Netflixed

by Gina Keating

  Netflix executives took the criticism in stride, joking among themselves that Bewkes probably suffered from traumatic flashbacks to Time Warner’s disastrous 2000 merger with AOL whenever the media asked him about his company’s online strategy.

  When Huffington Post publisher Arianna Huffington asked about the comment during the 2011 Consumer Electronics Show in Las Vegas, Hastings pulled a chain from beneath his shirt and joked that he was proud to wear the dog tags of the Albanian army. He later issued “Albanian Army” berets to executives for a two-day retreat at a Silicon Valley convention center. Many of the ninety-plus executives wore the berets throughout the two-day event.

  The chimp comment also provoked much mirth at Netflix, especially after David Wells mocked up a PowerPoint presentation for an all-staff meeting to show why chimps are smarter than gorillas. The final slide showed a photo-shopped picture of a chimp wearing an Albanian army beret and waving a Netflix flag.

  At the same time, the Internet service providers acted to curb Netflix’s growing might—first by threatening to stop offering unlimited bandwidth access and then by charging customers per gigabyte of bandwidth they consumed.

  Comcast, in the midst of acquiring NBC Universal, provoked public outrage by charging extra fees to Internet service provider Level 3 Communications for carrying Netflix streaming movies over Comcast’s broadband fiber. Hastings called the Comcast fee “inappropriate.” The incident set off a feud between Netflix and Comcast.

  Netflix hit back in a blog posting that ranked the speeds of U.S. and Canadian ISPs in delivering Netflix streaming videos to consumers’ homes. The threat of bandwidth caps propelled Hastings back into national politics for the first time since he lost his seat on the California board of education.

  He called on Netflix subscribers and public interest groups to demand greater U.S. government oversight of Internet neutrality rules to ensure that Internet service providers could not tamper with Web traffic to favor their own programming and slow down that of rivals like Netflix.

  To bolster Netflix’s spending on federal lobbying, which grew from $20,000 in 2009 to $500,000 in 2011, Hastings formed a political action committee called FLIXPAC to get his two cents on a raft of internet-related legislation governing Internet neutrality, offshore movie piracy, and the sharing of consumers’ video rental records.

  Federal Communications Commission rules approved in late 2010 barring ISPs and wireless providers from blocking any content or applications from customers won guarded praise from Hastings. By then the Netflix chief was riding high—and using his newfound stature as Fortune magazine’s Businessperson of the Year to influence the debate over Internet openness.

  • • •

  THE MAGAZINE COVER had been a sort of parting gift to Hastings by Ken Ross, the first of Hastings’s hand-picked senior executive team to leave since Tom Dillon retired in 2006.

  The Fortune cover had been a personal goal Ross had set several years earlier, when Netflix was trying to buck Wall Street’s perception that the company would be lucky to last a year against its store-based foes. For Ross a Fortune cover represented a distant peak in Netflix’s climb to legitimacy—a sign that it had achieved the well-deserved status of an iconic American brand.

  Once or twice a year, he would bring Hastings to the Time-Life Building in Manhattan to meet with Fortune’s editors, including editor-at-large Pattie Sellers, for extended chats about the business of rental. Hastings was at his best in these off-the-record conversations—provocative, candid, and smart.

  Swasey took up the cause as well, meeting with Fortune senior writer Micheal Copeland and with managing editor Andy Serwer and Sellers while Ross was out of the office after a serious health scare. Their careful, patient tending of Netflix’s image paid off in mid-2010, just as Ross returned to work. Fortune wanted to do a major story on Hastings but would not discuss the story’s placement within the magazine. Hastings sat for the interview. The story was delayed by two weeks, and then by two more weeks. When Ross learned that the piece would run in the Businessperson of the Year article, he felt deflated. The conservative magazine would never give the CEO of a tech company like Netflix that cover.

  We’re fucked, he told Swasey. The dream is dead.

