What’s more, Hastings was convinced that eventually one of the big, rich, experienced companies with a powerful brand name linked to entertainment, retailing, or online merchandising would see the same opportunity he saw. Every day he expected to see a headline announcing that Blockbuster was investing $500 million in an online movie rental business designed to blow Netflix out of the water. Or, if not Blockbuster, then Amazon. Or Walmart. Or Apple. Or maybe Disney …
Hastings’s only hope was to grow—quietly, under the radar, but fast—so that, by the time one of the big players decided that online video rental was worth bothering about, Netflix would already have a discouraging head start. Slow but steady growth was not an acceptable option.
So the question nagged at Hastings and his team: Why weren’t more people signing up?
Applying their intensely analytic orientation, Netflix’s seven key leaders (many of them still helping to run the company today) started their search for an answer by focusing on data about their existing customer base. One hopeful anomaly jumped out at them. Netflix’s penetration rate in the San Francisco Bay area (2.6 percent of households) was twice as great as anywhere else in the country. If they could sign up subscribers throughout the United States at the same rate, they’d quintuple their membership to more than 2.7 million.
What, then, was different about the Bay area? Why was the Netflix product seemingly more magnetic there than in Boston or Chicago or Miami?
Everybody on the executive team had a theory.
“The Bay area is where our headquarters is located,” one person suggested. “Maybe our employees have been talking about Netflix and getting friends and neighbors to sign up.” (That seemed implausible, since the number of people working at Netflix then was too small to have a big impact.)
“The Bay area is filled with high-tech people. They’re Internet savvy and comfortable with online shopping,” offered another. (Of course, there were plenty of other communities with lots of technologically sophisticated people—and they weren’t flocking to join Netflix.)
“It’s a relatively affluent community,” suggested a third. “Let’s face it, Netflix is a luxury, not a necessity. Maybe people with more disposable cash are more willing to spend it on movies.” (This was true—but then again, there were lots of affluent people in New York, Boston, and a bunch of other American cities who were staying away from Netflix in droves.)
“Maybe it’s because the Bay area is in California,” proposed yet another executive. “It’s the home of the movie industry! I’ll bet there are a lot of film buffs in the area.” (Based on this logic, Los Angeles should have been the number one market for Netflix—but it trailed San Francisco badly.)
Eventually, Reed Hastings put an end to the debate.
“No more theories,” he declared. “Let’s do some more research.” And so an intensive survey was launched to examine the attitudes of both Netflix customers and noncustomers in cities around the United States, with the specific goal of finding out why the company’s product was more powerfully magnetic in the Bay area than anywhere else.
And when the results came in, lightbulbs lit up in the Netflix offices.
There was one, and only one, consistent difference in the survey responses from Netflix customers in the Bay area—and it was big enough to explain the difference in subscription rates all by itself. Virtually every Netflix subscriber in the Bay area raved about how fast they got their movies. Practically no one in the rest of the country felt that way.
The revelation produced much head slapping at Netflix headquarters. The reason for the difference was now so obvious. The distribution center from which all the DVDs were mailed was in the Bay area! So when a customer in Oakland or San Rafael or Palo Alto dropped a movie in the mail for return to Netflix on Monday morning, it probably arrived at the warehouse on Tuesday. The next movie on that customer’s queue would be mailed out the same day and arrive on Wednesday—a forty-eight-hour turnaround.
By contrast, a customer in New Haven or Baltimore or Seattle might have to wait four, five, or even six days to get a new movie—just long enough to forget about Netflix and make planning a regular “movie night” around the next picture in your queue feel impractical.
Netflix customers who received next-day delivery were excited about its efficiency and convenience. They began looking forward to their next movie the minute they dropped the last one into the mailbox, and they bragged to friends, family, and neighbors about the incredible speed and reliability of Netflix.
Whereas with five- or six-day turnaround, the reaction was more, “Meh!”
It was a bit ironic. Netflix relied on two remarkable technological breakthroughs—the Internet and the DVD laser disc—and the incredible software created by a team of brilliant programmers. The company was a quintessential artifact of the high-tech world. Yet now its leaders had discovered—to their shock and, perhaps, their chagrin—that the secret weapon behind the company’s success was a low-tech delivery system founded more than two centuries earlier by Benjamin Franklin and run by government workers: the U.S. Postal Service.
And what happened next illustrates another trait that makes Reed Hastings such a successful demand creator. The minute he discovered this rather startling truth, he acted on it.
On January 21, 2002, Netflix opened its second distribution center. It was in Santa Ana, California, just south of Los Angeles. The following month, the third center followed—in Worcester, Massachusetts, just west of Boston. During the subsequent weeks, Hastings and his team closely watched the subscription rates in Los Angeles and Boston—and found that they began a steady climb, until they matched the double-the-normal rates of the Bay area. Netflix members in those communities, stunned to discover that they were suddenly receiving new movies within forty-eight hours, were telling their friends and neighbors—and those friends and neighbors were joining Netflix. That was the only possible explanation, since Netflix, in the spirit of scientific inquiry, had deliberately refrained from doing any local advertising or promotion that could skew the results.
