then makes the product better for users. So more users come to pay and then kind of feeds back into that cycle of the more capital they amass. So then theoretically, they have this thing going on where the product actually gets better because the catalog gets richer. So either they can charge more money over time, or they can keep their prices the same and reduce marketing costs to reach people that would have been reticent to pay for a worse product. But now that the product is amazing, because it has all this content, we can actually start to like really saturate the far edges while keeping the price point the same

for people that previously wouldn't have wanted it that bad. A lot of things about how they've structurally set up the business enable them to create this virtuous cycle and succeed more as they scale instead of less as they scale. Because I think for a lot of businesses, cost of acquiring a customer goes up over time because you've already hit all your best customers and gotten them and then you have to spend more but they just have this amazing characteristic where the product gets better it's funny i hadn't quite thought about this but it's a little bit like uber right like there there are a few of these businesses out there that are truly special where you actually have a period in your growth curve where your customer acquisition cost goes down uh now i don't know we haven't done the analysis or math to know if this uh what you're saying is is true about netflix but but it makes

sense at least uh intellectually like uber got to a point i believe it's now probably their incremental cost of customer acquisition at this point is probably going up but there was a point where it went down massively because the service improved so much with density and ubiquity of adoption. I think it's a tipping point. Like if you think about Uber, it's like it needs to get sufficiently good so that there's a ride within three minutes. And then I kind of don't care how many drivers are on the platform after that. But Netflix may not have this sort of point of inversion where it's like literally always more content is better. Interesting. Yeah. But there's probably diminishing returns on that too. Actually,

that's a pretty interesting framework to think about marketplace or aggregator or platform businesses. When is it that they don't have that good enough sort of like a point where the more you operate, the more valuable you get indefinitely instead of with diminishing returns. One more point to make here, which is kind of just an interesting thing to know about the company. Over the last three years, Netflix has grown its subscriber base by 30% year over year, give or take like 1%. Basically, every year, they're growing 30%. Interestingly, the company is extremely data-driven about when to do marketing spend and when they feel it's a good idea to go and spend on customers. So I think a lot of this stuff we're talking about is true in the abstract, like the product getting more valuable over time, new big hits drawing

people in. But Netflix, based on their earnings reports, appears to care about growing 30% year over the year and then flexing different levers to get there. So sometimes they spend more money on content, which for other companies you can sort of think about as product investment. And sometimes they spend more money on marketing. And I think it's probably, I would imagine the way that it kind of works is like when they feel like they have an opportunity to create a superstar show, they go hard into it. If it works, and they're going to hit their 30% growth, and they don't need to do an enormous amount of marketing spend, if it doesn't, then they need to do more marketing spend to bring people onto the platform. It's just kind of an interesting way to think about driving the business.

And since that's been so constant, it's sort of clear what levers they're moving to accomplish what end. I'm so glad we took all of this time to dive into Netflix. I at least did not understand this company or its history at all before diving in here, despite how nominally ubiquitous it is in Silicon Valley. One last thing. I also assumed before really diving in and looking at market caps

that they were much bigger than they are because people talk about them as a fang stock and what are the fang stocks. There's this great, yet another thing we'll link to in the show notes, a great tweet today by Benedict Evans at Andreessen Horowitz with a graph showing on the x-axis revenue on the y-axis revenue growth and sort of plotting all these companies like apple amazon google facebook they're sort of understandably at least way far to the right in terms of total revenue and and also growing pretty quickly

netflix is like way smaller in terms of revenue than than these other companies and also growing pretty quickly. Netflix is way smaller in terms of revenue than these other companies, and also they have less revenue growth than Facebook does, less than Amazon does. We talk about them like they're one of those five, but it's kind of arbitrary, and that's the point that Ben is making. I think, again, if I were to put my old media TMT investment banker hat back on, I think maybe the justification for that's that's the point that ben is making i think again if i were to put my old media tmt

investment banker hat back on i think maybe the justification for that is that is is back to just like the stability and predictability of subscription-based businesses like the thing about netflix is like they know you know they know what their revenue is going to be to the extent that they understand their churn rates and their grossed subscriber ads churn and then thus net subscriber you know growth or losses uh well and can forecast that accurately like that is an incredibly stable and predictable business and and that has value in terms of valuation versus like a you know an amazon uh well prime is a part of it but like you're just buying stuff on amazon like you may may buy more, you may buy less, you know, like or, you know, Facebook advertisers may advertise more,

