Season 3, Episode 9: Netflix (Part 2)

Transcript from https://podmenti.com/t/ea27d0fadbd0aff9

Oh my god, David, look at that podcast room you are in. That foam padding.

Welcome to season three, episode nine of Acquired, the show about technology acquisitions and IPOs. I'm Ben Gilbert. I'm David Rosenthal.
And we are your hosts.
Today we are back with the acquired version of Terminator 2.
The second part of our Netflix episode. You like that, David? It's just for you. Oh man. That's great. That's great. Love it. Listeners, now if you remember the last episode we did covered the DVD saga of Netflix and where we left our heroes in two thousand nine, shortly before the epic launch of Quickster.
So today we're gonna dive in on the era of streaming and later original content.
So David, I wanted to have a uh a fun fact to start us off on on Netflix. So as you remember, they were once a plucky startup mailing DVDs to customers and and a you know a remnant of the pre-dot com bubble starting in ninety-seven. Um and they were doing this, you know, even before most people had DVD players. They they were waiting for the DVD wave to crest.
This company now accounts for fifteen percent of all internet traffic.
I know.
It's in my show notes.
Well, sorry to blow your your cover early, but you know, streaming movies and T V as a category actually now makes up fifty-eight percent of downstream internet traffic.
And no single service accounts for more of that that bandwidth than uh than Netflix does. And at peak times it can even account for forty percent of the US's concurrent internet traffic.
So you could imagine maybe uh like eight PM Eastern or something like that.
Absolutely.
Incredible.
Yeah, and this is with some of the best compression and optimization technology that like humans as a species have figured out how to do. The last episode was about a company fighting to get its first five hundred thousand customers, and this episode is very much about sort of global domination.
All right. Listeners, we announced on the last episode that we had formally launched the acquired limited partner program. And we've been just totally floored by how many of you have have joined our LP community and are listening to the bonus show and are sending us really great questions for um doing QA on the show.
David, last week's episode was like very fun, so I'm pumped I got to meet Dan and thanks for bringing him on.
Yeah, it was super fun. We had Dan Hill, uh, who in addition to being the CEO of Wave's first portfolio company, Alma, co founder and CEO, he was Airbnb's head of growth for a long time and
had just great stories about growing Airbnb from
you know, series B days to
thirty billion dollar plus. And
Just so much to learn from him. Um so really fun to have him on the LP show.
Anyway, listeners, if you want to hear Dan talk about why Airbnb was successful sort of in the space and and how they chose their metrics and a bunch of other great stuff, you can click the link in the show notes to support the show for five dollars a month, or go to Kimberlight.fm slash acquired. That's K-I-M-B-E-R-L-I-T E dot fm.
Slash acquired.
I feel like we really need a jingle for that. Do do do
We could just play that every time.
Yeah, that's Yeah. Acquire needs better jingles, period. That might be one of my holiday uh holiday projects. Yeah.
Back to the show.
All right listeners.
Now is a great time to talk about a new partner of ours here on Acquired, Lagora.
The agentic operating system that is redefining how the world's best legal teams work.
Yep. It's sort of obvious that AI is gonna completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Lagora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry?
So the founders did exactly what great founders do.
operate with obsessive customer focus.
They embedded inside a massive law firm for months.
They sat with the lawyers just watching how the work really gets done.
And that's how you get features that customers love, like tabular review, where you
Drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Legor's bet here is interesting, since it lets each lawyer handle more complexity, any given person can increase the quality of their work and do higher value work. And this means that the pie can grow even as each individual task takes less time.
And they recently launched Lagora Agent, offering greater intelligence and performance. The agent lets lawyers set an objective. Then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required.
And Lagora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Lagora numbers essentially
speak for themselves. When they have a head to head pilot with their top competitor, they win seventy percent of the time.
Lagora now has over a hundred thousand lawyers on the platform from twelve hundred legal teams in fifty countries.
And crazily, they went from one million
To a hundred million in ARR.
In about.
Eighteen months.

truly insane numbers. And that is the real test.
Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client.
If your legal team wants to check it out, whether you're a law firm or you're in house at a company.
You can learn more at Lagora.com slash acquired
And just tell'em that Ben and David sent you.
All right.
Now on to the show.
On to the show, indeed. David, I I texted you before this. We have a little bit of follow up from uh from the last episode. We have some awesome listeners that wrote us in uh about Netflix part one, and since this is a two parter, we do get to um actually go back and uh and make a few corrections. The first one is actually on my carve out from last week.
Where I mentioned that the good place uh was a Netflix show.
That is a classic millennial mistake. It is completely not a Netflix show. It's an NBC show that just got syndicated on Netflix, but my cord cutting had blinded me from that, and Netflix originals have just gotten so good and plentiful that I just assumed that I was watching a Netflix show.
Uh shadowing for part two. I know the other one we uh is that we discussed that Blockbuster had an incredible business model where they only had to pay rack rate for DVDs, uh and then they could rent them as many times as they would like. Thanks to uh on Twitter Jim underscore Brown, uh we have a correction.
It's difficult actually to track down the exact number. It's sort of buried in some academic papers and
I think it came out in some uh court case filings that I gave up on trying to actually find it out, but it's it's somewhere between fifty and a hundred dollars that they actually had to pay for uh every DVD rather than just getting to sort of buy them at at store price in sort of a special deal that that they had orchestrated so that they could generate the
sort of high rental revenues that they they got from each one of those D V D.
So good to know there and thank you to Jim for for correcting us.
And the third one is we had an anonymous listener send us some amazing facts about Redbox, uh after we briefly touched on it in the last episode. So Redbox, um, as you know from the last episode, was actually
originally a project at Netflix that uh an executive quit to go and uh and and work on full time. So
Outer Wall, which was Redbox's once parent company.
uh was acquired for over a billion dollars in twenty sixteen by the private equity firm Apollo Global Management. And uh Redbox is now a standalone company inside of Apollo. Turns out it's wildly profitable. They're they're actually working on on starting a streaming service of their own, uh standing up a a a second attempt of that.
But looking at their core business, like it's not hard to figure out why they're wildly profitable. It turns out running a r a retail footprint of six feet feet by six feet um that rarely requires human intervention can be wildly profitable. No surprise there. They have like the
You know, if you think about sort of like the dollars per square foot per month at at retail establishments, like one one way people always focus on improving the numerator there, but you could also lower the denominator.
Yeah, they've sort of game the system on that metric. But h here's another crazy thing about Redbox right now. So in Disney's attempt to build their own relationship with customers through the uh
uh in my opinion, very dumbly named Disney Plus. They do not have a distribution agreement with Redbox. So what does Redbox do to get the Disney titles on their their machines?
Well, we heard a great story. It is official company policy to send employees store to store when new Disney movies come out to buy retail copies of the DVDs, or I guess Blu rays, and bring them back to stock the machines.
This is this is actually how Redbox acquires Disney movies to put onto their their platform.
Wow. Which I kinda imagine are some of the most popular titles on on
Redbacks machines.
I just think in general, I think we we sold the company short last episode. Um they deserve some of the credit also for destroying Blockbuster because while Netflix was hard at work hammering them on the online front, Redbox was also doing for one dollar what they used to do for three dollars and in many ways easier because they sort of had more endpoints at more stores. Blockbuster's main business was sort of under under attack there as well. So
Lots of kudos to to Redbox for um being a major player in this industry.
Indeed.
And eight.
So David.
Can you you take us in to what year two thousand seven rewind a little bit and and start with uh with streaming, or are you gonna like find some way to go to like the early thirties? Not that far back this time, but uh
We will pick up the story in part two as listeners
Remember in part one.
We covered the story of Quixer.
I mean
Netflix.
Founding
Once again, also in part two.
Wanna shout out the really excellent book, uh, Netflix by Gina Keating, um, which provides a lot of the history and facts. And really for anyone who's
more deeply interested in this company, um and this history. Uh
Can't recommend enough that you go read it. So we ended last time in two thousand nine.
Netflix, not yet Quixter, had basically, you know, snatched victory from the
The jaws of Blockbuster. Do you keep calling it Qixster because like their whole business basically was Quixote. Everything we discussed in the last episode was Quixter. They just reached
Ten million subscribers. It's two thousand nine. There the recession
uh has beset the US and and the world recently and and Netflix is one of the few companies that is
thriving during the recession. They're basically on top of the world.
But
The waves are shifting.
Streaming is coming and like any good, you know, C captains uh at sea, Reed Hastings and the Netflix management team, uh, they see this and they know that they're going to have to adapt.
And they're going to have to embrace this uh this new title wave of of streaming that that they see coming. So to rewind a little bit, how did streaming kind of come about? So
Uh really, I mean, I think you can point to
This was our
First episode? It was our first acquired episode, right? Disney Pixar?
Yeah, first or the second. I can't remember Instagram or or Pixar was one of the things. It was yeah, those are one and two. But anyway. Disney in two thousand six had acquired
Pixar.
And
That of course brought Steve Jobs, uh became the largest single shareholder in Disney and and Steve Jobs joined the Disney board.