  Swasey arranged for Hastings to be photographed for the article at the Los Gatos headquarters. When the Fortune crew headed by the magazine’s associate photo editor arrived with an enormous lighting kit and backdrops, and a make-up artist and wardrobe consultant, Swasey and Ross knew the portrait was destined for the cover. They could hardly believe it.

  The cover story lauded Hastings as “a guru to a new generation of Silicon Valley entrepreneurs” and noted that Netflix was “killing it,” even by the standards of the Valley’s number one export: Apple. The exposure and praise in one of America’s most conservative business magazines had an odd effect—it made Hastings and Netflix’s spectacular rise in a fast-evolving competitive landscape—and its frothy share price, which was approaching three hundred dollars—seem bulletproof. It soon appeared that Hastings thought so, too.

  Ross left six weeks later, satisfied that his ride at Netflix had ended at the right time but never knowing whether the Fortune cover had impressed Hastings.

  The close-knit senior team—Hastings, McCarthy, McCord, Hunt, Kilgore, and Ross—had imbued Netflix with a continuity that had comforted investors during the long and grueling war with Blockbuster. But absent the challenges that had focused them outward, the strong-willed executives had become more siloed and territorial. Hastings seemed less receptive to challenge and criticism. Blame for mistakes was assigned far down the chain of command, and in the opinions of their underlings, a culture of fear and inaction set in.

  McCarthy had been wrestling for the better part of a year with the idea of leaving Netflix, too, when he met with Hastings shortly after the Fortune cover debuted to talk about compensation, as he and every executive team member did at that time of year. He had seen the company through its knife fight against Blockbuster and Amazon, and there was no broader role for him at Netflix.

  Hastings was surprised but would not agree to give McCarthy the expanded responsibility and influence he required to remain at Netflix. McCarthy, perhaps anticipating Hastings’s answer to his demands, had cashed out $40 million, or 51 percent, of his Netflix holdings in previous months. He walked out of the office that day and never returned. A press release issued later that afternoon related simply that he had left Netflix to “pursue broader executive opportunities outside the company.”

  McCarthy declined to comment about his departure but attended a previously scheduled appearance at an investor conference with Hastings at his side in a show of mutual support. Hastings promoted David Wells, vice president of financial planning and analysis, to his place, a bright and capable man who some nevertheless saw as an executive that the Netflix chief could control more easily than the outspoken McCarthy.

  Others noticed that Hastings, seemed to take the star status conferred by the Fortune cover as a validation of his opinions above those of his executive team—or anyone else—and he became increasingly resentful of dissension. Investors and subscribers alike would soon have cause to lament the departures of Ross and McCarthy, and the reality check they might have provided, as Hastings retreated into an echo chamber of his own making.

  CHAPTER FIFTEEN

  CINEMA PARADISO

  (2011)

  THE COLLAPSE OF BLOCKBUSTER TOOK down its Canadian operations, which left an opening for Netflix to fulfill the international expansion dreams Hastings had had to abandon six years earlier. Blockbuster filed for bankruptcy just as Netflix launched its streaming-only service in Canada with great fanfare and a couple of embarrassing gaffes.

  A public relations firm that assisted with the launch hired actors to fill out a street party in downtown Toronto, and it passed around a written instruction she
et to “look really excited, particularly if asked by media to do any interviews.” The paper immediately fell into press hands and was widely ridiculed. Swasey went into action—meeting personally with reporters from the major outlets the following day to assure them that this was not how Netflix did business. The furor over the actors died quickly but Hastings’s remark in an interview that Americans were too “self-absorbed” to pay attention to world events required an apology, another intensive mop-up by Swasey, and still subscribers canceled.

  The bad press did not have a lingering effect. In less than a year, Netflix in Canada surpassed one million subscribers. Six weeks after the Canada launch, Hastings personally rolled out Portuguese and Spanish-language streaming-only services in forty-three countries in Latin America and the Caribbean.