Nine more distribution centers were opened before the year was out. During 2003, twelve more were opened. And in every area where a new distribution center was opened, subscription rates swiftly doubled.
It was as if a switch was being thrown, in one city after another, that was triggering demand for Netflix like the ignition key of a car generating power.
As of late 2010, Netflix was operating fifty-six distribution centers, making next-day movie delivery available to the vast majority of Americans. The Netflix subscriber rolls now number more than 20 million. Which tells us that Reed Hastings’s demand-creating engine still has plenty of room for growth.
Even before 2001, Reed Hastings and his team had created a magnetic product, which is the first essential ingredient for the creation of new demand. But a magnetic product is not enough. What was missing back in 2001 was a demand trigger—a critical element in the business design that would make it easy for lukewarm fence-sitters to get truly excited about the magnetic product and transform themselves into customers.
Actually, we’ve already seen this effect at work. Remember how density turned out to be the key to Zipcar’s popularity, and instant access to books made the crucial difference for Kindle? These were triggers that opened the spigots of demand. In the same way, delivery speed was the crucial trigger that supercharged demand for Netflix.
You’ve experienced the power of demand triggers yourself. Think about the last really great new product you bought. Now consider: How much time elapsed between the day when you first heard about the product and the day when you finally plunked down the cash or credit card to take it home?
The difference between hearing about a product and actually buying it is the demand trigger. Triggers work by overcoming customer inertia and by strengthening the magnetism of an offer. Some triggers do this by enhancing the functional aspects of magnetism: For example, they may improve the product’s price, ma
ke it more convenient, or make it more customizable. Other triggers increase a product’s emotional resonance: Brilliant advertising, promotion, marketing, or word-of-mouth campaigns can help make this happen. And some triggers get the customer to move by providing an occasion to test and purchase the product, as when samples, free trials, or discount memberships are offered. Triggers that have a lasting impact on a product’s magnetism will be more powerful than those whose effect is fleeting. (Netflix’s ultrarapid movie delivery is a brilliant example of the former.)
A magnetic product is a rare and wonderful thing. But without a trigger, even a magnetic product may generate little or no demand. Which is why the search for a trigger—or, better yet, two or three triggers—is a prominent feature in practically every story of demand creation.
BY THE TIME Reed Hastings and the Netflix team had their epiphany about next-day delivery in 2001, they’d already invested three years of incredibly hard work in getting their company to the point where a great demand trigger could produce liftoff. The Netflix saga, like the stories of Zipcar, Kindle, and Tetra Pak, illustrates precisely how difficult it is to create demand, and how many smart moves lie hidden in the history of every great demand-producing team.
Reed Hastings had learned a lot from his experiences in founding and nurturing Pure Software. “I had the great fortune,” he likes to say, “of doing a mediocre job at my first company.” As it grew from ten to 640 employees, “I found I was definitely underwater and over my head.” Losing self-confidence, he even asked the board to fire him and was frankly relieved when the company sale went through in 1996. He used the subsequent downtime to ponder his experiences and draw lessons to apply to his next start-up.
One of the lessons Hastings had learned was the importance of using resources available in the outside world to create the backstory needed to support your product, rather than trying to create it all from scratch. When you’re in the hunt for elusive new demand, there’s never enough time, money, talent, or emotional energy to master all the thousand-and-one backstory details that you have to get right. Investing resources in reinventing the wheel is a recipe for failure.
So rather than trying to invent a delivery infrastructure (as retailers do when they invest in real estate and physical plants in hundreds or thousands of locations), Hastings and his team devoted themselves to figuring out how to take advantage of a preexisting delivery infrastructure. It was, of course, the same infrastructure that would eventually provide the essential demand trigger—the U.S. Postal Service.
But piggybacking on the neighborhood mailman turned out to be far from easy. Reed Hastings’s quick-and-dirty experiment sending a batch of CDs through the mail had demonstrated only that one local post office, under one set of conditions, was capable of handling discs safely. Postal Service facilities varied enormously, from tiny rural outposts in Wyoming and Alaska to giant urban centers that sorted millions of letters and packages using a wide range of machines, some ultramodern, others antiquated. A Netflix that served customers anywhere in the country had to work with all of them while keeping the damage rate vanishingly low. (Imagine being an avid movie fan who has just joined Netflix. How many broken discs would it take to sour you on the service? One? Two? Probably not more.)
Jim Cook, one of the early Netflix team members, recalls:
To understand how the post office backend worked, I spent hundreds of hours at a few of the largest regional Postal Centers observing and asking tons of questions.
I noticed letters being sorted by several high-speed spinning circular drums. While these crushing metal drums enabled the separation and processing of over 40,000 standard-size letters per hour, it was obvious a thin plastic DVD would not survive the journey. With a sinking stomach, I felt the business idea slip away. But then I noticed a separate conveyor belt sorting magazines and other larger pieces of “flat mail.” How would I ensure the package always used this flat mail machine and not the letter sorter?
