Netflixed

by Gina Keating

  That summer, everyone at Netflix was exhausted and becoming demoralized. Hastings carried himself like a depleted man, and it was clear that Kilgore was very, very worried.

  CHAPTER THIRTEEN

  THE GREAT ESCAPE

  (2007–2009)

  LATER, CARL ICAHN WOULD REFLECT that John Antioco had, in fact, done a good job in setting up Total Access, and that if Antioco had not left the company in a huff over his bonus, things might have turned out differently.

  But in the summer of 2007, Icahn could hardly wait to get rid of Antioco. In his view, Antioco never cared as much about Blockbuster as he did about making money and escaping to his ranch to drink tequila. Icahn wanted to replace him as soon as possible. During the search for Antioco’s replacement, Icahn met former 7-Eleven chief executive Jim Keyes through another major Blockbuster shareholder, Michael Zimmerman, who ran Prentice Capital Management LLC. Zimmerman, who periodically called Antioco to offer advice on rehabilitating Blockbuster’s stores, convinced Icahn that Keyes had both the solid retail background to shore up the stores and the know-how to take Blockbuster into digital delivery.

  Keyes, then fifty, had retired after two decades at 7-Eleven when Tokyo-based Seven-Eleven Japan acquired the convenience store chain in a $1.4 billion buyout in 2005. He exited 7-Eleven with a $64 million golden parachute after presiding over a streamlining of the chain’s operations and a doubling of its stock price in the year before the takeover. In retirement, Keyes intended to devote himself to his philanthropy, Education is Freedom, and to perhaps add a helicopter pilot’s license to his airplane pilot’s license.

  As vice president of planning, Keyes had helped preside over a renaissance of 7-Eleven’s U.S. stores after they lost market share to gas station minimarts in the early 1990s. Icahn was convinced that Keyes could do the same for Blockbuster’s store operations, as well as guide the online operation to profitability.

  Shortly before his retirement in 2005, embarrassing allegations that Keyes and other top 7-Eleven executives took improper gifts from suppliers surfaced in a lawsuit by a food broker named Milissa Boisseau. The convenience store chain ended its relationship with Boisseau, and four 7-Eleven administrative assistants, whom they alleged had taken kickbacks from her, were fired or forced into retirement. The impetus for those actions had allegedly been Keyes’s relationship with another broker named Debra Miller, who subsequently attempted to pick up Boisseau’s accounts with 7-Eleven.

  The discovery process revealed, however, that Keyes himself had attended a fantasy baseball camp with the St. Louis Cardinals for several years, courtesy of Anheuser-Busch, and had accepted a spot on the AT&T Pebble Beach National Pro-Am tournament from AT&T, among other gifts from vendors. Other executives accepted special treatment from vendors at the same time that they decided to fire the four low-level assistants for accepting money to type up reports for Boisseau on how her products were selling in 7-Eleven stores, according to lawsuit documents.

  When Antioco heard that the board was seriously considering Keyes, with whom he had worked at 7-Eleven, he was surprised but did not believe Keyes could possibly win the job over Shepherd, whom he had promoted to chief operating officer in April after his brilliant rollout of Total Access. Realizing that Blockbuster lacked the in-house talent to run a streaming service, Shepherd had spent six weeks that spring on the road learning about digital delivery from the best in the business. With Blockbuster and the entire movie rental industry headed toward digital delivery, Antioco wondered how Keyes’s retail-heavy résumé was relevant.

  In Keyes, Icahn, who said he was attracted by Keyes’s ideas for a digital business, had found the anti-Antioco.

  Before the CEO position had become available, Keyes was exploring the idea of buying a large stake in Blockbuster, as a first step toward taking the company private.

  On the day that Blockbuster announced who the new CEO would be, Blockbuster board member Gary Fernandes told me that the board chose Keyes because of his success in turning around declining store sales at 7-Eleven and in forming partnerships with retailers.

  “That same kind of approach is what is going to be critical for Blockbuster,” Fernandes said. It seemed that the board expected Keyes to essentially carry out Antioco’s agenda. Work hard to squeeze every dollar they could out of their retail locations while growing the online business and creating an electronic delivery option, Fernandes said.

