Netflixed

by Gina Keating

  “The Giant Is Awakened,” the video concluded, with a shot of Blockbuster Online’s yellow-and-blue mailer and the logo “Blockbuster Online: The Movie Store at Your Door.”

  Amid cheers and applause, Antioco and Travis walked onstage and said a few congratulatory words to Evangelist, who had been promoted that day to senior vice president, and to his team. Then they pressed the button.

  Travis and Nick Shepherd had been invited to the bash as a gesture of inclusiveness, even though the suspicion between the two camps continued unabated. Shepherd, however, did not attend. Evangelist and Cooper got a good laugh when they heard a rumor going around Renaissance Tower that the online staff had filled its Paramount Building offices with the trappings of dot-com luxury—foosball tables and expensive office furniture—and that they enjoyed free meals as a perk of their supposedly sumptuous budget.

  In fact, although Viacom’s Karmazin supported the idea of an online rental service, he had balked at the potential expenditure of the $200 million or more that Evangelist estimated it would cost to build and run the service before it started making money. In the meantime, he was stretching the $25 million Antioco had allotted him nearly a year earlier until Blockbuster completed its split-off from Viacom in late 2004.

  Cooper had rigged the button on the stage at the Granada to actually make Blockbuster Online go live, and it worked like a charm. Back at the Paramount Building, however, a coding error cropped up almost immediately. and as traffic built, the bad code threatened to take down the site. The programmers had to “bounce,” or restart, the servers almost once an hour for nearly a week to keep the system running before they could fix the problem.

  The meme cache error was the first of a litany of technical problems to dog Evangelist and his affable chief programmer, Aaron Coleman, throughout Blockbuster Online’s sometimes painfully quick growth.

  Coleman, a thirty-year-old Bay Area technologist, was not sure he was interested in that lead job when his girlfriend Jenny, who worked for Cooper at Blockbuster Online, persuaded him to meet with Evangelist. But Evangelist’s personal charisma, coupled with the prospect of working for a well-funded start-up backed by a world-famous brand, won him over.

  His first day on the job, in February 2005, ended at 3:00 A.M. The days that followed were equally packed with battles to keep the Web site functioning while Blockbuster Online brought new distribution centers onto the system, hit daily subscriber sign-up records, and added thousands of new titles to their inventory each week.

  Within months, Coleman was fine-tuning the Web site applications and databases to process several thousand orders per second—making sure subscribers were matched with the next available movies in their queues, and then locating the DVD in the nearest distribution center—from a launch day average of about a dozen orders per second.

  In the coming three years, Coleman and his programmers would completely rewrite the code supporting each system to accommodate growth, and to evolve the site to match Netflix, metric by metric and feature by feature, and to eventually surpass its performance.

  The Blockbuster Online team looked at Netflix from the beginning with a mix of admiration and rivalry, and because they were young, they meant to balance their hard work with some fun.

  The voices of Hastings, McCarthy, and Kilgore wafted through the Paramount Building on speakerphones each time those executives gave a presentation to analysts or talked to the press after an earnings report. Any mention of Blockbuster Online by Netflix was usually greeted with catcalls and sarcastic comments.

  Sarah Gustafson was just four years out of college and typical of the full-time staff that Evangelist began hiring soon after the launch. She was bright and idealistic, and had followed Evangelist to the online service from Blockbuster’s business development division to run customer analytics. She gathered the metrics that informed their pricing and purchasing decisions as well as the shape of the products it would offer subscribers.

  While she relished the challenge of competing against a company she considered revolutionary, Gustafson had no illusions about the battle that lay ahead. Getting customers to try out the service was no problem, especially with cheaper prices and a better-known brand. Keeping them proved harder. When she dug into the cancellation data, Gustafson learned that two factors were responsible—delivery speed and availability of titles.