Netflix worked on designing a unique, ingenious envelope that would automatically get routed through the flat mail system. It also had to hold a DVD securely, shield it from the canceling device, and provide a postage-paid return envelope that could be quickly and easily opened by Netflix warehouse personnel with minimal risk of scratching or dropping the enclosed disc. And it had to be as light as possible, since every additional ounce would increase the company’s postage bill.
They tried and tried and tried again. Some of the early envelopes were made of paper, some of cardboard, some of plastic. (The plastic was soon scrapped—not recyclable.) Some contained a foam insert to cradle and protect the DVD. (That was scrapped, too—weighed too much.) Some were airtight, which meant they inflated and swelled when transported by plane. (A small air vent was added.) Some required the customer to peel off a sticker to reveal Netflix’s return address. (Too complicated.) One was printed with user instructions that included eight bullet points and no fewer than seventy-six words. (Arggh.)
It took Netflix scores of iterations to come up with the perfect envelope. They made one odd discovery after another, such as the revelation that printing the inside return address upside down made processing more efficient. In the end, they developed an envelope made of light yet sturdy paper with an inner baffle that safely secured the disc, a slit that permitted the bar code on the DVD sleeve to be read without opening, and even room for paid advertising. The winning design was simple, bold, and eye-catching. Most important, it was capable of navigating the postal service infrastructure with a damage rate far below 1 percent.
You probably know this envelope well, even if you’re not a Netflix member. It’s an unmistakable bright red and, at many post offices, it constitutes up to one-quarter of the daily mail deliveries. (And at $500 million, Netflix’s annual mailing costs represent a significant fraction of the U.S. Postal Service’s operating budget.)
One hundred and fifty versions of an envelope may sound excessive. But every detail tweaked by the Netflix design team meant some tiny customer hassle reduced, even if by an infinitesimal amount. Saving the customer three seconds when opening the envelope or reducing the risk of a damaged DVD from .08 percent to .06 percent may seem trivial. But multiply those numbers by millions of customers and hundreds of millions of deliveries, and the net benefit to Netflix members is substantial.
And at the same time, Hastings and his team were tackling the hundreds of other details they had to get right to make the Netflix product truly magnetic. (Such obsessiveness, we’ve found, is normal among great demand creators.)
They were innovative where they needed to be, imitative wherever they could be. Through months of experimentation, a team of direct-mail fulfillment experts, mechanical engineers, and software developers built an amazing distribution system around unique high-speed optical scanning machines capable of sorting and dispatching millions of DVDs every day, with a vanishingly small error rate. (Like everyone who is lucky enough to visit one of Netflix’s facilities, we were left slack-jawed by the vast size and incredible efficiency of the Fremont, California, distribution center we toured.) No one else has a system like it—and its mere existence is likely sufficient to deter other companies from trying to launch rival services.
Rather than wasting precious economic fuel and creative energy in designing a great retail website from scratch, Hastings studied Amazon’s and did a 90-percent-plus emulation. Netflix’s site mirrored Amazon’s navigation system, product and button placement, search tools, inclusion of reviews by customers and professional critics, and even the use of small, low-resolution cover images to allow fast Web page loading.
You might call this strategy “Imitate to be unique.” Of course, it must be used appropriately. The core of a new business design can’t be based on imitation. (In Netflix’s case, the core was “Reliable, convenient, affordable movie rental by Internet and mail.” A unique website design wasn’t part of that definition.) Like great artists and writers, great demand creators shamelessly imitate
minor things so they can focus their originality on major things.
In pursuit of fast, below-the-radar growth, Hastings used viral marketing and word of mouth rather than expensive advertising. He also searched for marketing partners to help Netflix recruit members. Hastings made agreements with Sony, Toshiba, and Panasonic, which sold a combined 85 percent of all DVD players in the United States, to offer a free trial subscription to Netflix with every DVD player shipped.
Under normal circumstances, manufacturers are hesitant to make such deals. “But at the time,” Jim Cook explains, “these DVD player manufacturers were actually in fear of becoming another failed Laserdisc or Betamax.” So they loved the idea of offering their customers ten free video rentals straight out of the box. Creating a backstory ecosystem that harnessed the marketing power of allied organizations multiplied Netflix’s customer reach while freeing up resources for other challenges.
And having honed its product to address one movie-rental hassle after another, Netflix then asked—as great demand innovators always do—what else can we do to connect the dots for our customers? To enhance the product’s value, Netflix offered not only video rental but also a convenient individualized queue for movie selections, movie previews, comments by critics, advance reservations of upcoming releases, and much more.
But their most powerful product enhancement was the Cinematch recommendations engine. (Here, again, Hastings drew inspiration from the world’s leading online retailer, Amazon, which had pioneered the concept of algorithmically generated product recommendations. Japan’s Tsutaya was developing its own media recommendation system along parallel lines.) Cinematch predicts how an individual customer will rate a particular movie based on his or her pattern of past ratings (the average Netflix member has rated more than two hundred movies). The system has become so popular that 60 percent of Netflix customers pick movies based on the hundreds of millions of recommendations that Cinematch offers each day.
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