How Netflix Beat Blockbuster, Revolutionized Streaming, and Changed Hollywood Forever

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“No late fees.”

1998 saw Netflix debut as a DVD rental service, and their unique selling point to prospective customers was a clear jab at what people disliked most about Blockbuster – excessive late fees for delayed returns. With over 9,000 outlets, Blockbuster was the largest video rental chain globally, but it faced customer backlash due to earning profits from steep penalties for tardy movie returns.

Reed Hastings, one of the founders of Netflix, remarked, “That was undeniably a sensitive issue.” He went on to say, “People enjoyed renting movies and viewing them at home, but the late fee represented everything unpleasant about that system. Consequently, we opted to develop something new.”

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Reed Hastings, co-founder of Netflix, pointed out, “It was a clear area of discomfort.” He explained, “People appreciated renting movies and watching them at home, but the late fee symbolized all the negative aspects of that approach. As a result, we chose to create something fresh instead.

Instead of charging late fees and giving customers an unlimited rental period for movies, Netflix opted for a flat monthly fee that allowed subscribers unlimited rentals. To add to the convenience, they began delivering DVDs straight to their customers’ homes, sparing them the trouble of driving to local Blockbusters to search through endless rows of films. However, some of Netflix’s high-ranking executives expressed concerns over potential issues with this new business approach.

Back in 1998, as I joined Netflix under Hastings’ guidance, I can tell you firsthand that the decision to scrap those dreadful late fees was indeed a nerve-wracking one. Late fees were essentially Blockbuster’s lifeline; everyone despised them, yet they were crucial for their profit margins. The question on everyone’s mind was, “How on earth will this work?” Many thought our move to axe the late fees was madness, but Reed was ready to stake everything on it.

The gamble made back then certainly proved to be a smart move. Nearly three decades after its modest launch, Netflix, now steered by Ted Sarandos, Greg Peters, and the successors of Hastings, has taken over Tinseltown. With a market capitalization of $392.68 billion, it surpasses the combined value of Disney, Warner Bros. Discovery, Paramount Global, and Comcast. This remarkable ascent was not without its share of corporate struggles, tactical maneuvers, and an unwavering appetite for taking chances. Netflix’s journey mirrors some of the most impressive transformations in corporate America, alongside giants like Apple and Facebook. Yet, the specifics of their climb to the top, and their role in ushering in the streaming age, are increasingly fading from memory.

Initially, Netflix functioned more like a casual startup. Key personnel often found themselves purchasing DVDs directly from retailers such as Walmart or Costco for full price, which Netflix would then rent out to its modest clientele. To expand, Netflix required connections with studios that could supply them in bulk and at favorable conditions. In 2000, Hastings brought on Sarandos, who had solid relationships with studios from his past role as an executive for video chains like West Coast Video, to help penetrate the Hollywood market. Since most of the company’s workforce consisted of engineers based in its Los Gatos, California headquarters, Sarandos spent his initial three years as chief content officer working out of his home in Los Angeles. It wasn’t glamorous, but due to his personal connections and endearing character, Sarandos was able to secure DVDs from studios like Warner Bros. and Sony.

Sarandos mentioned that it was beneficial because he wasn’t a typical Silicon Valley figure, accompanied by a lawyer or an agent, when discussing with the studios. He had a personal relationship with them as we had climbed the career ladder together.

Initially, Netflix encountered several challenges in delivering DVDs promptly and smoothly to its customers. A significant portion of those early years was dedicated towards expanding their network of processing centers, aiming to minimize waiting periods for rental deliveries. Over time, as these issues were addressed, Netflix gradually established a strong reputation.

As an ardent admirer looking back, I can’t forget that initial phase when nobody recognized us. However, things started shifting. That moment when I first spotted a post office box labeled for Netflix DVDs still resonates with me. Then came the day when I was at my own doctor’s office, and I saw the familiar red envelopes in the outgoing mail bin. Over time, we transformed from an unknown entity into something omnipresent.

At first, Blockbuster dismissed the challenge posed by its competition. However, according to popular tales, the company declined an opportunity to acquire Netflix in 2000. As with most stories, there’s some disagreement about the specific details of what transpired, but everyone seems to agree that a meeting took place at Blockbuster’s Dallas headquarters. Some Netflix executives recall being ridiculed when they suggested a takeover, while Hastings believes that the discussions never progressed that far.

He stated, “They kept us under their radar, but I’m not sure it was a major concern.” He implied that they didn’t view us as a key player in the game. Instead, he believed it was more about curiosity than anything substantial. For several years, Blockbuster paid little attention to Netflix. When they did acknowledge its presence, it was often with disdain. As a routine, Netflix executives would gather in a conference room to listen to Blockbuster’s earnings call, hoping to understand the competition they were facing.