  The biggest complaint that surfaced on consumer blogs and reviews of the service was the shortage of inventory that showed up as “long wait” notifications in subscribers’ queues. While praised for relatively quick delivery, the fulfillment system frustrated subscribers by often delivering disks from the bottom or middle of their queues first.

  In their haste to finish the project by Evangelist’s deadline the Accenture team had had to build the Web site’s main functions—its consumer interface and DVD allocation and distribution systems—on separate platforms. The arrangement got the site up and running but made it difficult to grow. Capacity was a constant problem that kept Michael Siftar, the software developer who Evangelist hired to transition Web site maintenance from Accenture to a permanent team, busy for the first few months of his tenure.

  Siftar, an easygoing, articulate thirty-year-old from Broken Arrow, Oklahoma, who had most recently worked at Priceline.com, set up his office in a dark hallway, sat his staff at card tables outside, and went to work on the complex algorithms that decided which movie a subscriber would receive next and which warehouse it would come from. Siftar divided his programmers into three smaller groups that acted as sort of computer SWAT teams, putting down problems across the balky systems and reconfiguring them to meet an ongoing schedule of price changes, product rollouts, and consumer tests.

  For all the problems with service levels, and in spite of their lack of experience, the Blockbuster Online team knew there was just one metric that counted to the financial press and to Netflix, and that was the size of its subscriber base. Evangelist made it everyone’s business—twenty-four hours a day, every day—to make sure nothing impeded its growth.

  He had Cooper rig their BlackBerrys to receive hourly reports showing subscriber sign-up levels. If any unexplained fluctuation in those numbers appeared, Evangelist would call—often late—and Cooper would slip out onto his back porch to talk to avoid waking his wife, Jess. He’d set the ring tone for Evangelist’s calls on Darth Vader’s theme music from Star Wars, and he only realized how obsessed with the reports they both had become after noticing that his dog ran to the backdoor every time it heard the ring tone. At the time they were signing up a few hundred people an hour—about three thousand a day.

  The numbers provided the tech and marketing teams with constant alerts to choke points in the system—a link on an affiliate’s page that wasn’t clicking through, or a problem with a particular browser, or a software glitch that was preventing sign-ups. As ingenious as it was, the alert system essentially turned every job at Blockbuster Online into an on-call gig.

  Evangelist set the tone for their work ethic and attitude: They were not Blockbuster crushing a smaller company; they were a start-up trying to catch a technologically superior and far more experienced competitor.

  His discipline was remarkable, the result of a lifetime of sporting competition. He did not drink alcohol or smoke, played amateur-level golf, and maintained his college gymnastics physique; he could still do a back flip from a standing start. He adhered to what his Blockbuster Online colleagues described as a hummingbird diet: It consisted almost entirely of processed sugar—Hostess CupCakes, Dr. Pepper, and candy bars—and he would consume four or five plastic cartons of Tic Tac breath mints at a single meeting. The sugar fueled his innate ambition and athletic prowess, making Evangelist extremely intense to work for, but he also had something of Antioco’s touch with people. His employees learned to simply roll their eyes at his more bizarre demands and find their own ways to accomplish what he wanted.r />
  He set a strict schedule of goals and meddled minutely in every department to make sure objectives were met on time and on budget. Everything at Blockbuster Online was data-driven—Evangelist loved market research and used it to back every product decision—even if the research consisted of polling people waiting at the streetcar stop down the block from the Paramount Building.

  The Blockbuster stores team steered clear of the West End operations, but Antioco and Evangelist exchanged e-mails or phone calls every night between 10:00 P.M. and midnight—a time the younger man prized as more valuable than his MBA from Southern Methodist University.

  Although Evangelist’s goal was to launch the online service separate from Blockbuster, to keep it from getting entangled in the rental chain’s bureaucracy, and then to quickly integrate it with the stores, Blockbuster Online first had to overcome a major technological hurdle. In 2004, Blockbuster stores still were not connected to each other or to the Internet. Every night the stores still used satellite technology from the 1980s—the same system Cooper had used at his high school Blockbuster job—to upload cash register and inventory data and download software patches. Wiring the stores to communicate with the online service would be costly and complicated.

