by Gina Keating
Kilgore anticipated an inflow of cash from the IPO and planned a multichannel marketing and advertising campaign designed to catapult Netflix beyond the reach of bricks-and-mortar competitors. She drew on her experience as a brand manager at Procter & Gamble to plan a full-scale campaign—online, radio, and television ads, as well as direct mail and retail partnerships—to broaden Netflix’s reach beyond early adopters to mainstream middle Americans.
Kilgore realized what valuable advertising real estate she had in the Netflix mailer and set about making it as eye-catching as possible. With the help of an outside advertising agency she redesigned the logo and color scheme and, rather than following her own intuition, canvassed subscribers and would-be subscribers to determine which branding scheme resonated best. The tests produced a clear winner: an arched, black-and-white rendering of the company name, with a lower-case F to preserve the symmetry, placed on a curtain of cinematic red. The look was reminiscent of the serials of 1930s cinema and, most important for a company with low brand awareness, it screamed for attention from mailboxes, the tops of subscribers’ televisions, and coworkers’ out-boxes.
• • •
NETFLIX WAS READY to launch on the national stage, but the dot-com meltdown that started in spring 2000 stopped the planned advertising push in its tracks. Wall Street began to shun companies with an e- prefix or a .com suffix, and Hastings and McCarthy were forced to withdraw the IPO.
In a lucky twist, Netflix’s existing investors had topped up its balance sheet with additional capital ahead of the planned IPO; they bought shares in anticipation of a pop in the stock price when the company went public. That cash would sustain operations in Netflix’s most difficult year yet, as Hastings and McCarthy sought some path to profitability amid ever-deeper losses and little prospect of new capital. They got a much-needed break on inventory costs toward the year’s end, when Lowe’s overtures to the studios bore fruit, and Warner Home Video and Columbia TriStar Home Video agreed to the first online DVD revenue-sharing agreements.
The deals cut Netflix’s cost of buying DVDs to between three dollars and eight dollars per disk and put two to three times more product in the company’s warehouse just as DVD player penetration levels soared to thirteen million U.S. households.
Losses of $57.4 million loomed in 2000, so Hastings and McCarthy decided to approach Blockbuster again to try for an alliance that would give Netflix a ready source of customers and a link to an established rental brand. It was a bit far-fetched, McCarthy thought, but he admired Hastings for having the guts to pitch it to the company they considered their top rival.
Hastings got a call, during a staff retreat in the faux Dutch town of Solvang, that his contact at Blockbuster, Ed Stead, was ready to meet. He boarded a rented private jet that belonged to former game show hostess Vanna White early the next morning, along with McCarthy and Randolph, and flew to Dallas.
The summons was unexpected, and none of them had brought business attire along to the retreat. John Antioco stopped in for a few moments to shake hands with them all at the glass-and-steel Renaissance Tower in downtown Dallas, and made a crack about McCarthy’s Hawaiian-style shirt and jeans. McCarthy still retained enough East Coast banking decorum to feel slightly mortified.
Hastings laid out his proposal: Why not turn Netflix into an online arm of Blockbuster? The win-win, as he saw it, was that Blockbuster would be spared the expense of converting its huge VHS inventory to DVDs and Netflix would get access to Blockbuster’s twenty million active store users, and pay a fee for the privilege.
Netflix would concentrate on back catalog and niche films, leaving Blockbuster with the new-release trade that made up about 80 percent of its business. He envisioned putting Netflix promotional materials and a sign-up computer in every Blockbuster store.
Antioco expressed skepticism about the viability of Internet companies and groused that the market had grossly overvalued unproven business models, a sentiment with which McCarthy secretly agreed. They weren’t surprised when Stead essentially laughed at Hastings’s alternate proposal—that Blockbuster buy Netflix for $50 million.
Talk on the flight back to California was tinged with bravado: Blockbuster was making a mistake that it would soon regret. Antioco was kidding himself if he thought Blockbuster could replicate Netflix’s technological innovations. They now had no choice but to kick Blockbuster’s ass, Randolph vowed.