  But Keyes had a different idea: “We will be revisiting the entire strategy.”

  Keyes was a round-faced man with an affable public demeanor. He had worked for Antioco at 7-Eleven many years earlier and had seemingly come away with a chip on his shoulder. At one point Antioco sent Keyes to what the latter jokingly described as “executive charm school” to remedy a marked lack of people skills. Shortly after he took over his new post at Blockbuster, on July 2, 2007, it became clear to his new colleagues that the lessons had not held up over time. They found Keyes impatient and high-handed, unwilling to listen or entertain data that undermined his ideas, and determined to eradicate any trace of Antioco. In their first meetings with Keyes, they also learned that he could be brusque to the point of rudeness and quick to raise his voice to threaten or ridicule subordinates.

  Although Blockbuster indicated in the press release announcing Keyes’s hiring that Antioco would stay and smooth the transition, he left two days before Keyes arrived.

  There had been a party at Renaissance Tower, complete with tributes and tearful good-byes. Shepherd, who had to retreat to his office to hide his tears, first snapped a photo of Antioco with his cell phone camera that he used as wallpaper for months to remind him of what a happy man looked like. Afterward, Antioco waited for his last paycheck to be cut and gave it to his assistant to deposit in his bank account. He later donated the disputed bonus amount to the Boys & Girls Clubs of America.

  Then he drove to Love Field in Dallas and hopped a private jet to the Hamptons, where he and Lisa and his three children planned to spend a month relaxing and visiting with his sister and his friends from 7-Eleven, and the old neighborhood. It was time for him to leave Blockbuster, and he was at peace with his decision to go; he was confident he had left the company on the right trajectory.

  As the jet surged down the runway, Antioco felt liberated.

  • • •

  NICK SHEPHERD HAD at least as hard a time as Antioco with Blockbuster’s board of directors. He had been run through the ringer when Icahn’s dissident directors joined the board and demanded to know why the stores kept losing money. Ed Bleier, in particular, seemed fond of strange ideas. “Nick, do people coming into your stores wear jeans?” the eighty-year-old Bleier asked, as a prelude to suggesting that Blockbuster clear room on its new-release wall for racks of blue jeans.

  “They also wear sneakers. Should we put those on the wall as well?” Shepherd replied. The tense exchanges crystallized the board’s sense that management was intransigent and the managers’ conviction that the board was completely dysfunctional. Finally, Shepherd invited the board to a daylong retreat to explain why many of the approaches they had suggested to revive the stores would not work. Working through a half dozen boxes of research on dozens of initiatives that had been tested over the previous four years, Shepherd explained the purpose of the initiative, how they had executed it, and the results.

  It all added up to the same conclusion: Nothing was going to bring the stores back. Store-based rental was on its way out. Digital delivery was the rental business of the future.

  Finally, Strauss Zelnick stopped the presentation. “I get it,” he said. Most of the board agreed and seemed to accept the managers’ strategy, although that did not stop Bleier from occasionally suggesting initiatives like hooking up with Hallmark cards or Barnes & Noble or selling pizza at the stores.

  Adding to his disappointment in not becoming Blockbuster’s chief executive, Shepherd now had
to go through the same routine with Keyes, who was reaching into his 7-Eleven playbook to revive the stores with a new mix of food and merchandise similar to the plan Antioco’s predecessor Bill Fields had tried. Shepherd planned to depart Blockbuster in October after helping Keyes transition to his new role, and he was determined to maintain a professional demeanor.

  Shepherd and Bryan Bevin offered to show Keyes the results of Field’s failed initiatives and other market research, but the new CEO demurred. He returned the reports they sent to him unopened.

  It was frustrating to watch Keyes make the same mistake that Fields had made in treating Blockbuster like a convenience store chain and assuming that its customers would simply shift their buying habits to purchase whatever merchandise it stocked. In consumers’ minds, Shepherd knew, the Blockbuster brand stood for one thing only: a place to rent the latest DVD releases.

