That Will Never Work

by Marc Randolph

  An hour later, after the meeting was over and Bezos had headed back to his office, Joy lingered behind to wrap things up. “I’m very impressed with what you’ve accomplished,” she started, “and I think there is lots of potential for a strong partnership to jump-start our entry into video. But…”

  Now, let me interject something here. I’m not a “but” man. Nothing good ever comes of that word. This time was no exception.

  “But,” Joy continued, “if we elect to continue down this path, we’re probably going to land somewhere in the low eight figures.”

  When someone uses the term “eight figures,” they are referring to digits. Eight figures translates to tens of millions of dollars. When someone uses “low eight figures,” that means barely eight figures. That means probably something between $14 million and $16 million.

  That would have been a pretty good outcome for me, since at the time, I owned about 30 percent of the company. Thirty percent of $15 million is a pretty nice return for twelve months of work—particularly when your wife is broadly hinting that it might be time to pull the kids out of private school, sell the house, and move to Montana.

  But for Reed, it wasn’t enough. He owned the other 70 percent of the company, but he’d also invested $2 million in it. And he was fresh off the Pure Atria IPO. He was already an “eight-figure guy.” A high-eight-figure guy.

  On the plane ride home, we discussed the pros and cons. The pros? We’d find a solution for our biggest problems: We weren’t making any money. We didn’t have a repeatable, scalable, or profitable business model. We were doing plenty of business, most of it through DVD sales, but our costs were high. It was expensive to buy DVDs. Expensive to ship them. Expensive to give away thousands of DVDs in promotions, hoping that we’d convert onetime users into return customers.

  And of course there was the bigger problem. Which was that if we didn’t sell to them, we would soon be competing with them. So long, DVD sales. So long, Netflix.

  Selling to Amazon now would solve all those problems—or at least it would hand them off to a larger company with deeper pockets.

  But…

  We were also on the brink of something. We had a working website. We had a smart team. We had deals in place with a handful of DVD manufacturers. We had figured out how to source virtually every DVD currently available. We were unquestionably the best source on the internet for DVDs.

  Amazon’s entry as a competitor would undoubtedly make things more complicated and difficult. But we had a bit of time. And it still didn’t seem like the right moment to give up.

  “Listen, Marc,” Reed said over airline peanuts and ginger ale, as we watched Mount Rainier scroll by outside the window. “This business has real potential. I think we could make more on this than on the Pure Atria deal.”

  I nodded in agreement. And then, for some reason, I chose that moment to tell Reed that we should abandon the only profitable part of our business. I think it was the afternoon with Bezos—seeing Amazon in the flesh, dingy office and all, just reinforced for me that we could never compete in the DVD retail sales market. Better to focus on what made us different and unique.

  “We just have to figure out some way to get out of selling DVDs,” I said to him. “Doing rental and sales is confusing for our customers and unnecessarily complex for ops. And if we don’t sell, Amazon will destroy us when they enter the field. I think we get out now. Focus on rental.”

  Reed arched his eyebrows.

  “Kinda puts all our eggs in one basket,” he said.

  “That’s the only way to make sure you don’t break any,” I replied.

  That’s true, by the way. One of the key lessons I learned at Netflix was the necessity not only of creative ideation, or of having the right people around you, but of focus. At a startup, it’s hard enough to get a single thing right, much less a whole bunch of things. Especially if the things you are trying to do are not only dissimilar but actively impede each other.

  Focus is imperative. Even when the thing you’re focusing on seems impossible. Especially then.

  But Reed agreed with me. “You’re right,” he said, throwing back a few peanuts. “If we get funding this summer, that’ll buy us some time. It’s a difficult problem.”

  He frowned, but I could tell he was pleased to have something new to chew on.

  “What percentage of revenue comes from rental right now?”

  “Roughly three percent,” I said, signaling to the flight attendant for a much-needed gin and tonic.