  One of the factors that helped Ross decide to leave Netflix was the prospect of spending what he estimated would be nearly two years on the road rolling out the service internationally. When he made up his mind to depart he jotted down a few names of potential successors on a napkin during a plane ride from Los Gatos to his home in Los Angeles. Heading the list was a former Wall Street Journal editor named Jonathan Friedland, who worked in the communications department of the Walt Disney Company.

  Friedland was a laid-back California native who had built an impressive career at the Journal’s bureaus in Latin America and Asia. Along the way he had earned a master’s degree from the London School of Economics. He arrived at Disney in 2006 after starting a chain of Spanish-language newspapers in Texas. With his business and media backgrounds, and ties to Latin America, Friedland looked like the perfect PR executive to take Netflix through its international expansion. He started in early 2011, in time to plan and execute the Latin American launch nine months later. It would be a rough year.

  Friedland and Swasey spent an exhausting eight days in South America and Mexico in September 2011 doing press for Netflix’s first launch of its streaming service in a non-English-speaking country. They put Hastings in front of four hundred journalists in São Paulo, Buenos Aires, and Mexico City on a junket that resulted in overwhelmingly positive coverage. Back home, however, Netflix was taking a drubbing in the press and on social networks for the lingering effects of a price hike it had introduced in its home market—it raised the price of its popular hybrid streaming and DVD subscription to a painful sixteen dollars during the worst economic downturn in a century.

  The media team was caught flat-footed by untimely—and inaccurate—reports that Netflix would levy a 60 percent across-the-board price hike on its U.S. subscriber base. In fact, just half of Netflix’s twenty-five million subscribers would see the steep rate increase, and another third—subscribers who wanted streaming only or DVD by mail only—would have a rate cut of up to 20 percent, as part of a new rate scheme. The news had leaked from a confidential briefing Netflix had done that summer, and the media team had no chance to stop the story from spreading throughout social networks and spilling into the media.

  The news reverberated through the burgeoning social networks—Facebook, Twitter, and the blogosphere—and simply would not die down. Consumers could not be talked down from their outrage. The stock price plunged, and one million subscribers eventually canceled their service.

  Lost in the maelstrom was the news that the DVD by mail operation would be spun off to a separate location and have its own workforce that would be headed by Andy Rendich, who had been Tom Dillon’s protégé and successor in operations.

  Hastings had often joked in years past that he would deliver the last DVD Netflix mailed out, sometime around 2030. That time frame seemed long to some, but Hastings insisted that Netflix could not retire the format until instant streaming could offer customers an equally satisfying experience, with a complete library of movies and television. It was not clear what changed his mind about waiting patiently until DVD rental died naturally as subscribers migrated into streaming—Hastings later blamed a “slide into arrogance” born of his previous successes.

  “The size and timing of that price leap still doesn’t make sense to me. Especially when Netflix used to be considered such a good-hearted, consumer-focused company,” New York Times tech blogger David Pogue wrote. “The way it handled this shift feels extraordinarily blunt, ham-handed and emotionally tone-deaf.”

  Swasey had had the unenviable task of downplaying the price difference to angry consumers as the size of “a latte a month,” rather than making the common sense explanation he had pushed Hastings to make: Netflix was losing money on DVD by mail as a result of the escalating costs of postage and shipping. The “latte” remark infuriated recession-weary subscribers, one of whom posted Swasey’s cell phone number in the comments section of Netflix’s blog. He patiently responded to the hundreds of calls and vitriolic voicemails by returning them personally and admitting to the surprised callers that the comment had been thoughtless and insensitive.

  Hastings summoned Swasey and Friedland to Netflix’s headquarters the Sunday after they returned from Latin America and informed them of his plan to try to refocus consumers and the press on the part of the announcement that they had overlooked—Netflix’s plan to split off its DVD by mail service as a new business called Qwikster. He thought that if consumers understood Netflix’s need to use its resources on streaming to create a better experience—a sleeker interface with more and better titles—perhaps he could stem the mounting subscriber losses.