And after that happened in the couple years following
Disney made a made a pretty unprecedented move. They brought all of their
video content to the iTun store. And so for the first time, all of a sudden I remember doing this in college and right after you could buy
digital copies of Disney movies and ABC TV shows. I remember doing this with Lost and you could buy a whole season at a time. Now this was not streaming, this was downloading. You would buy it on iTunes, download the entire file to your computer
Um in the beginning there wasn't even a video iPod. I like the disdain that you say for computer. It is, it is. I say as I'm talking into one, but I'm I'm
rapidly trying to move everything to iPad. But and so that w really kinda
started to open the industry's eyes. This was the first like this was real
content, mainstream content that that now could be available digitally. The other thing that happened
right around this time is his US broadband penetration finally passed
you know, fifty percent and then kept growing and and became really ubiquitous. You know, this this whole business whether downloads or or streaming would have been impossible in the in the dial up days, um, but ban finally enables it. So
Netflix, of course, and and Reed Hastings and the management team, they s they see all this happening and they know they need to do something. So in two thousand seven, they make
A
pretty key hire onto the team. They hire a man named Anthony Wood.
Now, Anthony had been the founder of a successful D V R company. Um, so you know those like set top boxes that were like TiVo's. So he had founded a competitor to TiVo called Replay TV that had been successful. And so they hire him to come and be a VP at Netflix and to work on what they're calling
the Netflix box. And the idea is that this would be a set top box made by Netflix that people would would buy and put in their homes next to their DVD players. And initially the vision was it would have a hard drive in it.
And just like when you would download a Disney movie uh via iTunes onto your computer, you would download
a a movie from Netflix onto this box and it would play it off the hard drive hooked up to your TV. I think I glazed over that at the research, like but the the
before streaming it really was like it was it was a basically a NAS like a a network store, you know, I just keep a bunch of stuff at at home. Well it was it was a replay TV. It was a D V R that's what it was. Uh it was a hard drive. Um
They realize though that that actually with broadband, like, you know, you have to wait to download the movie w when you're um in in this old paradigm that that actually just streaming, they have the technology to do that and and that would be better. So they pivot the project into that.
The the box is is coming along.
But Reed and the management team, they start to get worried, though. Uh, this is late two thousand seven. They they worry that if they release their own box, they see that there's
fights coming in this new paradigm. They're gonna have to fight with the cable companies. They're gonna have to
Fight with the content companies.
And they realize that if they release their own box, they're also gonna have to fight with the consumer electronics manufacturers.
And Reed's like one of his main jobs at this point is sort of going door to door with Xbox and with I think PlayStation and like really lining up these partnerships saying, Hey, we think streaming is been gonna be a thing. We're working on a way to get that delivered through the browser on computers, but we know that a lot of people
are gonna be reticent to, you know, when we do this watch on computers. So they they probably want to do on TVs, you guys are plugged into TVs. And and he's realizing like boy, these negotiations are are not going to go well. Uh if I have like competitive device to you guys.
What does he do? We've seen this before. He tells Anthony, Yeah, we're gonna have to cancel the project, just like they did with
Red box. And and they says, Oh oh okay, well, you know, we've basically built this thing. How about we do something a little bit different? I think they're two weeks from shipping. From people who uh who know sort of how this process works, they're in the third phase. So it's D V T design and validation testing or verification testing. Like the whole team has been over in China, like manufacturing
these things. They've did done several revs. They're coming off the line. They I think they have a hundred or fifty units made that are done and perfect. And they're taking those on the road show to like show sort of demos to potential partners. Yeah. Uh of of like, you know, the they're this thing's baked. It's baked. Yep. And and in a classic, you know
Netflix management team, read Hastings move. It's you know, nope, we're changing our mind, as we will see. But Wood would convinces them
Okay, rather than killing the whole project, how about we spin this out as a separate company? We've already built this device. It will behoove you, Netflix, to have this device out there to be the initial, you know, device streaming partner for this Netflix streaming service.
You know, we can have a win win here and I get to run, you know, my own company here.
Well, they talk it over, they decide okay.
They spin the company out.
And they name it.
Roku. Uh Roku. Roku, actually, um was a name so Wood had had a essentially a shell company after the after selling replay TV and uh or moving on from replay TV. It started a company called called Roku, which uh I believe in Japanese means six
Is the number six, and uh it was that this was his sixth company that he had started. Something like that. Yeah, um exactly that. And uh and so he he essentially restarts this company, leaves Netflix, and takes this box that they've built within Netflix and rebrands it as Roku and launches it in early two thousand eight. And it is um, you know, it goes on to
Great success and is now its own public company. Uh I PO'd earlier this year.
But they are the first device streaming partner for this Netflix streaming service.
And just like
Netflix wanted.
following this, this is sort of the proof of concept. They sign up Microsoft and Xbox as a
Device partner. Streaming comes that summer to
Xbox three sixty, um, Netflix streaming. And then they start, you know, going to PlayStation, they go to all these connective devices, knocking them down one by one.
Can we just pause and reflect for a moment what an unbelievably gutsy management decision that is? Like you have this whole like
arm of your company. For for listeners who are interested, we'll put a link in the show notes. The team like a month before canning it or maybe a couple weeks before it did an all hands where uh a group of employees did a parody video of the Dharma initiative from Lost, which was huge at the time of
of the sort of like secret project to build I can't remember what they called what the sort of secret project name was. Um I remember about Lost is that it was it's like such a period piece now.
Oh, the code name was Griffin. So it was it was like the Darm initiative logo with Griffin in the middle. But this video is amazing because it's it was shown at the all hands. It's got everyone from, you know, people who worked on it to the manufacturing team in China to Reed Hastings.
who like as part of this video and they're showing it to everyone at the all hands as like a hype video for get excited about this like new strategic direction the company is gonna take. We're doing hardware, baby, like we're doing our own video codex, like we're going from silicon all the way up to the cloud and we're gonna own the whole thing. And then just like on a dime, boom
It's its own comp like it's its own company that goes on to be wildly successful. I mean it's really amazing. Like uh I don't know if this says more about
Me and me living under a rock, or just that like this history of Netflix is not told that both Redbox and Roku come out of Netflix. Like it's incredible. They've had more spin offs than they have their own acquisitions. I think they've only ever acquired one company.
I know what their first was. I don't know if there were other ones after that. And the their first was quite recent. But the Roku thing, well, just one more note on this. I tried to do a bunch of research to figure out when they spun it out, what did the ownership structure look like? You're totally not living under a rock, because I look through the entire Roku S1, and a couple times it mentions Netflix as
obviously they have a large dependency on Netflix's business. It mentions in two places a lease like that they shared with Netflix in the sort of early days.
But it doesn't mention anything about like Netflix is part of the founding story of the company. Uh Reed Hastings nor Netflix appears on the cap table uh when they're going public of sort of major shareholders. Which is interesting because Netflix invested six million dollars when they spun it off.
But I wonder if they've just been diluted so much.
One other thing, that's six million dollars. I tried to find uh more information on that to figure out like if there was a valuation on the company, if they uh what it looked like. Uh there's a form D filed on Edgar, which is the SEC's website that you can go to that shows an investment. It doesn't name Netflix, it just names Reed Hastings.
Uh so maybe it was some kind of proxy thing, uh'cause I assume it was Netflix, and it's scanned improperly, so like you get to read half the previous page and half of the next page while you're looking at this document and scrolling through it, and none of it's in a digital format. So it's like one of these things that's like
You really have to scour to find anything and then you can't find that much other than the fact that it was killed and spun out.
Amazing. And this is now a, you know
Billion and a half dollar market cap public company.
Crazy.
So
That's the
story of the genesis of the uh one half of the streaming business for Netflix, which is
the distribution, getting getting
you know, content into people's homes.
But but it turns out the other half of the streaming business, the content side
quite frankly proves to be the harder half over the coming years, or at least the more capital intensive half. So unlike
DVD rental that Ben was addressing in in in the follow up in the beginning of the show at the top of the episode. Unlike DVD rental, there's no first sale doctrine here. So to stream
content, be it, you know, shows or or films to people via service, you have to negotiate with the rights holders of that content and you have to buy those rights from them.
Now, in the early, very, very early days, the two thousand eight, two thousand nine, when they're just getting started here, the content companies don't really
see the future as clearly as Netflix sees it here. You know, these are the days when cable network uh content deals are like still huge and the vast, vast, vast majority of these content companies' revenues. Um so they view streaming as just kind of like a nice add-on.
So the first deal that um content deal for streaming that Netflix actually does is with stars, the pay TV cable network.
This is a total steal. So they do a two year deal.
in October two thousand eight with stars to get all of their content.
for twenty five million dollars. So this is
T V shows, movies, their back catalog, everything that they have the rights to. Um Stars quickly comes to regret that. But it's only a two year terrible.