  Blockbuster had to close nonperforming stores and use the remaining stores to support the move to online rental and digital distribution, Shepherd said.

  “We’re retailers—we open stores. We don’t close them,” Keyes retorted.

  Less than a week later, Bevin walked out of a staff meeting with Keyes and quit the company. He could not bear to hear the new chief executive’s plans, which would inevitably send Blockbuster straight into an iceberg.

  • • •

  IT WAS CLEAR to Evangelist from their first meeting that Keyes had a personal animus against the online business.

  “Total Access is killing the business,” he told Evangelist. “You’re bankrupting the business. You can’t continue to operate at a deficit.”

  While conceding that online rental would cause big losses in 2007, Evangelist and Antioco had planned to run the service profitably the following year through price increases and simple economies of scale once the subscriber base got large enough. Evangelist explained that he would split DVD by mail off from Total Access and price it just below similar Netflix plans. The heaviest Total Access users and new subscribers would see a 25 percent increase in rates starting in the third quarter of 2007.

  Evangelist soon learned that Keyes’s ideas for online rental meant essentially abandoning Total Access, raising subscription prices across the board, and diverting the money Antioco had pledged to the online service to Blockbuster stores.

  “Jim, you’re missing this thing,” Evangelist said. “This is a singular program that attacks both Hollywood Video and Netflix. You don’t have another deal for that.”

  He knew, from the times Antioco had briefly cut funding to Blockbuster Online to renegotiate the parent company’s debt, that a strong marketing program was essential to constantly replacing customers who canceled their subscriptions Evangelist predicted that without ads to attract new subscribers, Blockbuster Online would wither from the 3.7 million when Keyes took over in July to 1.5 million by the end of the year.

  Keyes laid out his store-focused strategy to Blockbuster’s top management at a company retreat on July 30, 2007, at the luxurious Rough Creek Lodge & Resort about ninety miles south of Dallas. Blockbuster stores would become “great” again as entertainment destinations that would sell a new mix of prepared foods, such as pizza and fountain sodas, as well as electronics, such as iPods and DVD players. The presentation horrified old hands, who had watched nearly identical promotions crash and burn under Fields and Antioco.

  More shocking—because it displayed a lack of understanding of digital video technology—was Keyes’s contention that someday consumers would make it a habit to drop by Blockbuster stores to load movies and games onto flash drives or video-enabled devices at in-store kiosks, instead of simply using their home broadband lines.

  Store revenues would never recover from the swoon that began in 2005, and everyone in the room but Keyes knew it.

  The retreat was so disastrous that a number of senior-level executives—among them Evangelist, Shepherd, and Zine, who had announced his retirement—phoned in sell orders on most or all of their Blockbuster shares during the next “open” period when they could legally do so. Several, including Evangelist, Zine, and Antioco, when he heard of Keyes’s plan, plowed the proceeds into Netflix stock. They didn’t need inside information on Netflix—they knew exactly what was about to happen to Blockbuster.

  Keyes was furious when he saw the securities filings disclosing the stock sales. Because his new employment contract allowed him to hold up to a 4 percent stake in Blockbuster, he ended up buying back their stock himself. “You can sell your shares, but you should tell me first,” he told them.

  Despite the unspoken yet pointed warning from his staff, Keyes stuck to his plan.

  • • •

  THE BLOCKBUSTER BOARD took its cue from Icahn and let Keyes go forward with his plans to defund Total Access and sell merchandise on consignment in the stores. Keyes’s plan to make a bid for the ailing Circuit City electronics chain also won board approval, even after Wall Street analysts roundly panned the idea.

  As promised, Keyes raised subscription prices on all Blockbuster Online subscribers and diverted the millions that Antioco had pledged to Total Access to the stores. He also refused to consider Evangelist’s repeated pleas to sell Blockbuster Online—now worth close to $1 billion at Netflix’s original offering price—saying he needed the online service as a bridge to digital delivery. Later, he refused to consider a second offer Hastings made to buy the subscriber base.