CHAPTER FOUR
WAR OF THE WORLDS
(2001–2003)
THE DOT-COM BUST WAS SILICON Valley’s version of the Dust Bowl. Young software engineers, paid in now worthless stock options, haunted a wasteland of abandoned office parks, looking fruitlessly for work before many returned to school to become lawyers or accountants. The stock market lost $5 billion in asset value, and many blamed inexperienced, free-spending Internet entrepreneurs and investors’ “irrational exuberance” for sinking the economy. The rate at which new Web sites sprang up dropped to a fraction of the growth of the late 1990s’ go-go years, as the New Economy mantra of “get big fast and never mind profits” was repudiated.
Hastings now was on a mission to prove to Wall Street that Netflix’s survival of the dot-com meltdown was more than a fluke. In interviews in early 2001 he confidently predicted that Netflix would reach five hundred thousand paying subscribers and positive cash flow by the end of 2001. Data gathered by Kilgore’s marketing department showed that customer retention was finally headed in the right direction.
The executive team made the rounds of the entertainment and financial media to make other predictions, too: Kilgore and Hastings told Billboard in March 2001 that Netflix projected a subscriber base of ten million by 2004, and that a robust catalog of streaming online video would be available to mainstream consumers within ten years. By the time the company reached one million subscribers, Hastings added, independent filmmakers would probably bypass the movie studios and distribute their films online through Netflix. When that happened Americans would already be used to renting online—at Netflix.
What he did not say was that Kilgore’s marketing data also showed that Netflix still was not connecting with ordinary Americans—80 percent of its subscribers were still high-earning young males with better than average computer skills, i.e., computer geeks. Before they made another stab at an IPO, Netflix had to broaden its appeal to mainstream consumers.
THE MAIN THING Joel Mier loved about Netflix’s Web site was the data it spit out every day telling him who his customers were: where they lived; how many times and when they shopped on his site; which pages they clicked on and for how long; and what they rented.
He had to strike close to home to kill his customers’ habit of renting movies at Blockbuster—their homes. Mier and his staff often called new subscribers living within a short radius of Los Gatos to ask how they used the Web site: why they clicked on certain objects; why they signed up on a particular day and not a day or a week earlier.
If the conversation went well, Mier or his researcher would ask, “Hey, could we come over and visit with you, and watch what you’re doing?” More often than not the startled subscriber would say yes, and a researcher would drive over with carry-out Starbucks drinks and watch as the subscriber searched for movies on the Netflix Web site. Mier, at an imposing six-feet-five-inches tall, generally assigned home visits to members of his staff, so as not to intimidate his customers.
They learned that Netflix was preaching to the choir, and that that was not bound to change quickly. Their male, educated, and well-heeled subscribers had a lot of opinions about how Netflix should improve its site. Mier mused that their Usenet banter provided a useful running commentary about what had to be fixed before the service could appeal to a less tech-savvy audience.
“If one were to judge Netflix solely on the basis of newsgroup postings, one would come to the conclusion that this is a service not worth spending good money on,” a
poster named Mark V. from Cincinnati wrote in 2001.
My personal experience with them during the past 10 months has been mostly positive, however, especially now that they have improved their turnaround time on returns. I believe true movie buffs would be quite satisfied with their service.
Another poster had canceled his subscription after all thirty-five movies in his Queue had been listed as unavailable.
Among them was Titus which had been sitting in my cue [sic] for 3 months. This is completely ludicrous and indefensible. If I see from this group that Netflix has picked itself up out of the slag heap I will return but not until.
The target Mier was aiming for was small but growing quickly. By 2001, about 60 percent of U.S. households—mainly upper and middle-income earners—had a home computer, and a slightly smaller number had Internet access, U.S. Census data showed.