Does Starz actually own the rights to all those movies that they're putting on their sort of like high hundreds cable channels? Yeah, so I believe the way this works, this is I'm I'm mostly conjecturing here, but I uh I'm I'm recalling my old days as a media TMT investment banker uh around this time. I believe the way it works is that stars had negotiated with the
with the content production company be Disney, Fox, you know, whoever NBC who had
originally made the movies and and T V shows. Um they had acquired the rights to show them on cable and I believe
It also included
streaming or whatever the language was. It wasn't really something that was contemplated then, but they had the right to then resell those rights.
tha that's a theme between music and movie. It's really all media is like
you since you don't know what the next frontier is going to be, sometimes people can sort of slip it into the contracts like if if
It's like, Oh yeah, we'll just bundle in forward looking like the VR rights to this thing and you're like, Yeah, yeah, whatever, but like you don't know what's gonna end up being huge and what's not. Yep.
Totally.
This happened and and Netflix also does a deal in two thousand eight with NBC Universal for uh streaming access to some of their content, including Saturday Night Live, I believe streaming the day after uh on Sunday. Um
Once again, just like we saw with Netflix in in part one, this is like instant product market fit. So, you know, everybody who uh
is is any inkling of watching video on a, you know, computer or mobile devices are emerging any screen at this point. So, you know, mostly millennials and younger, but um, but lots of other people too. I mean YouTube has been around for several years at this point. They just go
nuts. And and this is drives tons of signups for Netflix, even during the recession. I mean it's a way better product. I mean like why would you uh the old paradigm is you only want video when it's on TV.
you you know, when you what you want is on versus you can watch it whenever you want, wherever you want. Like that's a no brainer customer value prop there. And I remember in the summer of two thousand eight
Previous to that
I wasn't able to do Netflix's what do they call it? Like instant watch or watch now.
feature. I think it was instant queue. You had your regular Netflix queue for D V Due was your cue of what you wanted to watch, you know, lined up uh uh via streaming.
You're so right. Yeah. And and you could only it only worked on Windows because like they just hadn't
they hadn't gotten around to building the sort of Mac client for it yet. And then when they did, you had to like use I can't remember what browser it was, but it only worked in one browser and you needed Silverlight. So like think about sort of this
Oh my goodness. The way that this works today and the way that it it used to work, it was just the cloogiest way that you could imagine trying to like it would take fifteen minutes to get the video sort of set up on your computer so you could watch it. This was the only reason I had Silverlight installed on my computers.
Wow, how quickly we forget.
This is you know, 2009, 2010, Netflix is just but they've beaten Blockbuster at this point. Yes, they're competing with Redbox, but like they're the only game in town when it comes to streaming. They are having a bonanza, just adding subscribers, uh like there's no tomorrow. And s so much so that by 2010, uh Ben gave the stat
that um today Netflix is still fifteen percent of all US internet traffic. Back then in two thousand ten, they were twenty percent of all US internet traffic. Wow.
Internet grew. Yeah, I assume. Uh well think about how much more streaming video there is now versus in twenty ten. Um Right. Yeah. Well it probably wasn't sixty eight percent of the internet or fifty eight percent of the internet then.
Yeah. I mean uh of course there was YouTube, much smaller than it was today, but you know, there was no uh there was no Amazon Prime streaming, there was no Facebook video, there was no, you know, Snapchat, there was no Instagram, nothing. Infrastructure wise, there also wasn't gigabit to the home then.
Yeah.
Yeah.
And Netflix already knew this was the future. This is like not just the future, this is now. So they they realize they need to sign up as much content as possible and just keep this keep this train running. So they're willing the content companies are also seeing this and saying, Oh wow.
We can extract a lot of dollars out of Netflix. Netflix says, We're happy to pay dollars. We've got subscribers coming out the wazoo. They sign in twenty ten
a remember their their first deal with stars was twenty five million dollars. They sign an eight hundred million dollar deal
Five year deal with Epics.
E P I X. Now Epics was a joint venture between Paramount, um, which is part of uh Viacom, Lionsgate, Paramount was the the
film uh studio of Viacom. Lionsgate, independent and MGM, which were
the two remaining major independent film studios. So they get all of their content, all the back catalog, all the new content that's coming out. And MGM at the time, I remember I was working uh on Wall Street, they were facing bankruptcy. And so they desperately needed this cash. Um and it was this Netflix deal that uh between Epics like really keeps
a lot of these companies alive through the recession.
Everyone else sees this and they start coming back. Two stars and NBC come back, they demand much more money. And Netflix realizes they need to get really smart. So they spin up a whole
content acquisition department. Um and they start spending a lot of money all this content.
So there's there's foreshadowing there. Netflix spending a lot of money on content. Okay. It's coming back.
But a a c a quick real quick detour about the media industry.
So all of these content production companies, the media industry has been around for a hundred years in the US. There has been tons of consolidation. They are either
under the same parent company in the case of like Time Warner.
Um, or or or very closely tied to the cable companies, to the distribution. Like content and distribution are all within the same house.
If not directly, then at least they're they're in bed together. Also going on as a as a result of this, cord cutting starts becoming a thing. Consumers are saying, like, man, I'm getting so much great content from Netflix, from YouTube, from streaming.
And it's the recession and you know, cash is tight. Do I really need to be paying a hundred bucks a month for my
Yeah.
So So you've got the the content side of the house then you're saying is like very incentivized to do these deals, but the distribution side of the house is like this is the thing accelerating. Can we have a conversation for a minute? Yeah, exactly. So they st the distribution side of the house, the cable companies, they start getting very protective.
Versus Netflix. Now, what do the cable companies also own most of in the US? They own the broadband pipes to
Yeah.
most people in the US at this point in time and and and really still to this day, I would assume, are getting their internet connections in their homes that they're using to stream from
their cable company from Time Warner Cable, from Comcast, from whatever, from their cable modem.
Quick side note. Do you know about fast.com? Vaguely, but So forever I use speed test.net to test my sort of upload and download. Netflix
was having all these issues through all the net neutrality stuff where, as you're about to suggest, the pipes did not like them because they were taking up most of the bandwidth but not paying anything special to be on them. So Netflix was getting throttled. So what did they do? They created fast.com
and put it on the same IP block and on the same CDNs as their content. So then they were they ran a big campaign and encouraged users. By the way, fast.com is a great way to check your upload and download. It is far sort of like simpler and lighter than speed test. Um
they encourage consumers, hey, if you ever feel like gosh, it might why is my Netflix slow, go to fast dot com um and and compare that against however fast you think your internet should be and you'll get a a reading of uh, you know
uh what your ISP is actually treating us as
Interesting. Well of course.
Than what you are
Referencing here is throttling.
The the cable company is the the
ISPs, they start throttling Netflix because it's a competitive threat to their whole business model. So what does Netflix do? Reed Hastings is like I can play politics. I know how this works. Remember back to part one, uh and his days on the uh California Board of Education.
He starts a pack, a political action committee. Uh called uh not to support a particular political candidate. It's called Flicks Pack, uh and it's to lobby the FCC.
to set up net neutrality rules. So uh if if you we all go back in the time machine a little bit here and start remembering when did net neutrality start becoming a thing? When did we first start hearing about this? It was in twenty ten, and it was because of this. And it was because of Netflix that really
Um remember all these campaigns about like, you know, net neutrality and stop sopa and all the all this stuff, like uh
David, some of us some of us wrote a big
forty page thesis paper on on network neutrality in two thousand seven. So like you know, h hipster net neutrality. You were just ahead of the curve.
I was. It's the only time in my life I can ever claim that And I remember these big huge, huge fights. And and then finally at the end of end of twenty ten, Netflix wins and the FCC approves rules essentially preventing ISPs from from blocking content. That's under attack again today. I don't know actually the details of the latest FCC ruling. Um
This year or last year in the Trump administration, uh, I believe reversed a lot of this. This is one of those things I followed and then
the rest of the world's news got so insane that I lost the thread. Yeah. Yeah. Me too. I cannot speak authoritatively on this anymore. Anyway, um twenty ten
Basically goes really well for Netflix. They're spending a lot of money, but they're they're growing hugely.
twenty eleven also starts on a very positive note.
They finally launch international expansion. Now, international was hard to do with the DVD rental business because you needed, you know, basically cooperation of the national post office and all this infrastructure and everything. Um, but streaming, you know, it's just it's just bits. It's not Adams. And turns out a lot of the world speaks English, too, and watches
US made uh Hollywood uh video content.
So first they expand first in Canada, naturally, and then before the end of the year in Mexico and Latin America. Um, and this becomes a huge, huge growth driver for them over, you know, the subsequent throughout the twenty tens. Now international is a a bigger business for Netflix than their than their US business. Um so all going well. They're
You know, still kinda on the top of the world here.
And this is twenty eleven. Twenty eleven. Yep. I don't think
We talked about the chaos monkey on the last show, correct? No, I don't know if we didn't we talked about the chaos monkey. Go for it.
This is the the time that Netflix decides we're ful now an internet company in a bigger way, you know, that we're a streaming company. And so we need to be world class at technology. And anybody that has that watches Netflix today sort of knows like it is remarkably bulletproof.