  Antioco and his store managers also had bigger issues to face, with the spin-off from Viacom underway and ominous forecasts of declines in store-based video rental business. Evangelist put plans for the integration to the side and did what every kid playing catch-up does: Run hard.

  CHAPTER SEVEN

  WALL STREET

  (2004–2005)

  JOHN ANTIOCO WAS THE GUY from the wrong side of the tracks. He grew up not exactly poor, the son of a penny-pinching milkman who would die many years later having amassed a secret stock portfolio worth almost $1 million. He lived on a blue-collar block of walk-ups in Brooklyn, the youngest child and only son of his Italian American parents.

  Johnny, as his mother called him, was a troublemaker at the Catholic elementary school he attended, which was on a leafy street with buckled sidewalks and had a tiny walled playground; he developed a reputation in the neighborhood for petty misbehavior as he approached adolescence. His father, a taciturn man, moved the family to a neat bungalow in the Long Island burg of Mineola when Antioco was twelve, to separate him from his bad-seed friends.

  The upheaval of the 1960s mostly passed by Antioco. He avoided service in Vietnam thanks to a high draft number and attended the Woodstock festival only because a friend happened to be going and Antioco didn’t have anything better to do.

  The one thing that fired his imagination was making money. His father’s miserliness was a topic of neighborhood gossip in Brooklyn and Long Island, and the constant corner cutting and patch jobs made Antioco swear that one day he would have enough money to never again have to live with half-broken things.

  His landed his first real job at a Baker’s shoe store in the Roosevelt Fields Mall on Long Island, where he discovered that he was good at selling things and loved working on commission, where his success or failure was toted up each night on a chalkboard for his fellow salesmen to see. He found it exhilarating.

  Part of the attraction of coming to Blockbuster in 1997 was the chance to run a publicly traded company and join the top echelon of America’s CEOs. By 2004, Antioco had fulfilled his mandate from Sumner Redstone—to make the giant rental chain healthy enough to split off from Viacom—and his promise to investors: to claim a growing share of the $8 billion movie rental industry. Blockbuster’s annual revenue had grown to $6 billion, and its earnings topped $600 million.

  But Viacom chief operating office Mel Karmazin, who came to Viacom in its 2002 merger with CBS, liked the cash Blockbuster reliably generated, and he convinced Redstone to rethink the decision to split it off.

  Antioco was now saddled with the regulatory requirements of a public company and a parent company. He began to explore his options. He had been denied the chance to run Circle K and Taco Bell, and he did not want to mark time at Blockbuster if it was going to remain a subsidiary of Viacom.

  Besides, Blockbuster faced a fast-changing competitive landscape, and Antioco believed he needed more autonomy to confront it. In 2003, Antioco brought several initiatives to Karmazin intended to beat back challenges to Blockbuster’s market share from online rental and video on demand. When Karmazin saw a price tag totaling hundreds of millions of dollars in expenditures, he realized Viacom had to let Blockbuster go.

  • • •

  TO KEEP ANTIOCO onboard Redstone had cut him an even more impressive compensation package than the generous executive remuneration for which Viacom was known. The performance-based package brought Antioco’s stake in Blockbuster to 3 percent and had the potential to total as much as $50 million in salary and stock-based compensation, assuming a healthy rise in Blockbuster’s share price each year. Redstone also built in a $54 million severance package to protect and reward Antioco for bringing Blockbuster back from the brink of bankruptcy and taking it public that he could claim if he lost his chairman title or was fired without cause.

  The contract he signed with Blockbuster gave Antioco everything he had ever dreamed of in his work life. Johnny Antioco from Brooklyn had arrived.