Many U.S. Internet households confined their Web surfing to the curated universe of America Online, even though the revolutionary search engine Google.com, launched the same year as Netflix, was already available in twenty-six languages. On the e-commerce front, Amazon was still not profitable, and Apple’s online music store, iTunes, and its revolutionary portable music player, the iPod, were still closely guarded secrets. No one had ever heard of Facebook, because the social network’s founder, Mark Zuckerberg, was still in high school.
The mainstream customers that Netflix needed were still renting at Blockbuster, Hollywood Video, and Movie Gallery, so Hastings and Kilgore decided to take the battle to their rivals’ turfs. The idea wasn’t so much to get the bricks-and-mortar chains’ attentions as to define Netflix by contrasting it with better-known opponents.
A true contest with Blockbuster, which had fifty million registered users (twenty million of them active) to Netflix’s three hundred thousand, seemed ludicrous, but it was a great storyline—if only Hastings could get the rental giant to simply acknowledge a potential threat from online rental, thereby legitimizing the business in the minds of consumers, investors, and the media.
Throughout the spring and summer Hastings and other executive team members took swipes at Blockbuster in interviews and advertising.
“There are ten thousand movies on DVD, and we stock them all. That’s more than ten times the selection of the largest Blockbuster,” Hastings told USA Today in June 2001. “Everybody hates late fees. We never have late fees.”
The contrast between the old-world giant and the agile young comer was irresistible to the media, and soon a David-and-Goliath tale emerged that Blockbuster could not ignore.
• • •
BLOCKBUSTER’S JOHN ANTIOCO may have looked a bit like ancient coin portraits of Augustus Caesar—deep-set eyes, a receding wreath of hair, and an aquiline nose—but he had an uncanny feel for what regular people wanted and liked. Antioco had an almost languid demeanor that could be misread as inattentive, until he pulled one of his startling, bet-the-ranch moves. He was a gifted storyteller and a good listener, the latter a quality that won him tremendous loyalty from his employees and the customer bases of several major U.S. corporations that he had turned around by the time he landed at Blockbuster at age forty-six.
Antioco was a people person, and he knew how to play favorites in a way that made employees want to work harder for him. He rewarded big wins with big prizes—African safaris, cash bonuses, and promotions.
His first job out of college required him to turn delinquent or underperforming 7-Eleven franchisees in New York City out of their stores—sometimes risking bodily peril from angry store owners—and return them to profitability for the parent company, Southland.
He discovered a knack for reading his customers—for putting thought into improving their shopping experience and finding the right mix of products for the stores in each neighborhood. In two decades he rose to vice president of marketing at Southland. He left in 1990 to find his own company to run.
Antioco developed a reputation as a reliable turnaround specialist while hopscotching among a roster of America’s best-known brands. He brought the Circle K convenience store chain out of bankruptcy and took it public, did a stint at the Pearle Vision eyewear chain, and rescued PepsiCo’s Taco Bell fast-food chain from cost cuts that went too deep. He was waiting to hear whether he or David Novak, head of KFC and Pizza Hut, would run the restaurant division that PepsiCo planned to spin off as Yum! Brands when Viacom chairman Sumner Redstone came calling in 1997.
Redstone had bought Blockbuster three years earlier primarily for the $1.25 billion in cash reserves on its balance sheet and its large, steady cash flow, which he used to offset the $10 billion he paid for Paramount Communications in a highly leveraged deal.
At the time, Blockbuster was near the end of a growth spurt fueled by its rapid acquisitions of smaller, regional video-rental chains. In those glory days of its near monopoly Blockbuster also had made ill-advised and expensive forays into music sales and an “entertainment convenience store” concept called Blockbuster Block Party that featured restaurants, rides, and games.
The competitive threat posed by DVDs and video on demand prompted Blockbuster’s then chief executive, Bill Fields, to try to diversify his stores by selling clothes, magazines, books, and candy as a hedge against what he believed would be an irreversible decline in store revenues. The costly initiatives failed.
Fields, who knew the DVD ecosystem intimately from his time as chief of Walmart’s stores division, told Redstone and Blockbuster’s own managers that the big chain would never again see positive store revenue growth.