  “That’s horrible,” Reed said. “But sales are a Band-Aid. If we rip it off…”

  “Then we have to focus on the wound,” I said, squeezing my lime into the drink.

  We went back and forth like this for the rest of the plane ride, and it was only when we landed that I realized we hadn’t actually formally decided not to take Bezos’s offer. We’d just naturally gone back into our carpool-on-17 mode, lobbing ideas back and forth and shooting them down. Without deciding, we’d decided: we weren’t ready to sell.

  Before we landed, we agreed that Reed would let Amazon down lightly—and politely. We’d be better off having Amazon as a friend, not an enemy. And once they entered the DVD sales business, there might still be a way to make it work.

  In the meantime, we needed to figure out a way to get people renting from us.

  When an opportunity comes knocking, you don’t necessarily have to open your door. But you owe it to yourself to at least look through the keyhole. That’s what we’d done with Amazon.

  As the weeks went by that summer, that glimpse started to look a lot more enticing. Because not all the meetings I attended with Reed went as well as the one with Bezos.

  Our number one problem, after launch, was money. We had taken on an additional $250,000 just before the launch from Rick Schell, an old colleague of mine from Borland, but that had quickly been absorbed by the steadily increasing pile of DVDs that we were shoehorning into our warehouse. We still had cash in the bank, but we were rapidly approaching the point where we’d need more. That money was definitely not coming from our own profits—it was still far too early for that. But to raise our Series B round of funding, we were going to have to convince some people that our business wasn’t just shiny and new, but that it had the potential to be profitable. Massively profitable. And fairly soon.

  We weren’t approaching friends and family this time. We were approaching professional investors. Real venture capitalists. And they would need more than a sincere look communicating how hungry I was. They needed data.

  Sounds easy, right? Wrong.

  Flash-forward to my Volvo station wagon idling in a parking space in front of the Sand Hill Road offices of Institutional Venture Partners, a prominent Silicon Valley venture capital firm. In just twenty minutes, we will be ushered into an opulent conference room, where we’ll make the case for why IVP should invest in us. We’re asking for $4 million. I’m freaking out, and even Reed, who normally isn’t one to show emotion, is visibly concerned. It is obvious to both of us that my numbers aren’t adding up.

  For the previous three nights, the lights have stayed on late in our small conference room. Duane Mensinger—the interim CFO who isn’t even confident enough about the numbers to come on full-time—and I have burned the midnight oil coming up with multiple financial scenarios, trying to make the numbers show that, with just a nominal investment, we can get our company to a place where we could actually make money.

  But it’s not looking good.

  Reed is hunched forward in the passenger seat, looking at the numbers for the first time and seeing clearly what will also become evident to the IVP partners just a short while later: that without some tectonic change in the market landscape, our company won’t make it.

  “Okay,” I say, flipping open my laptop and rehearsing my pitch. “As you can see, our user growth has exploded in the weeks post-launch. Site traffic is up three hundred percent, with at least half of all visitors to Netflix.com tryin
g the service out. We expect that, pursuant to our deals with Toshiba and Sony, we’ll see a two hundred percent uptick in user acquisition by the New Year, when DVD player sales…”

  “These numbers don’t make sense, Marc,” Reed interrupts. “You still aren’t capturing enough revenue from each new user to cover the expenses of the promotion. It’s like a taxi driving all the way to another state just to pick up a four-dollar fare.”

  He’s right. Our promotions with Toshiba and Sony are reaching new DVD owners, but they’re enormously expensive. We are spending a lot of money up front to get people in the door. Factoring in two-way shipping, the mailer, the labor, and the DVD, each of those three-free-DVD rentals is costing us more than $15, and the Sony deal—with its ten free-rentals—is even more expensive.

  None of this would be so bad if every free trial eventually turned into a return renter (read: paying customer), but most of our free-trial users are only tire kickers. In fact, only about 5 percent of them actually return and rent again. That means that we have to subsidize twenty freebies (at $15 apiece) for every actual customer we get out of the deal. Do the math: every paying customer is costing us $300. We call that CAC. Pronounced kack, it stands for “cost of acquiring a customer.” It’s also the noise you make when you realize that you’ll never be able to make enough money to justify CAC being so big.