  Redstone went ahead with plans to split off Blockbuster in a stock swap. Under the complex transaction that was announced in February and completed in September 2004, Viacom shareholders received 5.15 shares of Blockbuster stock plus a $5 special dividend for each share of Viacom stock they relinquished. Blockbuster took on $1.2 billion in debt to finance the special dividend, including paying Viacom $738 million to buy back its Blockbuster shares.

  To satisfy its creditors’ terms Blockbuster had to maintain a strict debt-to-income ratio—a challenge for a company in a mature industry that was forecasting eroding store sales and struggling to find a future in e-commerce.

  Once the split-off was completed Antioco turned to three initiatives he believed would secure Blockbuster’s future. First, he had to correct the overbuilding of video stores: He wanted to buy the Hollywood Video chain and shut down about half of the combined store base. Cutting underperforming stores would buy time for healthy ones as the industry transitioned to digital delivery. He figured it would cost about $700 million to buy the number two chain, which was controlled by its founder, Mark Wattles, and a group of private investors—if federal antitrust regulators did not object to the match.

  Second, Antioco wanted to drop late fees to lure disaffected consumers back to the stores to try the new programs he was pitching: game and DVD trading and reselling and the in-store subscription that was similar to Netflix’s all-you-can-watch rental plan.

  The End of Late Fees, as Blockbuster named the program, would cost the chain a steep $250 million to $300 million a year in operating income, but their market research showed no better way to turn around dwindling store traffic than eliminating the strongest argument for online rental and other forms of distribution that promised greater freedom.

  Consumers’ ability to create, manipulate, and share their own videos online made them impatient with rules governing how, when, and where they watched rentals or purchases. Antioco saw this and knew Blockbuster had to distance itself from punitive late fees and other tenets of its managed dissatisfaction strategy.

  Finally, he planned to make major investments of money and staff in online rental and the digital delivery system he had been hunting for over the past five years.

  In October 2004, Antioco proposed a Blockbuster–Hollywood Video merger. Since 2001, movie rental revenue had shrunk by 19 percent, and the once mighty U.S. store base of seventy thousand locations—including Blockbuster, Hollywood Video, Movie Gallery, and other chains, as well as mom-and-pop stores—had winnowed to eighteen thousand, according to a report by media analyst Tom Adams. Blockbuster had to seize control—of its own fifty-two hundred stores, Hollywood Video’s two thousand s
uperstores, and Game Crazy’s seven hundred–plus locations—before store rental revenue got too thin to support its far-flung U.S. store base. Federal antitrust concerns had prevented the sale of Hollywood Video to Blockbuster in 1999, but Antioco figured that the emergence of strong rental alternatives, including Netflix, would now force the agency to a different conclusion.

  A buyout firm, Leonard Green & Partners, had already offered Wattles $10.25 per share to take Hollywood Video private in August—a transaction Wattles backed, put the number two U.S. rental chain in play, and allowed Hollywood’s board to consider other offers. On November 12, Blockbuster made a tender offer of $11.50 per share to Hollywood Video’s shareholders. A successful merger would give Blockbuster control of 45 percent of the U.S. store-based rental market. A week later, Dothan, Alabama–based Movie Gallery, the number three movie rental chain, entered the bidding with an undisclosed offer that analysts estimated was worth at least $760 million.

  A week after that, Blockbuster said it would sweeten its offer in exchange for a look at Hollywood’s books. Wattles, however, would not turn over the information to Antioco unless his rival agreed not to tender an offer directly to Hollywood Video’s shareholders. Wattles said publicly that he welcomed the offer, but he privately expressed doubts to the Blockbuster executives that U.S. antitrust regulators would approve the deal.

  The proposal had drawn the attention of billionaire investor Carl Icahn, a former corporate raider and self-styled shareholder activist, who then planned to profit on both ends of the Blockbuster–Hollywood Video merger. Icahn sank $150 million into Blockbuster shares and about $60 million into Hollywood Video. In a securities filing Icahn said he might seek to participate in, and influence the outcome of, any proxy solicitation and the bidding process involving the owner of the Hollywood Video stores.