Like that it kinda always works. And h how is that?
Well, Netflix invented something that you can find on GitHub now that's part of a larger suite of software uh that's that's open source in twenty eleven called the Chaos Monkey. And what the Chaos Monkey in its original incarnation did was it was a software package that you would turn on on the server
sort of on your on your whole infrastructure. And it would just start pinging around all the different
you know, internals of your system and just kill random processes at will. It was literally a chaos monkey.
Yeah, and and what it would do, and the the philosophy behind the whole thing was what better way to uh prevent failure than to always be failing and be able to construct systems that are extremely resilient and sort of fail gracefully instead of failing in a catastrophic manner? And so uh some of the original things that they did were
the uh experience t could degrade where the resolution would get worse or where your recommendations weren't available or your profile wasn't available, but you could always do the number one thing that people want to watch on Netflix, which is search for a thing and then watch it.
And I it's just crazy impressive mentality that, you know, back in twenty eleven, they're pioneering sort of like a uh it's actually it's used in a ton of companies now. There's that book famously named Chaos Monkeys about the about Silicon Valley in general. It's sort of a brilliant infrastructure decision and just showed the uh
the sort of level of talent in the engineering department there.
They still run it now like nine to five or something, so they don't have to wake people up in the middle of the night because the chaos monkey tips something over that that you know was still sensitive. That's uh well an an apt analogy for what's about to happen here. Uh I feel like this is also the story of the
business side of the Netflix house, which is like there's a chaos monkey amunk and they keep shooting themselves in various body parts, but manage to persevere uh and are very, very robust uh as a business. So summer 2011 now.
This is when the dominoes start to tip.
the other way.
They make an announcement.
So I again we're now a couple of years into this streaming business.
It's again instant product market fit. People love it. It's twenty percent of the internet.
They know this is the future. So up until this point.
Everybody who was a Netflix subscriber to the DVD rental business just got the streaming baked into it. Like you just subscribe to Netflix. It's just one product. It's like Prime. We're just gonna throw stuff in to sweeten the office. Exactly. Summer twenty eleven.
They
Change the pricing structure.
And there are a couple there are a few things in this press release. What gets all the attention is they come out they build this as a price cut. It's anything but in reality.
Come on, don't don't bury the lead. Like PR rule number one. If you're about to announce something that consumers hate
Do not make the title. You're gonna love the I thought you're accusing me of burying the lead. No, the lead comes later. Separate press separate press release. But yes, yeah, no totally. No, I'm saying yeah, that press release hardcore bury the press. Yeah, this is uh gunshot wound self inflicted number one. So w what did they do? They they changed the pricing.
their pricing tiers to so they they now have three options. You you can subscribe to just DVD rentals.
And they bill that as a price cut. So cheaper than what
Just subscribing to Netflix was before. You can subscribe to Meanwhile, they know the greater usage is on the streaming side. Right. You can subscribe to just streaming.
Four.
Also cheaper than the price of the old bundled Netflix plan.
Or you can have the bundle. You can have both.
And that goes up uh, I think like twenty percent of price, or twenty or twenty five percent or something like that. People react uh very negatively to this quote unquote price cut. Um so negatively, they lose a million subscribers basically instantly. Now they've grown a lot, so it's not like you know, w losing a million subscribers back in part one was like losing, you know, twenty percent of their business. Um
But still, like it's the stock price takes to be significant. Yeah, it's still very significant. People people are very upset. My father was one of them and I I don't know if he still listens to the show, but I distinctly remember him like boycotting Netflix for a year or two before he signed back up and he was furious about this.
Again, this is the recession, like
is just so tone deaf. Like people loved Netflix. Like people were losing their jobs.
And cutting the cord on their cable company, but keeping Netflix because this was like their
you know, their happiness. Like it was like one of the most high whatever the you know, those brand ratings that they do. Netflix was like up there with
Apple and Amazon and like the very, very best
best brands in America. And this just did huge damage. People felt betrayed.
Their stock plummeted too. I mean I I think Netflix has always sort of been valued on their subscriber growth, uh and actually more recently really on sort of what their uh projected subscriber growth will be next quarter.
Um, and this was to to have a down quarter where they actually lost subscribers. It was like w what the only time this had happened in the past is what we saw in part one when when Blockbuster launched uh Total Access.
So
What are they gonna do?
Hastings has a plan, of course. Now uh we should know I I forgot to mention earlier. Um at the end of twenty ten, also something, you know, long time coming, foreshadowed that we knew happened, but sad for Netflix.
Their great hero, Barry McCarthy, uh retires and leaves the company. He decided not to leave his friends in the knife fight against Blockbuster, or I'm sorry, against Amazon when they thought that Amazon was coming in, and so uh
Now now they're safe, so he can leave. He he leaves and uh he takes some time. He he becomes an investor with T T V and um then does his short stint at Clinkle and then joins Spotify uh as as we talked about in that episode. But back to Netflix. So there's no no Barry McCarthy.
Reed you know, he has a plan to address this issue.
He thinks that the way to do it is, you know, he knows the future. It's the public that doesn't get it.
They don't get that streaming is the future. He is going to open their eyes to this. He just needs to push.
Yeah.
In that first press release they about the price.
cut, quote unquote, that got so much negative reaction. Kinda at the end he said, you know, and
This is a precursor to we are going to spin off the D V D rental as a separate business eventually.
He decides that the way to fix all of this is explain that this is really part of the bigger strategy and to do this spin off and execute it and show America like the path
Forward. So he decides the way he's gonna do this. So the plan is that they're spinning off the DVD rental business into Quickster and uh longtime Netflix um executive who we didn't talk about in the last episode, Andy Rendit, who who ran um I believe ran up all D V D operations, he's gonna be the CEO now of Quickster.
Yeah, and he'd been there for like twelve years or something. He'd been there for a long, long, long time. How are they gonna do this? They're gonna do what, you know, all the hip kids are doing these days. They're gonna make a a video and they're gonna post it on YouTube and it'll go viral and everybody'll understand, you know, the vision.
This is like the the seven eleven dude at Blockbuster coming back and be like the kids, they're gonna come, they're gonna eat pizza at the Blockbuster stores
Was it was it party on the block? Uh Rock the Block. Rock the block. Rock the block. This is the rock the block moment for Netflix.
They're gonna post a viral video on YouTube. Well, they make a video. Um Reed and and uh and Andy, they they make a video.
And it does go viral.
Uh in September twenty eleven. Hashtag winning. Hashtag winning. Um but it goes viral for the
wrong reasons. We will link to this video in the show notes. It is still on the Netflix YouTube channel. I think this might be the most painful thing I've ever yep, it's still there. I so I I thought it would be you know on YouTube somebody else and many people
I have mirrored it and you know copied it on on their accounts. It's still on the Netflix account. This is amazing. They're proud. They're proud. Oh my God. This is the one of the most painful videos I've ever watched in my life.
I imagine the least like
Cool.
most fake like corporate like dad thing you could ever imagine and and then multiply by ten. That's this. It's so bad. And it's a three and a half minute video, the two of them basically like it's like scripted, so like they're trying to be hip and cool their own like patio furniture outside the Netflix headquarters and Reed is wearing like a
Like a teal like shirt and he's got his goatee and like most people never seen Reed in person at this point. Listeners, if if
If this is ever us and like we are we become like tone deaf
Like well, and maybe we are already. Please write us emails. Please. Acquire at FmH Email.com. Oh, don't worry, if we do something like this
I wouldn't be worried about getting feedback because within like days of this getting posted, read on on his personal blog, he gets thirty
Thousand
comments on his blog. Basically just trashing him for like how bad this is. So Saturday Night Live, they it's so this goes so viral. They parody the video on Saturday Night Live. They've uh Fred Armison, the um
Uh, you know, the Portlandia guy. He's Andy, I think, and I forget who does it uh does read. We'll link to this in the show notes too. And it's just like it's so funny. You know, the stock price got crushed. The first press release. This time it gets crushed even further. Like
Netflix and Quickster basically become the laughing stock of the internet. Um a lot of their big bets pay off, a lot of them don't, but they take big bets.
They take big bets. Th this is one they really should have thought through a little more.
before the July press release they were trading at three hundred and five dollars a share. After the Quickster announcement, they're down to sixty five dollars a share. So they lose like what is that, eighty percent of their value as a company in like a couple of months here. And and the Quickster thing itself, like part of it is
A big part is the way they announced this and how this went down.
It's also just like it's half baked. Like this is not
A good product. This is not well executed. This is not well thought through. So customers, when they they announce the spin-off into it, you have to have a separate account on
Quickster and Netflix.
Separate billing.
Separate cues that you manage, separate customer service. Like Separate company, man. What do you expect? Yeah. Talk about like a terrible experience. Uh this is this is like the kicker here. Netflix didn't even grab the Quister Twitter handle.
So there was some dude out there who had the Quickster Twitter handle and uh apparently he was like a pot smoking like soccer player guy and he's like just starts trolling Netflix and is like publicly extorting them and like, you know.