may advertise less. Same for Google or Apple may create a hit product, may not. You know, there's just more inherent unpredictability there. Yeah, still feels arbitrary. True. Well, that's why we're no longer investment bankers. Is there something worth grading in here so we talked about grading the spin-off of the dvd business just to have something to grade i think it's worth it to just do it quickly i mean like it's really like what if they didn't yeah what if they didn't i mean of course it was the right thing to do the future was streaming the dvd rental business online dvd rental business was going to go the way of the offline dvd rental

business of blockbuster like that market is it still exists but was shrinking of course they had to transition the company they just executed it terribly the first time and then executed it the right way the second time where they just didn't talk about it i would say like um a for strategy f for execution like f minus for execution but But I don't know. What's your take? Yeah, I'm with you. The only thing that I have on sort of execution is like, do you group timing into execution? Because I think they couldn't have done it quietly when they did it. And the question is, should they have done it a different way at the time? Probably. But how much better could you have done it? Or know was it was it pressing did it need to be done then or could it wait three years yeah no there's

no reason to do it then other than reed hastings feeling like he you know wanted to be you know push america and the public into his vision of the future which was correct it was just you know he just sort of waited a couple years which gets into i know we're past tech themes but like steve jobs and apple do this all the time and they take shit for it and then it's fine. Like they pulled the floppy drive out of the iMac and they pulled the headphone jack off the phone. And like, you know, you could argue that was a little too early, but. Apple usually gets these things right though. Like when they pulled the headphone jack, like they released AirPods.

You know, it's like, here's a better alternative. The thing is when the Quickster, when they did Quickster jack like they released airpods you know it's like here's a better alternative the thing is when when the quickster when they did quickster streaming wasn't better it was better on some dimensions but a lot of the content wasn't available you know and so like it wasn't quite there that it was just obviously better on all dimensions to go to the new thing and apple toes this line for sure but like but they present you with the like here if you buy this, if you buy the AirPods, they're amazing. They're way better.

Yeah, that's a good point. Carve outs. Carve outs. Mine real quick. I believe on the Zappos episode with Alfred Lin, we did a carve out of Justin O'Byrne's Google versus Apple Maps deep analysis. You're remembering what carve outs were on what episodes? Yeah, man, we go deep here.

Next level. He did an awesome follow-up this month on the new Apple Maps. And is it now better than Google Maps? Spoiler alert, no. In some ways, if you're interested in forests. Yeah, in some ways, but yeah. Well worth the whole read. Amazing work uh as was the last one i've got a podcast to recommend it is from the very first person that i followed on twitter i

discovered this the other day when taking a deep dive down the twitter rat hole kevin rose i used to be like a really big dig nation fan i think i watched every episode of dignation yeah when he was on um tech tv uh the screen yeah and then g4 g4 oh yeah oh i used to watch that in high school it was that was actually that show was like a big part about me wanting to like get into tech dude and it was a cable channel like i know like that was on tv long tail content cable channels good businesses i think this probably had a good amount to do with me getting into the tech industry too. I mean, I think

who would have thought that by watching Kevin and Alex drink beers on their couch talking about tech news that one day we could grow up to do the same thing, David. The more things change. Yeah. Well, he's got this great podcast episode uh where kevin's very into

sort of like quantified self uh type things i know we don't use that phrase anymore because the wave is sort of passe and and you know now it's digital health or whatever but he's got this um sleep phd researcher on from uc berkeley who's starting a company um it's absolutely fascinating learning facts about sleep i think sleep is going to be the thing 20 30 50 years from now i don't know when but lack of sleep will be treated like smoking some of the facts that he's throwing out on there about the results of even depriving yourself of a few hours of sleep from one night in your body's ability to repair cells before they can start to become cancerous, for example, there's just a tremendous amount that sleep helps us repair. And there's another one specific thing

he mentions that was fascinating was, when you take sleeping pills, you're not you're not actually sleeping, like you're not conscious. But like, he's like, I wouldn't call that sleep. And you're you're not doing your body, you're not putting your body into the state that it really needs to accomplish a lot of the sort of healing and repair and sort of regulatory things that it does. So well worth the hour or whatever it is to listen to it and actually has sparked sort of a new area of interest and set of sort of companies and ideas that I'm starting to look into. Awesome.

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