  I pivot, laying the charm on thick. “We’re seeing a thirty percent increase, month over month,” I say, pointing to a graph, its columns growing, April to July, like an in-progress skyscraper. “That number will only increase, as the format grows more popular. Already, DVD players are half as expensive this year as they were last year. People are buying the technology—and when they do, Netflix is one of the first things they see. Christmas this year will be huge.”

  “It won’t matter if Santa Claus himself rides into Scotts Valley,” Reed says, “if we’re just giving away the house on promotions.”

  “I know,” I say, frowning. I’ve been so focused on the launch, on growing the company, on making it exist at all, that I’ve lost sight of the reason we’re doing this in the first place: to create something real that can stand on its own.

  I’ve missed the forest for the trees.

  Reed looks at me curiously, cocking his head, then shaking it. He’s not accustomed to seeing me this rattled. Historically, I’ve been the one to help him out with presentations, with pitches. I’ve helped him soften his message, helped him pivot from inconvenient problems. I’ve tried (mostly unsuccessfully) to teach him to lighten tension with a joke. The key to these pitches is to read the room, sense what they want to hear, and then give that to them—without lying, obfuscating, or distorting the truth. In a pitch, perfection isn’t always the goal: projection is. You don’t have to have all the answers if you appear to be the sort of person to whom they’ll eventually come.

  I am not that person, sitting in the parking lot. And Reed can see it.

  “Come on,” he says, opening the door. “Let’s go.”

  I sit for a while, clicking through the slides one more time, chugging a few last gulps of coffee.

  “Get your shit together, Marc,” Reed says. Then he shuts the door.

  The pitch did not go particularly well. Though they didn’t question my slides the way Reed had, the firm seemed dubious. And within a few days, one of their analysts was calling the office, asking questions that I didn’t have great answers for yet.

  Eventually, they decided to fund us. But that had less to do with my pitch than Reed’s presence. Reed was a known quantity, venture capitalist catnip. He’d orchestrated major deals, he’d appeared—reluctantly—on the cover of USA Today next to his Porsche. People with money trusted him because he had a track record of making them money. Even in 1998, he had around his head the halo of Silicon Valley success: when Pure went public, well before the merger with Atria, he made a lot of people rich.

  More importantly, he had a track record of solving seemingly unsolvable problems. Investors and VCs knew this even then. They definitely know it now. That’s why the second he walks into a room, people whip out their checkbooks. They know that what he does isn’t teachable, isn’t reproducible—hell, it’s barely even explicable. He’s just got it.

  That’s what great entrepreneurs do, in the end: the impossible. Jeff Bezos, Steve Jobs, Reed Hastings—they’re all geniuses who did something that no one thought was possible. And if you do that once, your odds of doing it again are exponentially higher.

  IVP funded us not because our forecast was good, or our pitch was perfect, or because I’d wowed them with my slides and enthusiasm. IVP funded us because, despite how impossible things looked, Reed was a miracle worker, and Reed was on board.

  I was thankful for that. And I was thankful, too, that even though Reed was still running TechNet that summer, he had started taking a daily interest in what we were doing in Scotts Valley. But in retrospect, I can also now see that that’s when everything started to change.

  One of the paradoxes of memory is how it distorts time. If you’d asked me, before writing this book, how long the truly early days of Netflix lasted—the days of lawn chairs and pathetic Christmas parties, heated arguments and hash browns at Hobee’s—I would have scratched my head and said a year and a half, two years.

  Really, it was about a year. But those eleven or twelve months were crucial. They exist in a kind of peaceable vacuum, set apart from what came before and what came after. Before we almost sold ourselves to Amazon, we were just trying to make something happen that no one else had ever done. We were working independently of competition. We were, in a sense, protected by the walls of that bank vault. We had a stinky, green-carpeted place to dream.

