A couple of days ago, Reed Hastings, the co-founder and long-time CEO of Netflix stepped down from his role at the streaming giant. So in today’s Finshots, we thought we’d look back at how Netflix almost lost to Blockbuster and then won!
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The Story
The year is 1997.
At the time, VHS (Video Home System) tape rentals defined entertainment in the US. When people wanted to watch a movie, they’d just pop into their video store, browse through the library and pick up what they wanted.
Oh, you probably have no idea what a VHS is unless you’re a 90s kid. It’s those big, ugly, black cassettes that you had to insert into a player connected to the TV set. Ask your parents, their wedding film probably came in a VHS cassette.
So, in the US, a company called Blockbuster dominated this movie-renting business. At their peak, they had over 9,000 stores and made a staggering $6 billion in revenues. It was an unstoppable force.
Enter Reed Hastings, the man behind Netflix. See, Hastings had rented out a VHS of Apollo 13, a space movie about an abandoned mission to the Moon, and he’d forgotten to return it. Blockbuster meanwhile was tracking this delay closely. It charged a late fee of $1 a day. In fact, late fees were extremely lucrative for Blockbuster — it fetched nearly $800 million a year. So forgetful folks like Hastings were its bread and butter.
And when Hastings had to pay a $40 late fee, you can imagine he wasn’t too happy. And he knew that many others like him hated paying these fees. Hastings wanted to solve this problem and on a car ride with his friend Marc Randolph, they thought, “What if we build a business on the premise of zero late fees?”
Netflix was born. Randolph’s mother even gave them $25,000 to begin.
Now even with the money they’d raised, Netflix couldn’t set up physical stores and compete with Blockbuster’s might. It was unthinkable. They thought they’d mail the movies to people instead. Now mailing VHS tapes would’ve been hard. They were big and clunky and would have cost a lot of money to mail.
What was the alternative?
Well, an innovation called the DVD caught on in 1997 and 1998. A simple disc that would play videos. Sales were growing at a fast clip. So Hastings and Randolph took a punt on this. They found that they could ship DVDs to people’s homes for just 32 cents. It was easy.
But wait…that still didn’t solve the problem of late fees, no?
Well, they had another idea — a subscription! Just like what we pay for Netflix today.
For around $17.99 a month, a customer could rent 3 DVDs at a time from tens of thousands of titles. And they could hold on to the rental for as long as they wanted. No more annoying late fees!
It was a game-changer.
But even then, competing against Blockbuster was proving harder than they thought. 3 years into building Netflix, the company only had 300,000 subscribers and it was losing money hand over fist — over $50 million a year. While online rentals might have been the ‘future’, physical rentals were still the ‘present’.
So Hastings and Randolph made a pitch to Blockbuster — “Buy us out for $50 million. You focus on the physical stores. And we’ll run the online business. Combine the powers together. It will truly be a case of the whole being greater than the sum of its parts.”
You can imagine what happened next. Blockbuster’s CEO John Antioco laughed it off. He didn’t see the tiny Netflix as a threat to the Blockbuster behemoth.
And guess what?
Maybe, he’d have been right. See, Blockbuster was one of the pioneers of video streaming. In 2000, it actually teamed up with Enron — the failed oil and gas giant that also had a broadband business — to create an online video-on-demand service.
It could have killed Netflix. And we’d all be watching movies on Blockbuster today.
But…things didn’t work out. The online business remained a side project for Blockbuster and the deal collapsed within a year.
Meanwhile, Netflix was growing slowly and steadily. It went public in 2002 and hit the 1 million subscriber mark in 2003. It was growing.
Blockbuster needed a change in strategy. Its late fees were one of the most hated things on the planet. So in 2004, it killed the late fees business and embraced the internet — Blockbuster Online. People could now easily rent DVDs online.
You’d think that was a great move, right? Sure, it was late to the party, but not completely out.
But here’s the deal — going online was actually the nail in the coffin for Blockbuster.
Let us explain.
The first nail — Without the lucrative late fees, Blockbuster stood to lose millions of dollars in revenue. Also, it needed to pump in another $200 million for the new online venture. Its owner, the media giant Viacom, didn’t think this was smart and it sold its shares.
The second nail — in 2006, Blockbuster launched a scheme that would allow an online subscriber to go to a Blockbuster store and exchange the DVD for free. It had the might of its 9,000 stores. And 90% of Americans lived within easy driving distance of these stores. So it made sense. And initially, it worked. Netflix actually lost subscribers to Blockbuster.
But…it was a loss-making proposition. Each time a DVD was exchanged at the store, Blockbuster lost $2. It was the startup playbook of burning cash to get market share.
And the third and final nail — Investor pressure. See, Blockbuster wasn’t a startup. It was a legacy business that had boatloads of debt. It had borrowed a lot of money to expand the physical stores. It couldn’t really burn cash. And remember we said that Viacom had sold all its shares? Well, those shares were bought by hedge funds. More specifically, Wall Street billionaire and activist investor Carl Icahn picked up 10% of Blockbuster.
He wanted to bring change. He said that going online was a fool’s errand. He wanted Blockbuster to bring back the lucrative late fees. He wanted the revenues to pay off its massive debt and boost the share price.
Needless to say, it didn’t work. It failed spectacularly.
Blockbuster was crushed by its debt during the 2008 financial crisis, it was delisted from the New York Stock Exchange and eventually, declared bankruptcy in 2010.
Blockbuster failed. And as they say, “the rest is history.”
The more nuanced reading of this is that it wasn’t Netflix that killed Blockbuster. It was massive amounts of debt and the quest for superfast growth!
Maybe Netflix should make a docuseries about this, no? We’d definitely watch it!
Fun Fact: Netflix still has a $20 DVD subscription model. And it earned $182 million from this business in 2021.
Until then...
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