  He wanted to avoid the mistake of protecting the still-strong but ultimately doomed DVD business—as he had seen Blockbuster try to protect its store base from online rental. Businesses that failed to evolve along with technology died—this was a central tenet of Hastings’s and Netflix was the manifestation of that belief. The death of DVD was inevitable, and Hastings was simply prodding it along—for the good of Netflix and its customers.

  The PR team was horrified at his idea: make a major product announcement in a homegrown video that would be posted on YouTube at midnight East Coast time on a Sunday. The financial press would be livid. And the script he intended to read buried the news of the split off of the DVD by mail service deep in the ninth paragraph. The makeshift message had every mark of another PR disaster, but Hastings would not be dissuaded.

  Hastings arrived at Netflix’s headquarters wearing a rumpled, teal beach shirt. He had recruited a reluctant Rendich to star in the video with him. He had liked the idea of using a handheld, homemade-looking video camera to make what he expected would be an unvarnished apology and explanation. He refused to rehearse his message, but Swasey insisted on ordering a professional camera crew to the makeshift set.

  “We’re making this video today to apologize in person, or at least on camera, for something that we did recently,” Hastings began, as Rendich looked on uncomfortably.

  Reaction to the video, posted on YouTube, was swift and almost universally negative. Intellectually, the tech and financial press supported the idea of splitting up two different businesses—one growing rapidly and the other slowly fading. But they concluded that requiring subscribers to the hybrid plan to maintain separate accounts, billing, and queues was a customer service disaster.

  Consumers agreed, and Hastings’s blog quickly accumulated more than thirty thousand mostly angry posts.

  “Reed, you may have an amazing vision of the future but you are suffering from major George Lucas syndrome—a visionary with a bunch of yes-men working for him,” wrote one poster.

  “Terrible idea. Bad after bad decision. What’s next, only offering movies made in the eighties? I’m getting tired of this. And you,” another wrote.

  When it seemed as if the opprobrium could not get worse, late-night television and professional comics piled it on: Saturday Night Live comedians Jason Sudeikis as Hastings and Fred Armisen as Rendich appeared in a Web video to poke fun at the apology and strategy changes, and Seinfeld actor Jason Alexander begged for donations for th
e Netflix Relief Fund on the Funny or Die Web site, calling the price increase “the worst thing that has ever happened to white people.” One cartoonist compared splitting the streaming and DVD services to having to get a sandwich’s bread at one restaurant and the meat at another.

  The public ridicule appeared to humiliate Hastings, and finally he seemed to realize the gravity of his mistake.

  A few days before the videotaped announcement, Kaltschnee at HackingNetflix got word of something a Netflix insider had called “Quickster” in a hurriedly dashed off e-mail. “That is a really silly name,” he thought.

  When he heard the details of the Qwikster split off—during a party at the home of a neighbor who was also a subscriber—he was dumbfounded. Kaltschnee shot a couple of e-mails to Swasey while fielding a barrage of messages from HackingNetflix readers asking, “Is this for real?”

  From Swasey’s tight-lipped response, it was clear the communications executive had “been caught in the middle between what they did and what they should have done,” Kaltschnee reflected later.

  As a programmer, he knew Hastings had to split the two very different services. But it shocked him that the lessons of the Profiles and Friends debacles years earlier apparently had taught the Netflix CEO little about how to communicate with his customers.

  The concept of making subscribers maintain two queues and search two separate databases for movies was ridiculous. If they could not find the movie they wanted on the streaming site, Kaltschnee thought, people obviously would just go to iTunes or Amazon instead of ordering it on Qwikster.

  It frustrated Kaltschnee that Hastings still seemed to think that he could write a blog post or slap a video together and all would be forgiven.

  • • •

  RENDICH KEPT HIS head down and proceeded with the spin-off plans. The Qwikster staff of about two hundred people had moved into a small satellite office down the street from Netflix’s campus, so as not to distract the streaming operation. Hastings barred Swasey and Friedland, who had their hands full with the continuing international rollout, from helping Rendich with the public relations disaster he had handed Qwikster.