So bad.
So bad.
W w what is the net of this? What what all happens within one month
It was September when they do this ill advised YouTube video announcing Quickstare within a month
they cancel the Quickster. They completely unwind the whole company. Andy uh Rendich, you know, the the 12 year next uh Netflix veteran who'd been tapped as CEO, like he's gone. He resigns. He leaves the company. Uh everybody, you know, like half the people who'd gone over to Quickster, they get laid off. They're gone. Like they just completely like
I mean this is one thing about Netflix and and and Reed is like they make
Big
decisions, they make them confidently and um
You know, if they're the wrong thing, then they pull the plug. So they they pull the plug on Quickstar.
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Another
Bad thing for Netflix. Oh well, bad thing at the time. I think good thing in the long term happens for them in twenty eleven.
Amazon.
They didn't launch the Netflix competitor in the DVD streaming in the D V D rental era.
they launched the Netflix streaming competitor.
Amazon instant video and they get into the
Streaming game.
And then early in twenty twelve, they also do a deal with Epex, the
joint venture that Netflix had done a deal with, spent I think about the same amount of money, about a billion dollars, get all the same content.
And so now not only has Netflix just shot themselves, you know, in multiple body parts with this quickster thing, now they have Amazon out there, which is offering
Amazon instant video bundled with prime
If you are a prime subscriber already. Like Netflix is like Oh yeah, yeah, you were paying for Netflix, like now I'm gonna make you pay twice for this. Amazon's like Oh, great. Oh yeah, you want this entire company's value prop for free? Yeah, yeah, yeah. Do you know sweetens our offering a little bit. Yeah. Here you go.
So
The net result of this is twenty twelve is eight.
Tough, tough year for for Netflix. I didn't go back and verify every quarter, but I believe they missed their subscriber targets every quarter of the year. Um the stock price is totally languishing, uh still around the$60 a share. You know, one thing they do start in 2012, though, that uh is a name no one will recognize but foreshadows everything to come.
Is uh Netflix produced their very first show called Lily Hammer. Yes, they do, which was a Sopranos clone.
Um
I don't think it does for I mean I don't I don't never
Seen it. Um I've never watched it, yeah. Yeah. But uh
Harbinger of good things to come. Uh but one more bad thing in twenty twelve. This is ripping on Netflix. It'll just make their rise so much better. This was a another unbelievable thing that uh
I I I again I didn't know about the first part in part one, and I didn't know about the second part here. You cannot make this stuff up.
Even if you did a Netflix special.
Carl Eichen, who comes in to, you know, the stock price is languishing by the end of twenty twelve.
Who returns but acquired super villain? He's like Barry McCarthy's gone. Great. Take another go at this one. Take another go at this one. He is back in the movie business game.
He announces that he has accumulated a 10% equity stake in Netflix on the public markets. Uh I believe this is October twenty twelve.
And uh, you know, he's gonna start getting involved. I love how this happens too. Like in in public companies, you can just slowly buy and buy and buy and buy, and then you know, you don't wanna announce that you're buying because it'll move the stock price. And then like suddenly you just say, Hey guys, you may not know this, but through various sources I have a tenth of your company. Yeah. Incredible.
You know, he thinks that that really what Netflix should do, you know, they've been so much mismanagement here, you know, the uh but it's there's so much value and streaming is the future, uh they meant represent strategic value. They should sell themselves to a media company or or to another tech company. Do you know if he held
Like is he still a major Netflix shareholder? He held until twenty fifteen and then he announced in twenty fifteen that he had uh liquidated his whole stake. I believe it was
About halfway through twenty fifteen. He made a ton of money. A ton of money. But the only, I guess, good thing for um people who dislike uh Carl Icon, uh uh if you're if you're on the superhero side of the house here, is he misses out on like a ton of gains still. And like he believed in twenty fifteen that like
Amazon was gonna crush them and
Well, um that hasn't happened. So he missed out on the majority of games that he could have had.
But twenty twelve, despite all this bad stuff that happens.
Netflix now, like they're they've really
been the only player in this huge new market of streaming for the last, you know, at this point, three
plus years, they start figuring a couple things out that nobody else has figured out yet. Uh, and this is really what what saves the company.
they realize they they start see is seeing the data for the how people are streaming, they're doing two things that were not obvious.
One they're
binge watching. So like when somebody sits down to start streaming Netflix
They stream for a long time. And if they're watching like a a a T V series or something, they watch just episode after episode. And and and up until this point, the media content industry operated on this assumption, I remember this, of like appointment viewing, you know, like, you know, people tuned in at
eight PM on you know Wednesday to watch the latest episode of Mad Men or whatever. And like Which with with linear television, that is still what works. All the top shows on linear TV are still exactly that. And actually m most of them are alive.
It's just all sit around these like standalone like half an hour or one hour like get your fix and then tune in next week.
And and they realize that th that's not what people want. They want to watch the whole thing all at once.
And related to that, the other thing that they figure out is unlike the DVD rental business,
The content that really works in streaming is television shows, not
films. Not not these self contained, you know, two to three hour
films, but like really, really long form episodic content that people can binge watch. Television at this point, this they're kinda like the you know, the little sibling of the of the media world. Like it was the big blockbuster movies that everybody wanted to make.
Yeah, so this brings back an interesting and and classic acquired fashion, jumping forward to tech themes, um, and we'll pull it back. But this brings back something that I think we talked about in the Marvel episode. That is there's been a trend, I'm gonna get the numbers wrong, but if you look at like
In nineteen eighty five, out of the top twenty five movies, the number uh that were sequels, there's like three.
And if in twenty fifteen it was the exact opposite, like twenty two were either sequels or s some form of unoriginal IP. So you have this trend going on where
Hollywood is spending more and more money on films, so because they're spending a hundred million dollars plus on every single production, they're taking less risk. So they want more sort of sure things, so they're reusing IP
um from, you know, children's stories or or or bringing back movies from the eighties and nineties. So the experimentation needs to f go somewhere. It's kind of the same thing as like startups, like the the sort of the lean startup where where do you sort of prototype whether I p is good or not. So it sort of opens up the opportunity for this golden era of of television or golden era of of
you know, TV shows that attracts really top-notch both uh writers, directors, uh actors, and it really blows the doors wide open for some of the best people in the business who don't want to be part of Aquaman 7.
to go and do something creative and original and and Netflix is sort of the place where you could actually facilitate that format.
Ben you referenced Lilyhammer in in twenty twelve, you know, the one
probably in and of itself wasn't that much of a bright spot, but that was what, you know, the sign that Netflix had finally kind of figured this out, what they'd learned from
Their customers.
was hey, we sh we need to pump more
you know, episodic series based
quote unquote television content into the streaming platform. So they may they make
Lily Hammer, they released it in twenty twelve. And then in twenty thirteen, they do two things.
One, they bring back I remember when this happened, uh, even though I wasn't a fan of the show, but it was just such a big deal, they bring back arrested development.
Yeah.
It was worse but better. Like it was more complex and crazy than the original development, but like somehow it just it didn't quite have the magic, but it was good enough that like you got your fix of of what you felt like you'd have missed.
And then the other thing they do, they they debut in early twenty thirteen.
is their first real big swing at content.
House of Cards.
And this was just such
A seminal moment. I did some research on this because I remember at the time I
binge watched the whole first and second seasons pretty aggressively and uh was a was a huge fan of the show. I remember at the time reading about it and just thinking, like, wow, this is so special. This company
spent a hundred million dollars across these first two seasons. And I remember looking it up at the time and I just sort of went back now to double check all that and see like what a big bet that was. So this isn't early twenty thirteen. In twenty twelve the company had two hundred and ninety million dollars of cash on hand.
And they had committed a hundred million
to creating just this two seasons of this one show.
A few more stats on this. So like the even the total current assets, including their entire content library, prepaid content, short term investments, all of that was just over two billion.
So like what a colossal bet for the company. Now if you f go to today, like they have three billion dollars in cash alone, close to nine billion dollars in total assets, you know, you can sort of see how they're investing so much in content, but like they created a cultural moment.
around, oh my God, Kevin Spacey and this incredibly high production value thing just dropped on Netflix. Yeah. Well, and it's crazy, like uh they
I mean one, as we've seen time and time again again with this company, when they swing, they swing hard. But this was one unlike the quickster debacle, like this was so informed. Like of course they couldn't know what was gonna happen with House of Cards, but it was f informed by all the advantages they had. So they knew
You know, Kevin Spacey, obvious we've learned a lot more about Kevin Spacey since twenty thirteen. But at the time, he was this like actor that everybody kinda knew about him, but nobody he wasn't like a box office draw. Like there wasn't if you had a blockbuster movie coming out, you didn't want to cut the K Pac
Mm.
Case in point. Uh you don't want to cast Kevin's face. You know, he's not Leonardo DiCaprio here. K Pac was great.
Don't hate it. Maybe there was less of us that that loved it, but it was great.