  Wall Street reacted negatively to Keyes’s price increases for Total Access, which raised the cost of the premium plan by $10 a month, to $34.99. In a note to clients, Citigroup analyst Tony Wible upgraded his rating on Netflix, predicting that the price hikes could drive away as many as half of Blockbuster Online’s subscribers.

  • • •

  NETFLIX GREETED ANTIOCO’S departure and Keyes’s plan to run Blockbuster for profit with relief. Keyes’s public revelation that Total Access had been killing Blockbuster validated everything that McCarthy and Hastings had been telling analysts and journalists for months. Finally Blockbuster would be forced to run a sustainable business strategy, and they believed Netflix could compete against that approach, and win.

  A group of Netflix executives, including Ross and Kirincich and David Wells, listened to one of Keyes’s first presentations to Wall Street, in which he rolled out plans for rejuvenating the stores with a concept called Rock the Block. He presented drawings for the elaborate new stores that Ross admired, but that he thought looked a lot like the multilevel glass Toys Я Us store in Times Square

  Like the Blockbuster veterans, Ross and the others knew that Keyes could do nothing to save the stores, no matter how he rebuilt them. But if Keyes wanted to expend manpower and resources on the fruitless project, they welcomed his mistake. Publicly Hastings praised the store concepts but behind closed doors the Netflix staff were thrilled that Blockbuster had taken its eye off online rental.

  As Evangelist predicted, Blockbuster Online began losing subscribers as soon as Keyes cut its marketing budget. Analysts were correct in assuming that the price hike, planned for December, could cut the subscriber base by half, he warned.

  During a series of tense strategy sessions with Keyes and Blockbuster chief financial officer Tom Casey in the autumn of 2007, Evangelist again raised the subject of selling the online service to Netflix. “Sell it for what you can get for it,” he said. “Guarantee our subscribers in-store exchanges for about a year—just price in what it’s going to cost us to service them. Open it up to Netflix customers and tell them they can exchange their DVDs in our stores for two dollars.”

  Again, Keyes turned him down. “Who is going to buy it, Shane?” he asked mockingly.

  “I don’t know, Jim. Why don’t we start with that guy in California who offered us two hundred dollars a sub?” Evangelist said. “Just let me go on the road for six months and I’ll get it sold.”

  Evangelist’
s increasingly desperate attempts to prevent Keyes from gutting Blockbuster Online went nowhere. Finally, Keyes reiterated his plan to cut funding to the online service at the end of one meeting. He turned to Evangelist and said, “If you don’t like it, get the hell out.” Although Keyes had offered him several jobs in Blockbuster’s upper management, Evangelist got a call from Blockbuster’s Human Resources department as he drove home that night, asking about Keyes’s ultimatum. “Just trigger my contract,” he said. “I don’t want to work for him.”

  As he sat on his back porch that evening, watching the Texas sun sink, Evangelist began sobbing. It suddenly occurred to him that four years of his life had just evaporated.

  When she learned that Evangelist had resigned, the controlled Hessel locked the door, sat in her office, and cried. She resigned a few weeks later.

  • • •

  EVANGELIST ATTENDED A dinner at the San Francisco home of Silicon Valley investors Ellen and David Siminoff about three weeks later. Ellen Siminoff sat on the board of the online auto parts store U.S. Auto Parts Network, which had just hired Evangelist as its chief executive. And David Siminoff had invited his friend Reed Hastings to join them for dinner.

  It was the first time the two men had met. They sat across the table from one another making polite conversation until dessert, when curiosity won out.

  In the spirited discussion that followed, Evangelist learned that Hastings had been prepared to pay Blockbuster Online as much as three hundred dollars per subscriber to put Evangelist and his team out of business.

  “You had us in checkmate,” Hastings said, conceding that while Netflix knew that Blockbuster Online was burning through money, Total Access was a value proposition they could not match.

  The talk turned to Keyes’s new initiatives, especially the Blockbuster chief executive’s preoccupation with rebuilding the store base. Both knew that Keyes would fail, and it would be a matter of time before the board replaced him, possibly with a more tech-savvy executive.