At one point, an analyst put Netflix to Blockbuster CEO John Antioco, to which he responded something like, ‘They are insignificant. They are nobody. They’re just a nuisance.’ According to McCord, upon looking around the room where this conversation took place, there was a chart displaying our subscriber growth on the wall, showing an upward trend. That moment made him think, ‘He doesn’t understand the situation.’

Eventually, Blockbuster realized the importance of online streaming. In 2007, they introduced a service called Total Access, which allowed customers to rent DVDs online and receive a free movie when returning the previous one at any of their physical stores. Since Blockbuster had numerous retail locations, customers could swap discs conveniently without waiting for a new one by mail. Initially, Total Access gained popularity, attracting 2 million online subscribers in its first year, surpassing a quarter of Netflix’s user base. However, the service proved unsustainable as it led Blockbuster, a traditional company with high operating costs, into financial trouble; after accounting for shipping and other expenses, they were losing approximately $2 on every disc rented.

Blockbuster faced insurmountable challenges, one of which was a massive debt of $1 billion that it accumulated after being separated from its original company, Viacom, in 2004. As its customer base shrank, it eventually had no choice but to file for bankruptcy in 2010. Furthermore, Blockbuster functioned as a franchise, allowing individual store owners to use the brand without the corporation investing in its online operations at their cost.

Michael D. Smith, a professor at Carnegie Mellon University’s information technology department, explains that Blockbuster’s corporate objectives and those of its franchisees were not in agreement,” says Michael D. Smith. “This misalignment resulted in the company taking too much time to adapt.

Netflix’s triumph over Blockbuster wasn’t necessarily predestined; it had its own share of hurdles to overcome. For instance, their initial public offering was halted following the 9/11 attacks and the dot-com market crash. Additionally, Netflix’s strategy of prioritizing subscriber growth over immediate profitability came with inherent risks.

At first glance, it seems clear now that we would emerge victorious, but back then it didn’t feel like that,” notes Jay Hoag, an early investor in Netflix and a member of its board. “We were engaged in a price war with Blockbuster. Our stock was volatile. It was a tough period for the company. However, Reed and Ted had a vision to provide a superior service, and they remained steadfast in their pursuit.

When speaking with Sarandos about joining Netflix, Hastings was already envisioning a future beyond DVDs. At that time, the internet was new, unreliable, and slow, making it hard to imagine watching a full-length movie online, but Hastings had a vision of transforming Netflix into a streaming powerhouse. Although the term “streaming giant” hadn’t been coined yet, the name Netflix itself hinted at his aspirations, with “flix,” short for films, and “net,” internet-related, signifying his intentions.

When Sarandos initially encountered Reed, he painted a picture of Netflix remarkably similar to what we know today. However, instead of using the term ‘streaming’, Reed referred to it as ‘downloading videos’. Yet, his vision was crystal clear – he envisioned all forms of entertainment being delivered directly into homes via the internet. This was an era when such a concept was virtually non-existent.

Right from the start, the plan was to develop Netflix along two paths. The company aimed to keep expanding its DVD-rental customer base while simultaneously enhancing its technological foundation, preparing for a time when internet speeds would allow subscribers to stream longer films and series online. By 2007, digital technology had advanced to match Hastings’ vision, and Netflix launched its streaming service as a result.

The service was well-received by subscribers, resulting in a significant growth of the customer base from 7.3 million to 18.3 million over a three-year period. However, obtaining movies and shows for the platform introduced new hurdles. Studios tended to send their latest films to conventional cable networks following their theater runs, leaving Netflix to negotiate with less prominent studios instead. For two years, they also produced and distributed their own movies – low-budget independent films like “Sherrybaby” starring Maggie Gyllenhaal – under a temporary label called Red Envelope.

According to David Hyman, Netflix’s chief legal officer, “We didn’t have a wide variety of options,” he said. “Mostly, it was specialized content – unusual, cutting-edge, even daring at times. The success rate was unpredictable.

Back in 2008, I struck an ingenious deal with Starz, a cable service at the time. This agreement enabled me, Netflix, to stream approximately 1,000 movies annually. These films included fresh releases like “Ratatouille” and “Superbad”, which Starz had obtained licenses for from Disney and Columbia.

However, Sarandos understood that this was merely a temporary solution. He came to recognize that other production companies might not consistently be willing to collaborate with a company targeting the same audience as them. To ensure its future, Netflix recognized it needed to assume control of its own destiny.

Initially, Hastings viewed Blockbuster as his main competitor. However, Sarandos later perceived HBO, known for its glamorous cable image due to “The Sopranos” and “Sex and the City”, as a potential rival. He believed that Netflix had the capability to create shows and movies that would generate buzz similar to watercooler discussions.