Well, he didn't have mass appeal to the traditional Hollywood movie studios. However, Netflix saw that people
Yeah, because they had all the data on what people were watching. That once people watched a Kevin Spacey, streamed a Kevin Spacey movie, they tended to go find all the other movies that he had been in the like, okay, there's something going on here. And then House of Cards had been a British show uh that they readapted to the US
And the British show was on Netflix and they were like, Man, nobody knows about this thing, but like people love it. When people start watching it, they get totally hooked and then they binge it.
So what do they do when they release House of Cards? They release I I believe this is the first time this had ever happened.
They release all thirteen episodes of the season all at once.
People in the content industry are like, Why are you doing this? You're completely upending the model. Like, you know, you're not gonna like you're gonna miss the ability to draw out this whole thing over a period of time.
Like
Completely like
Huge win for Netflix.
It was David Fincher too, right? He d d directed it or or wrote it. Yeah, I think something like that. And this w he w he was super hot at the time'cause he had just done the social network and the girl with the dragon tattoo. Yep. That's right. That's right.
Huge win with House of Cards in early 2013. Subscriptions pour in, because again, this is the first time there's like this water cooler moment. Uh everybody in America is talking about House of Cards, and you can get the whole season and binge watch it all at once, and people are doing this, and like the only way you can do that is if you subscribe to Netflix. So subscriptions pour in the stock goes back up for the first time over$200.
Remember, it was three hundred dollars before the whole quickster debacle. So they're finally like getting back up. And and then they follow they they realize this is gonna work. So then this is the beginning of going all in on this content acquisition and and production strategy.
Later in the year they do a deal with Marvel, uh before Marvel gets acquired by Disney.
To create
Episodic TV content around Marvel superheroes. This is like Daredevil and um
Was it Luke Cage and all the stuff you see on Netflix? Uh, this is where all this comes from.
In twenty fourteen
They realize
Man, we've got this like
This this flywheel here.
Where the more
great original content that we have, original and exclusive content, that leads to more subscribers.
The more
subscribers that we get.
The more
financial ability we have to invest in
original and acquired exclusive
Content.
How can we start accelerating this flywheel even more?
We can do this with a debt.
capital. Like this is we have a very predictable subscription based business. If we can forecast our subscriber growth accurately, and Ben, you alluded to this about subscriber growth becoming the big thing for Netflix, we should be able to raise debt ahead of this and use that debt to invest in content, which we will know will drive subscriptions. So twenty fourteen
They basically changed their whole capital market strategy. They've been
you know, like most tech companies at this point, no debt completely equity financed and and cash flow positive. They start raising debt and investing it into content to the point where now today they have over eight
Billion dollars in debt.
And and for folks that sort of don't
deal in the equity versus debt world, this is the perfect thing to take debt for. You as a company like it because it's non-dilutive capital, so nobody's equity is getting pushed down. The people who are issuing you debt
are very happy to give it because you can provide them
incredibly high certainty about what your ability to uh repeatedly sort of generate cash on cash returns from you investing that that Again the the magic of subscription based businesses that we've talked about on acquired. Like
You know what your revenues and cash flows are gonna be.
Yeah, and to like way oversimplify it. I mean if you know that you have a
10% interest rate on that debt, but you know that by spending that to accelerate your flywheel, you can get twenty percent per year. It's like how how much debt can we have?
You know? Yeah. So they start slowly. They do uh I believe a four hundred million dollar bond deal in uh twenty fourteen.
And then they start getting bigger and bigger to the point where their most recent
Bond deal that I think they did this month in October twenty eighteen was two billion dollars. And
And they have eight billion in in total.
Dead outstanding.
Which is a huge amount for a tech company. But but again.
based on the cash flow dynamics and the subscription dynamics of this business, as long as they are for act can accurately forecast subscriber growth. Yeah. It it can work. Yeah, I mean unless there's some if there's some competitive thing. I mean, as we saw with Tesla, like if there's something that materially changes, David, to go back to your thing from the uh the LP show, the going sideways
And sort of explaining what that is. When you s rack up a lot of debt with a belief that you're gonna have very predictable cash flows and then there's something um structural that changes in the industry, that's when you can open yourself up to a world of hurt. So that's sort of the only reason why you wouldn't wanna just keep stacking it. Yep. I mean that's the danger of
Uh of that.
So far though.
It's worked really, really well. So you know to
wrap things up and get us get us to today.
Um
Summer of twenty fourteen as their
investing heavily into this strategy, they passed 50 million global subscribers, uh, thirty-six million the in the US, 14 million internationally.
Then in in
two thousand sixteen in January, they
make a big announcement at CES.
Uh that they are
Launching
worldwide in a hundred and fifty countries. I believe literally every country except mainland China, uh, North Korea, and one or two others. Um Crimea. Yeah. Crimea and Syria. Yeah. And of course it's all, you know, English based. They haven't actually translated Netflix into all these languages yet. Although they they start
that project. And now I believe they have translated into many of these languages. They passed seventy five million subscribers globally. During the year in twenty sixteen, they released a hundred and twenty six original
Films and T V shows series more than
Any other
content company out there, period. Any other cable channel or or or network. Now actually I don't know if that includes like the I I believe it's less than the big conglomerates, like Disney as a whole or
Viacom as a whole, um, but of any one like division, like Netflix is the largest single content production company.
And then the irony of ironies is
In two thousand sixteen, they actually do finally successfully execute.
The spin off with quick steer.
They just don't call it quickster. DVD.com, if you go to DVD.com, that is the DVD rental business for Netflix. So you can no longer subscribe uh to the online DVD rental uh via Netflix. You now
have to go to this separate company. Separate login DVD.com. But is it a separate company? Like it's different shareholders? Uh it is a it is a DVD.com quote a Netflix company. So I believe it is a hundred percent owned by Netflix and a uh wholled subsidiary. And it has something like they do like 120 million in revenue a year and like sixty million in
Profit or like you know, cash flow.
So nice, you know, but no. Classic Growth stock. Yeah, right. Value stock. Value stock.
And and you know, things just keep
Going from there. So this year in twenty eighteen, they passed a hundred billion dollar market cap. There have been several stock splits uh over the last few years. So the stock price isn't isn't quite the same. But now, you know, in October twenty eighteen,
Um, you know, they just announced earnings and they now have just under sixty million US
Subscribers. So if you go on a household basis, uh assume there are a hundred ish million US households, that's 60% of the US market, larger than
any cable company in America, Comcast, Time Warner, you know, uh what have you, charter, and a hundred and thirty seven million subscribers worldwide.
Oh, which is just incredible. If you look at that sort of third quarter announcement and sort of play forward what it's gonna be by the end of the year, they're gonna do
close to fifteen billion dollars in revenue this year and over a billion in in net income or profit.
I think this will be their first year that they that they do a billion dollars in in net at net income.
Yeah.
One of my other favorite stats on catch up to today.
In the first half of twenty eighteen
The stock doubled.
So
I think that was something like seventy billion dollars of market cap were created.
Like seventy billion dollar market cap companies don't double in six months.
Not that
uh stock price is necessarily exactly value creation, but um
Yeah.
Pretty it's pretty impressive.
Maybe something to get into here in in tech themes that
It's probably the right moment to transition into it. You know, for years.
people have been talking about the fang stocks and and lumping Netflix in with um with Facebook, with Amazon, with Google. Uh but Netflix is actually much for for most of the last few years and and even today, much, much smaller than those companies. And you know, I think that's how you can get such uh you know a doubling in in market cap is
You know, they're
Only quote unquote. I think about a hundred and thirty billion dollar
market cap company, you know, compare that to the
you know, five hundred milli billion to trillion dollar market caps of the other fan companies.
Another interesting data point about them being smaller, I was surprised to learn they only had fifty five hundred employees.
Where if you look at someone like an Amazon who has you know eight X the market cap, but they have a hundred X the employees.
Compared to the f other fang stocks, they have remarkably few employees for their valuation. Cause you look at Microsoft that has one hundred and thirty, Amazon has over six hundred thousand, Apple has one hundred and thirty two thousand, including retail, you know, even Facebook's over thirty thousand, Google at eighty five. I mean there's there's no one that's down in this sort of like sub ten thousand
employee category. I I sort of wonder two things. One, is it because their product offering is so simple that most of the sort of product and engineering work that you would, you know, typically have big teams on is is a lot of sort of infrastructure and that they've really pared down the the product line to be pretty streamlined.
But I also wonder
A lot of these
people that are working on these productions, I mean, those aren't employees. You sort of staff up those productions and staff them down on sort of a contract basis.
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Are are we like
Ankles deep into uh into the water of tech themes now. Let's do it.
I mean at this point we're two and a half hours into history of Netflix. I th I think we can get it to technically.
There's a great tweet a while ago. It was from one of John Gruber's like three and a half hour podcasts on the talk show that was like, I can't remember the last time I wasn't listening to the talk show.
It's like uh we hope to not quite get there, but um we do actually have a pretty good meaty tech themes part,'cause th I think whereas the last episode was really more narrative, this one, there's a lot of good analysis to be done on on on Netflix. And so I'll start with some of the more sort of like
uh things that are interesting to point out, but not crazy analytical.
