by Gina Keating
“How long do you think I have?” Hastings asked.
“Two years, tops,” Evangelist said.
At the end of the evening, Hastings invited Evangelist to come speak to his team. A few months later, in early 2008, they re-created their dinner conversation. Sitting on the stage together at the Los Gatos Theater, they took turns asking each other the questions each had been dying to pose during the price war’s long years.
• • •
AS EVANGELIST HAD predicted, Netflix suddenly began growing again in 2008. It was as if a spigot had been turned on as soon as Keyes shut off the Total Access marketing program. The renewed growth returned Netflix’s subscriber additions, revenue, and earnings back to the previous year’s level, but Hastings reported: “We are much happier today than ninety days ago, but we are still not where we would like to be in terms of subscriber growth.”
Movie Gallery had filed for bankruptcy over the summer, besieged on all sides by Redbox, Total Access, and Netflix. Netflix’s instant streaming feature was growing faster and proving more popular than Hastings had expected. In all, the online rental playing field looked a lot more advantageous for Netflix than at any time in the previous four years.
Hastings reminded investors that online delivery would now manifest as three distinct and only partially overlapping market segments: Netflix’s subscription streaming, Apple iTunes’s file download, and free streaming, in which YouTube was the innovator. Netflix intended to own the subscription streaming piece, putting the company on a collision course with the $81 billion cable industry.
Netflix’s now unquestioned domination of the online rental space gave it growing subscriber and cash bases to leverage in negotiations over movie rights.
“We now have more resources, bigger competitors, and a much bigger prize to earn,” he said.
But it would be a decade or more for a streaming-only offering to win with consumers, simply because it would take at least that long to obtain streaming rights for all seventy-five thousand titles in Netflix’s DVD library. Studios got 41 percent of their revenue from DVD sales in 2006, and they would protect that source of cash as long as possible.
The format war between Blu-ray and HD DVD to win the high-definition video space would add another few years to DVD’s life span, and Netflix was content to let DVD wind down at its own pace, Hastings said.
In early 2008, Netflix announced its first consumer electronics partnership incorporating its streaming software into a set-top box by LG Electronics. The goal was to bring a smooth streaming signal straight from the Internet to users’ big-screen televisions for an experience that was as good as cable or satellite. A few months later, Roku, the streaming technology company that Hastings and Anthony Wood had incubated at Netflix’s Los Gatos headquarters, was ready with its own Netflix-powered set-top box.
The ninety-nine-dollar Roku box, about the size and shape of a square hockey puck, was an instant hit with tech writers and consumers alike for its instinctive user interface and ready-out-of-the-box installation. Consumers and critics responded to the luxurious experience of selecting from the relatively enormous (by pay-per-view standards) catalog of twelve thousand streaming titles and waiting only about twenty seconds for the DVD-quality picture to appear and play without a hitch.
The first shipment of Roku boxes sold out within a few weeks of the product’s launch, and the critical and popular reception opened the door to other partnerships.
The timing of the Roku launch in May 2008 brought the first big disagreement over public relations strategy between Hastings and Ross, who believed they should introduce the little box after announcing a big streaming partnership with a major platform like Sony’s PlayStation or Microsoft’s Xbox, so it would not appear as if Netflix had been unsuccessful in finding other platforms for instant streaming. In fact, the nearly unanimous praise for Roku provided an enormous publicity boon for Netflix, as it showed the world its ability to create beautiful, elegant, and user-friendly hardware.
The blogosphere buzzed with excitement about a potential tie-up between Netflix and Xbox, after Netflix began surveying subscribers about their interest in streaming movies through the popular game console. Getting in the Xbox did much more than give Netflix access to ten million Xbox owners. Microsoft taking on the likes of Netflix—even though Hastings had joined the software giant’s board of directors a year earlier—gave the fledgling streaming service the imprimatur of the mighty, ubiquitous Microsoft brand.
The companies announced at the E3 Media and Business Summit in Los Angeles that Microsoft would launch the Netflix service—by subscription—in an upgrade to its Xbox 360 right before the holiday season. Ross was disappointed that Microsoft Interactive’s John Schappert had sandwiched the Netflix news into a number of other announcements, but the media and consumer reaction was gratifying.
The successful launches of Roku and Xbox opened a floodgate to similar deals. A steady flow of new streaming partners followed: Blu-ray players, set-top boxes, televisions, laptops, and mobile devices all equipped with Netflix software. Netflix implanted its streaming software in more than two hundred types of Internet- and video-enabled devices over the ensuing three years.