  The ancient Greeks had a term for this: halcyon days. I won’t bore you too much with the mythology, but essentially, they referred to the seven days each year when the winds were calm and Alcyone, a kingfisher, could lay her eggs.

  The halcyon days of Netflix ran from the summer of 1997 to the summer of 1998. There wasn’t a moment, that fall or afterward, when I realized that they were over—transitions rarely work like that. When change is incremental, it’s hard to put your finger on the end point. The ironic thing is that change is what you wanted all along. It’s the point of any startup, and it’s what we worked so hard to have happen. But that doesn’t make it any easier when it does.

  Still, with the benefit of hindsight, I can pinpoint a high-water mark, and tell you that the halcyon days of early Netflix were at their apogee in June, during our summer company picnic at Hallcrest Vineyards. I remember it so clearly: picnic tables topped with pizzas, an open field surrounded by redwoods, glasses of wine in all our hands. Luna and a pack of other people’s dogs ran free in the grass, and all our kids were shooting each other with brand-new Super Soakers, bought for the occasion. With Reed’s help, we’d just raised $6 million to get us through to the end of the year, and we were expanding daily, hiring new engineers and web designers, building our inventory, and acquiring thousands of new customers per month. I’d given a toast to our employees and bored kids, and at the end of it, Mitch Lowe had proudly presented me with a NETFLIX vanity license plate. I was holding it with one hand, and with the other I was holding a glass of Pinot Noir, looking down into the Valley and thinking, You know, this is going pretty well.

  A year, maybe a little more. Doesn’t sound like a lot. But those twelve months or so determined so much about the company’s culture, direction, and ethos. Netflix today wouldn’t exist without them—or if it did, it would look a hell of a lot different.

  Netflix also wouldn’t exist today without what happened after. That’s the thing about halcyon days: you need them, but if you want your egg to hatch and the bird to fly away, you need a little wind.

  11.

  Two Cents for Bill Clinton

  (September 1998: five months after launch)

  WE HAD A PROBLEM.

  Remember those deals I was so proud of, the ones with Sony and
Toshiba that would direct new owners of DVD players straight to Netflix? The deals that required me, Marc Randolph, startup guy to the core, to don the NMO like a superhero and convince a bunch of hidebound Japanese consumer electronics companies to fast-track a promotion? Well, it turns out that when a big company accustomed to long lead times and reliant on a careful, methodical rollout does something on the fly, things go wrong.

  Remember? For users, our promotion was pretty simple. If you bought a Sony DVD player in the fall of 1998, there was a promotional sticker on the outside of the box, promising ten free DVD rentals and five free DVDs. All you had to do was head to Netflix.com, enter your DVD player’s unique serial number, and bingo: ten free DVDs to rent, five free DVDs to keep.

  It would have been better if the coupons were on the inside of the box, but Sony’s methodical production schedule didn’t allow for it. Besides, you still had to buy the DVD player to get the serial number, right?

  Wrong.

  A few weeks into the promotion, Jim’s guys in the vault started to notice a repeat customer. This guy was ordering truly massive quantities of DVDs. Hundreds of them per week.

  Now, back then we had no cap on rentals. We were desperate for renters—we weren’t going to turn them away. The problem was, this heavy user wasn’t renting. He was just raking in free DVDs from the Sony promotion.

  “Either this guy really loves DVD players and is buying a metric shit-ton of them,” Jim told me in the vault, frowning down at a pile of mailers, all of them addressed to the same address, “or he is scamming the hell out of us.”

  That afternoon, Mitch and I drove out to Fry’s. We wanted to see exactly what a customer would see. There they were, the Sony DVD players, our yellow Netflix stickers neatly pasted to every top-right corner. So far, so good. Mitch picked up one of the boxes, turned it over, put it back down. He tugged on the promotion, and it came off easily. He walked halfway down the aisle, looking at the identical DVD players. I was scanning the information on the bottom of the box closer to me when I saw it.