So one of them is there's a a great business insider page and we'll we'll uh link to this in the show notes that shows the evolution of the home page over the years. I was thinking about it. It seems very obvious to go to Netflix now and and just start watching. Like that's what you do, you go to Netflix, you start watching. Um, but they had to do a ton of education over the years, both on the sort of innovative D V D model.
um and then on this crazy idea that you could stream movies over the internet on your computer. And for many years there in the awkward middle, the homepage was like this cluttered mess to explain how to do all this. So there was like one half of it was like
One, two, three, like we will mail you a DVD, you will watch it, you will put it in this envelope, you will mail it back, and these like infographics of how to do that, because that that was confusing. And then on top it was like or
instant like click here, then download Silverlight and I mean there's this big hairy explanation to consumers to tell people what they did. And today you go to Netflix.com, you don't have any options. Like they've done a
tremendous job, number one, doing what they needed to do to be sort of really messy to educate people on what are these paradigms that we're basing our company around. But then also once they've sort of hit critical mass and this this tipping point where now they can be incredibly simple.
And there's a bunch of stuff that they've cut over time that has been really like
It's crazy looking at the Netflix today and thinking about the Netflix that that was. So the things that they've done that have have been less over time.
You know, DVDs are this subsidiary. They spun out the set top box, they said no to vending machines, they deprecated a lot of these things that were brands. So like the search on their site used to be FlicksFinder and their algorithm used to be Cinemach. And they like they they were it was all about having all these like branded things that they were telling you about themselves.
They in twenty thirteen or something launched this very advanced social feature where you would connect your Facebook and then it would make recommendations based on things that your friends liked. They've completely cut that and the only thing you can do with Facebook anymore is log in with Facebook.
I mean it really reminds me of the time the the Steve Jobs coming back to Apple and pointing out the product matrix and saying, like, we're getting rid of three quarters of this.
uh Netflix never really changed leaderships, but sort of spiritually they had this moment where
the public now knew what they did and they could sort of drop all of the posturing and all of the education and just be
we deliver this thing that has an incredible value prop and perfect product market fit and that's all we do.
The one that that just s sparked was um
We didn't really talk about Amazon, uh and and the history and facts other than mention that, you know, they launched uh what
instant video that became prime video. I think all that that really did, everybody was so terrified of it. Uh and in twenty twelve that was part of you know why it was such a bad year for Netflix and the stock price.
In a market that is growing so big and growing so fast as streaming, you know, like the streaming market is is
displacing the cable
all of video content consumption, uh, you know, in America, that is a way bigger market than the DVD rental business. So like in a smaller market, like still very large, yet smaller market like the DVD rental business, Blockbuster and Netflix fighting it out, like eventually
became like a a a you know, a a fight to the death.
still, even though these companies are so big, Amazon video, uh Amazon's video division and and Netflix, like the market is so big, they are just helping one another. Amazon launching even like an essentially free version of Netflix
is just helping Netflix grow right now, I think. And likewise, Netflix is just helping Amazon video grow because they're each adding like their own exclusive content. Uh and and people are like, Well, you know, I really wanna like I wanna watch Man in the High Castle and I wanna watch House of Cards. So like I'm just gonna subscribe to both. And like they're educating the market, you know
Both ways.
So interesting to think about myself in that situation. Like I'm subscribed to Netflix because that's where I go to watch stuff. I'm subscribed to Amazon because of course I'm gonna subscribe to Prime. Other than like the the exclusives, I really just haven't gone there to watch stuff. And I don't know I think lots of our listeners probably are like, I watch all my stuff there, but uh for whatever reason, like Net Netflix is the
The default for me and it's only when I hit the wall if I can't find anything do I go over to
to Amazon. I'm not sure I would pay for Amazon if it wasn't bundled into my Prime subscription. Well it'll be interesting to see. I mean we're gonna hit people have been forecasting this, but it hasn't seemed happen yet. Hit subscription fatigue, where it's like, look, I'm not gonna do my HBO now and Netflix and Amazon and
Disney
Fing plus um like I you know, well I think we'll have to see
Uh yeah, we'll have to see how how to vote. See where that lands and see what people's comfort number is. Yeah.
But it's interesting, like to this point, like it hasn't I don't think any of these companies have hurt one another.
Uh, Amazon is definitely behind in subscribers.
I think the in the same research report that said that Amazon that Netflix was fifteen percent of internet traffic, the amount that you can attribute to uh
prime video, I think is like or Amazon video at all is like less than a third of that.
Interesting. The the other
quick tech theme that w we talk about all the time on this show, um, but that this
uh highlighted for me.
Uh which
Dan Hill on the latest LP episode, you know, talked about if you make something that people love,
It can kinda overcome all sins, right? Like Netflix kept screwing up so many times about the, you know, product wise all the stuff you were just talking about, like the whole Quickster thing, but like at the end of the day, like people loved the fact that they could, you know, binge watch all thirteen episodes of House of Cards. Like, how amazing is that? Of course they're gonna tell their friends. And if you can make something that people love,
that they will tell their friends about like
That is a recipe for success, you know, despite many other failures along the way.
All right, drifting toward business model, the magic of zero distribution costs and particularly when you don't have a Rev share in place, is you know worth talking about here. We're this is
You know, if you compare Netflix to like a Spotify, for example, Netflix licenses all of this content up front or creates it, so they don't even have any licensing fee. They just sort of create it and take all the risk, um, or spend to create all that risk. So then all the marginal revenue goes to them.
But you know, they they have
high capital costs, high operational cost, very high fixed cost to create this content, but like little little marginal cost. So then the game for them becomes like
Okay, how much can we blow it out?
Uh once we have this thing, how can we get the maximum utilization out of that asset? This
kind of dives into two points that uh Ben Thomson of Strattechery talks about these and they're fantastic points and I'd say he talks about them so often and makes them so well that we would be remiss not to sort of credit him with this thinking when we talk about it. You know, now that Netflix has this huge subscriber base, as I sort of mentioned, how big can we blow it out?
they can dump a hundred million into things like House of Cards without batting an eyelash, since the cost of producing a show is spread across a massive amount of subscribers. So their strategy to produce a broad set of shows for a broad audience is the winning strategy in this market.
And compare that against what HBO was thinking a few years ago, and some others have done this too, of we want to produce
amazingly well produced content that really hits home for a narrow audience. You just can't
amortize the cost of that across nearly as many people. And so
over time, like you just can't afford to spend to create the best content because you just don't have as many people to deliver it to. You know, you can find yourself between a rock and a hard place if you're not thinking about the same thing that Netflix is thinking about, which is more subscribers to sort of reduce the per person cost of producing expensive content.
For sure that is a winning strategy. They've also done both, right? Like there's a tons of niche
Like Netflix produced
niche content on Netflix.
Uh
They just don't spend that much money on like I feel like they're really good analytically at understanding like what is the ROI in terms of uh either new subscriber growth or subscriber retention that we're gonna get for this piece of content. And for something like House of Cards, that's gonna be so
broad based in in reach like
they can spend a hundred million dollars for something like a documentary on um
Uh there's actually a pretty good like documentary on um like the roots of hip hop on uh Netflix that I watched on a plane once and like you know
Great. Lots of people should watch it, right? But it's not like it's clearly low budget, you know, like they did the math on how much they could invest in that.
There's also a pretty bad documentary on Vince Carter called the Carter Effect. They make all kinds of uh Might've watched that late one night.
Well, okay, so I'll throw out a little counterargument to that. So the thing that drives new subscriber growth for them is hit shows.
So when they have a quarter that
tons and tons and tons of people uh come and sign up for Netflix, it's because they have an orange is the new black that draws in all the people. You know, Netflix's strategy hasn't has been to stay away from sports and live and things like that that are not evergreen content, even though they they want to create evergreen and they amass this really rich catalog
there is a little devil in the details that is people that sign up that quarter are probably signing up because they have this new hit piece of content that that everybody's coming for. And so
Uh, I think your point still stands that they'll spend a bunch of money on the big splashy thing and then they'll spend a little bit of money producing sort of the long tail of niche based stuff to make sure they satisfy all the different niches on their their platform. But I felt it would be a a failure not to point that out.
Okay, I have another one that I've been like almost talking about that I wanna I wanna actually hit. And it's another good strategy thing. So
Netflix is flywheel. So they focus on this content that's relatively evergreen, staying away from live. So
the more capital that they amass, either through debt or equity or earnings, the more content they can license or produce.
which then makes the product better for users, so more users come to pay.
And then
kind of feeds back into that cycle of the more capital damass.