Redstone, who wanted Blockbuster off Viacom’s books but could not find a buyer, went looking for new leadership. He had a headhunter contact Antioco to arrange a meeting in Beverly Hills.
It was the second time he had been approached to run Blockbuster, and Antioco still wasn’t sure about moving to Dallas. He was even less keen on a proposal by PepsiCo chairman Roger Enrico that he and Novak run Yum! Brands together. Antioco didn’t know much about the entertainment industry, but he was an expert at rehabilitating franchise-based retail businesses, and he liked movies.
He met with Redstone at the Beverly Hills Hotel and took an immediate liking to the seventy-four-year-old billionaire who had built his family’s regional movie theater chain into a media empire.
Redstone offered to beat Antioco’s already prodigious PepsiCo salary, which Enrico had stuffed with stock and cash incentives while bidding for Antioco’s services against the private equity firm that owned Kinko’s. More importantly, they agreed that after Antioco righted Blockbuster, he would take it public as its chief executive.
• • •
BLOCKBUSTER HAD WHAT Antioco considered a fatal flaw: an arrogance born of being the only game in town for too long. Its business model, which the company internally described as “managed dissatisfaction,” had produced a wellspring of consumer resentment toward the big chain over late fees, poor selection, and bad customer service. Blockbuster’s own research showed that customers had to visit stores for five consecutive weekends to get the video they wanted. Antioco found that, to add insult to inconvenience, the stores were dirty, the merchandise mix was often wrong for their neighborhoods, and the goods were overpriced.
What other business treats you like that? he thought.
Confounding the search for ways to fix the stores were Blockbuster’s mulish franchisees, who owned a collective 20 percent of the U.S. store base and felt burned by Fields’s attempts to turn them into entertainment convenience stores. He also encountered a demoralized, entrenched bureaucracy in the corporate-owned stores.
Antioco focused on what he could fix right away, like cleaning up the stores and, with Redstone’s help, pursuing revenue-sharing deals with the movie studios that would allow Blockbuster to cut its inventory costs and triple its hot new releases. He tapped store managers and staff for ways to improve morale and, by extension,
customer service. Lastly, he let customers know what he had done with a nationwide advertising campaign starring animated characters, a guinea pig and a rabbit named Carl and Ray, who delivered Blockbuster’s new mantra: Movies were now “guaranteed to be there.”
Customer satisfaction improved at a rate that surprised Antioco as a result of these measures. Rental revenue rose by 13 percent, and active memberships were up 7 percent a year after he stepped into the executive suite. Viacom’s stock price more than doubled in the same period. Redstone, who had overpaid for Blockbuster and was still taking a lashing for it in the financial press, was thrilled, but he still wanted to pull Viacom’s money out of the chain before the cable companies’ new gambit—video on demand—started to erode its market share.
The plan was to spin off 20 percent of Viacom’s Blockbuster stake in 1999 to make a market in the stock, and to sell off the rest when the share price stabilized. Viacom sent Antioco and Blockbuster’s new chief financial officer, Larry Zine, who had served as Antioco’s number two at Circle K, on a road show to present the plan to investors.
Zine was a slight and quiet man, and he became fast friends with Antioco when the two men worked to bring Circle K out of bankruptcy. Over the years, Zine, whose tranquil solemnity provided an interesting foil for the more dynamic Antioco, had learned to anticipate Antioco to the extent that he could often finish the CEO’s sentences.
The road show turned out to be an exhausting ordeal. In some seventy meetings with suspicious investors, Antioco, Zine, and Viacom senior vice president Tom Dooley had to explain how Blockbuster would survive competition from video on demand and pay per view, and why Redstone’s desire to sell his stake was not a vote of no confidence in the video-rental company.
Zine swore that some of the fund managers took the meeting simply to argue with them about why Blockbuster was doomed. Toward the end of their tour, in Paris, Antioco fell asleep on his feet while giving the presentation.