Ted consistently steered us towards HBO as our primary goal,” Hastings explains. “He envisioned us more as a content network rather than an e-commerce giant like Amazon. However, he later admitted that he regretted this slightly, stating it should have been both HBO and CBS. This was because we didn’t want to limit ourselves to elite programming; instead, we aimed for content that would appeal to the masses as well.

Much like Blockbuster in the past, HBO dismissed any idea that Netflix was comparable to them. In 2010, Jeff Bewkes, head of Time Warner (HBO’s parent company), compared Netflix to the Albanian military, a force not feared by anyone.

According to Hastings, we all acquired Albanian Army emblems for our clothing unintentionally, with Jeff’s assistance. It was significant because this action inadvertently boosted our profile, placing us in a competitive position against the current administration, thereby adding credibility to our cause.

Sarandos recognized that he needed to secure a significant deal to demonstrate Netflix’s far-reaching aspirations. He discovered this opportunity in “House of Cards,” a reimagining of a BBC miniseries, which replaced the British Parliament with the U.S. Congress. Every broadcast and cable network was eager to claim the project due to the star-studded talent — David Fincher was overseeing production and directing the first two episodes, with Kevin Spacey and Robin Wright slated to portray a ruthless power couple.

On a weekend, it came to light that Fincher intended to present his television series to broadcasters. Upon examining statistics regarding viewership of Fincher’s and Spacey’s films on Netflix, Sarandos discovered that both were well-received by the platform’s subscribers. Initially concerned that the show would be overly political, Sarandos found relief after perusing the script for the first episode, as he realized “House of Cards” was less about the nuances of legislation and more about the dramatic betrayals reminiscent of Shakespearean plots.

Sarandos stated, ‘It offered both intimacy and vengeance – exactly what viewers crave from TV.’ We simply couldn’t pass it up.

In a conversation, he reached out to the producers and expressed his disinterest in listening to a proposal for “House of Cards.” Instead, he aimed to persuade Fincher and his team on why they should opt for Netflix, despite its limited experience in producing shows. During their meeting, Sarandos pledged to invest $100 million into the series and committed to ordering two seasons upfront – a rare move before a pilot episode had been filmed. Moreover, he promised not to interfere creatively, giving Fincher complete control over the project. This deal turned out to be so lucrative that no one, not even HBO, could rival it.

At Netflix, some colleagues expressed concerns about Sarandos’ decisions, as Hastings himself admitted he felt uneasy about it. “It appeared dangerously bold to me, bordering on reckless,” Hastings said. “For over a decade we had worked together, so I trusted Ted’s intuition. However, his choices were not ones that I would have made myself.

Sarandos continued stirring up changes within the industry. Following the acquisition and production of “House of Cards,” he advocated for its entire season to be released simultaneously, rather than the traditional method of releasing a new episode each week as other television broadcasters and cable networks did. His observation of Netflix users’ tendency to binge-watch older shows, consuming episodes one after another in marathon sessions, sparked an innovative idea that would disrupt the industry.

Sarandos recounts receiving a call from Les Moonves, who was once the head of CBS. Moonves asked, ‘Are you familiar with how TV programming works?’ Sarandos explained. Moonves continued, ‘You provide episodes sequentially, and you can span them out across 13 weeks before needing to introduce something fresh.’

When “House of Cards” premiered in 2013, it received critical acclaim and drew a multitude of new viewers due to its intriguing portrayal of Washington politics. Additionally, it demonstrated Netflix’s ability to create sophisticated, prestigious TV content similar to what HBO had been renowned for. Consequently, it sent a clear message to Hollywood.

For about a decade and more, creators of films and series found themselves drawn to Netflix, enticed by offers of greater creative control and substantial financial resources. The output from Netflix – ranging from “Stranger Things” to “Roma” to “Squid Game” – has garnered numerous awards, praise, and a rapidly expanding global fanbase. This success inspired most other entertainment industries to establish their own streaming platforms, some of which, like Disney+, have been well-received although they haven’t reached the 300 million subscriber base that Netflix boasts. As a result of the revolution in content creation and distribution initiated by Netflix, streaming has become the primary method for audiences to consume films and television series.

Smith remarks that Netflix revolutionized the entertainment sector. They not only executed many strategies effectively, but their timing for these strategic moves was impeccable,” or simply, “Netflix transformed the entertainment industry by doing many things correctly and at the perfect moment, according to Smith.

Over time, as Netflix focused more on creating content and delivering it through streaming services rather than DVDs by mail, there were fewer customers making use of this service. In the year 2023, Netflix sent out its last red envelope, effectively ending a business that had become less relevant to their profits. As a result, Netflix completed its transformation into a company that solely offers streaming content.

McCord states, ‘They showed the bravery to sacrifice the initial business for the sake of another, and that’s the Netflix tale. I wonder how many other businesses could have dared to do something similar?’

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2025-03-20 18:26