So then theoretically
They have this thing going on where the product actually gets better because the catalog gets richer. So either they can charge more money over time or
Or they can keep their prices the same.
and reduce marketing costs to reach people that would have been reticent to pay for a worse product, but now that the product is amazing because it has all this content, we can actually start to like really saturate the far edges while keeping the price point the same for people that
previously wouldn't have wanted it that bad.
a lot of things about how they've structurally set up the business.
enable them to create this virtuous cycle and succeed more as they scale instead of less as they scale. Cause I think for a lot of businesses, like
cost of acquiring a customer goes up over time because you've already hit all your best customers and gotten them and then you have to spend more, but they just have this amazing characteristic where the product gets better. It's funny, I hadn't quite thought about this, but it's a little bit like
Uber, right? Like there there are a few of these businesses out there that are truly special where you actually have a period in your
Growth.
Curve where you're
Customer acquisition cost goes down.
Uh now and I don't know, we I haven't done the analysis or math to know if this uh what you're saying is is true about Netflix, but it but it makes sense, at least uh intellectually. Like Uber got to a point I I believe it's now
the probably their incremental cost of cut customer acquisition at this point is probably going up. But there was a point where it went down massively because the service improved so much with density and ubiquity of adoption.
Uh.
I think it's a tipping point. Like if you think about Uber, it's like it needs to get sufficiently good so that there's a ride within three minutes. And then I kind of don't care how many drivers are on the platform after that. But Netflix may not have this sort of point of inversion where it's like literally always more content is better. Interesting.
Yeah.
But there's probably diminishing returns on that too. Actually that's a pretty interesting framework to think about.
uh marketplace or aggregator or platform businesses.
When is it that they don't have that good enough?
Sort of like uh
Point where
The more you operate, the more
valuable you get indefinitely.
instead of with diminishing returns.
One more point to make here, which is kind of just an interesting thing to know about the company.
Over the last three years, Netflix has grown its subscriber base.
by thirty percent year over year, give or take like one percent.
Basically every year they're they're growing thirty percent.
Interestingly, they're they're basically the the company is extremely data driven about when to uh do marketing spend and sort of when they feel it's a good idea to go and spend on customers. So I think a lot of the stuff we're sort of talking about is is true in the abstract, like the product getting more valuable over time.
uh new big hits drawing people in. But Netflix, based on their earnings reports, appears to care about growing thirty percent year over the year and then flexing different levers to get there. So sometimes they spend more money on content, which for other companies you can sort of think about as product investment. And sometimes they
Yeah, and sometimes they spend more money on marketing. And I think it's probably I would imagine the way that it kind of works is like when they feel like they have a opportunity to create a superstar show, they go hard into it. If it works
And they're gonna hit their thirty percent growth and they don't need to do an enormous amount of marketing spend. If it doesn't, then they need to do more marketing spend to bring people onto the platform. Um, it's just kind of an interesting way to think about driving the business. And since been so constant, it's sort of clear.
uh what levers they're moving to accomplish what end.
I'm so glad we took like
All of this time to
Dive into Netflix. Like I at least did not understand this company.
Or its history at all.
Before.

nominally ubiquitous it is in in Silicon Valley.
One last thing I also assumed
before really like diving in and looking at market caps that they were much
bigger than they are because people talk about them in as a fang stock and like what are the fang stock? There's this great
Yet another thing we'll link to in the show notes. A great tweet today by uh Benedict Evans at Intrigue Horowitz with a graph showing on the X axis
revenue on the y axis revenue growth and sort of plotting all these companies
Like Apple, Amazon, Google, Facebook, they're sort of understandably
at least way far to the right in terms of total revenue and and also growing pretty quickly. Netflix is like
way smaller in terms of revenue than than these other companies and also not like they have less growth, revenue growth than Facebook does, less than Amazon does.
Like
We talk about them like they're this
You know, they're one of those five.
But
It's kind of arbitrary. And that's that's the point.
Uh Ben is making it.
Yeah, if I were to put my old
media TMT investment baker hat back on. I think maybe the justification for that is that is is back to just like the stability and predictability of subscription based businesses. Like the thing about Netflix is like
They know.
You know, they know what their revenue is gonna be.
To the extent that they understand their
And their gross subscriber.
Adds.
Turn and then thus net subscriber, you know, growth or or losses.
uh well and can forecast that accurately. Like that is an incredibly stable and predictable business. And and that has value in terms of valuation versus like a, you know, an Amazon uh well, Prime is a part of it, but like you're just buying stuff on Amazon, like you may buy more, you may buy less, you know, like or
You know, Facebook advertisers may advertise more, may advertise less. Same for Google or Apple may create a hit product, may not. You know, there's just uh more
Inherent unpredictability there.
Yeah. Still feels arbitrary.
Sure. Well that's why we're no longer investment bankers. Is there something worth grading in here?
So we talked about grading the spin off of the DVD
business just to have something to grade.
I think it's worth it to just do it quickly. I mean like it's really like what if they didn't?
Yeah, what if they didn't I mean, of course it was the right thing to do.
The future was streaming. The
D V D.
rental business, online DVD rental business was going to go the way of the offline DVD rental business of Blockbuster. Like that market is it still exists, but was shrinking. Of course they had to transition the company.
They just executed it terribly the first time and then executed it the right way the second time where they just didn't talk about it.
I would say like um
A for strategy, F for execution, like F minus for execution, but uh I don't know.
What's what's your take? Yeah, I I'm with you. The only thing that I have on sort of execution is like do you group timing into execution because I think they couldn't
They couldn't have done it quietly when they did it, and the question is, should they have done it a different way at the time? Probably, but how much better could you have done it? Or you know, was it was it pressing? Did it need to be done then or could it wait three years?
Yeah, no, there's no reason to do it then other than
Reed Hastings feeling like he, you know.
wanted to be, you know, push America and the and the public into his vision of the future. Which was correct. It was just, you know, he just should have waited a couple years.
Which gets into and I know we're past tech themes, but like Steve Jobs and Apple do this all the time and they take shit for it and then it's fine.
Like they
Pull the
floppy drive out of the iMac and they pulled the headphone jack off the phone and like
You know, you could argue that was a little too early, but
Apple usually gets these things right, though. Like when they pulled the headphone jack, like they released AirPods. You know, it's like here's a better alternative. The thing is when when the Quixer, when they did Quixtir, streaming wasn't better. It was better on some dimensions.
But a lot of the content wasn't available, you know, and so like it wasn't quite there that it was just obviously better on all dimensions to go to the new thing.
And Apple toes this line for sure, but like but they present you with the like
Here, if you buy this if you buy the AirPods, they're amazing. They're way better.
Yeah.
That's a good point.
Carve outs.
Carve outs mine real quick. I believe on the Zappos episode with Alfred Lynn, uh we did a carve out of Justin O'Burn's um Google versus Apple Maps, uh
Deep analysis. You're remembering what carve outs were on what episodes? Yeah, man. We go deep analysis. Next level. Uh he did an awesome follow up this month um on the new Apple Maps, and is it
Uh is it now better than Google Maps?
Spoiler alert.
No, in some ways, if you're interested in in forests.
Yeah. In in some ways, but Yeah.
Um
Well worth the whole read. Um
Amazing work, uh, as was the last one.
I've got a podcast to recommend. It is from the very first person that I followed on Twitter. I discovered this the other day when taking a deep dive down the Twitter rat hole, Kevin Rose. I used to be like a really big dignation
fan. I w I think I watched every episode of Dignation. Yeah, when when he was on um tech TV, uh the screen savers. Yeah, and then G G four. G four? Oh yeah, that's right. Oh I used to watch that in high school. That show was like a big part about me wanting to like get into tech
Dude, and it was a cable channel. Like that? Oh no. Like
That was on TV.
Long tail content.
Cable channels. Good businesses. I think this probably had a good amount to do with me getting into the the tech industry, too. I mean I think uh
Who would have thought that by watching
Kevin and Alex drink beers on their couch talking about tech news that one day we could grow up to do the same thing, David. The more things change.
Yeah.
Yeah.
Well, he's got this great podcast episode uh where um Kevin's very into sort of like quantified self uh type things. I know we don't use that phrase anymore'cause the wave is sort of passe and it and you know, now it's digital health or whatever, but he's got this um sleep PhD researcher on from U C Berkeley who's starting a company. Um it's f absolutely fascinating learning facts about sleep.
I think sleep is going to be the thing
twenty, thirty, fifty years from now, I don't know when, but lack of sleep will be treated like smoking.
Some of the facts that he's throwing out on there about the results of even depriving yourself of a few hours of sleep from one night in your body's ability to repair cells before they can uh start to become cancerous, for example. Th there's just a
tremendous amount that uh sleep helps us um repair. And there's another one specific thing he mentions that was fascinating was
When you take uh sleeping pills, you're not
You're not actually sleeping.
Like you're not conscious, but like he's like, I wouldn't call that sleep, and you're you're not doing your body you're not putting your body into the state um that it really needs to accomplish a lot of the sort of healing and repair and sort of regulatory things that it does. So well worth the hour or whatever it is to to listen to it, and actually has sparked sort of a new area of interest and um
uh set of sort of companies and and ideas that I'm I'm starting to look into.
Awesome.
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Thank you so much for for listening as always.
I think that is all the things that I have to say. Yeah. We'll see you next time for our season finale.
All right.
See ya.
Yeah.
Mm.