Ross and Swasey worked multiple deals simultaneously, feverishly slotting the announcements into Netflix’s calendar as each deal closed and the software was finalized. The impression Netflix created with its constant drumbeat of partnership announcements was that of the inevitability of digital delivery over physical media.
On the content side, Sarandos cut deals with CBS and Disney to stream TV shows on Netflix, and pay-television channel Starz Entertainment signed a three-year deal to let Netflix stream twenty-five hundred movies, TV shows, and concerts that had been destined for Starz’s defunct online movie service, Vongo.
Success bred success, and partnerships bred more partnerships, Ross believed. If Netflix built momentum with a steady stream of deals, electronics manufacturers and movie studios would fear being left behind as video streaming took off.
Walmart shuttered its movie download service at the end of 2008, less than a year after it launched, emphasizing with its second failure that size and money alone did not guarantee success in the new world of digital delivery.
• • •
AT BLOCKBUSTER, KEYES was also pursuing a deal to make consumer electronics an integral part of his movie rental scheme. In April 2008, he made an unsolicited $1 billion offer to buy Circuit City Stores to accelerate Blockbuster’s transformation into an electronics retailer. The proposed deal became public a couple of months after Keyes saw his private offer rejected, because the Circuit City board did not think Blockbuster could find financing for the deal.
CNET’s Jim Kerstetter captured Wall Street’s reaction to the proposed merger the day it became public: “Like most other people who learned about this deal Monday morning, I’m baffled. And I smell desperation.”
The Circuit City board was equally perplexed, and at first refused to open its books to Blockbuster, until Icahn said he and other investors would purchase the chain if Blockbuster could not find financing. Three months later Blockbuster bowed to resistance from Circuit City and public ridicule of the idea and withdrew its offer.
“Although we withdrew our offer for the company, and have no plans to continue that course of action, we remain confident that consumer electronics, especially portable video-enabled devices, represents an opportunity for Blockbuster stores to remain relevant and viable well into the future,” Keyes told investors.
Finally Keyes turned to looking for a viable streaming plan after publicly downplaying the importance of both online DVD rental and digital delivery for more than a year. In an interview with technology blog PaidContent.org, Keyes defended his strategy of cutting marketing for online DVD rental by insisting that Blockbuster had been “taking people out of the $24 billion in-store segment, and
we’re forcing them into this smaller by-mail segment.”
“Really, where all the money is, is in stores,” Keyes said. To that end Blockbuster had invested in in-store kiosks that would someday be transformed from movie vending to digital download machines. “Imagine in the future the ability to have the entire library captured on a kiosk,” he enthused.
Before Evangelist left he convinced Keyes to pay $6.6 million to acquire Movielink, the movie downloading service founded by the major Hollywood studios, mainly because of the content deals that came with the deal. Nearly a year after Netflix rolled out its first streaming partnership, Blockbuster announced that it, too, would get into the set-top box business. In November 2008, Blockbuster introduced a ninety-nine-dollar digital media player that downloaded high-definition quality movies to customers’ televisions via broadband lines.
Although the title selection was smaller than Netflix’s instant streaming service, Blockbuster OnDemand boasted newer titles as a result of the movie rights granted to Movielink by its studio founders. But Keyes still had not caught on to consumers’ impatience with being told how and when to watch movies: Blockbuster OnDemand charged $1.99 for movie rentals and gave renters twenty-four hours to watch the movie once they pressed play. The rental expired after thirty days even if the customer never watched it.
• • •
WHEN THE RECESSION derailed the U.S. economy in late 2008, Netflix found itself well-positioned to take advantage of new trends in collaborative consumption. Customers stayed home and turned to Netflix for cheap entertainment and got hooked on a growing number of devices that could suddenly stream videos—game consoles, cell phones, DVD players. The Netflix application was everywhere, and consumers signed up at a rate of ten thousand per day in late 2008 and early 2009.
The DVD-by-mail operation also reached its pinnacle of efficiency, delivering 97 percent of its deliveries in one business day from sixty distribution centers and scoring at the top of e-commerce customer satisfaction surveys.
About a month after Netflix surpassed ten million subscribers, in spring 2009, I interviewed Hastings at Netflix’s offices in Beverly Hills. During our forty-five-minute conversation he seemed relaxed and thoughtful, fluently answering questions ranging from the effect of the recession on subscriber growth (there had been none: They posted record subscriber additions that quarter), to why Blu-ray DVD penetration was growing so slowly, to how long it would take for Netflix to get the rights to stream new releases (at least ten years).
When we got around to discussing the competitive landscape, I could tell something had shifted profoundly. Rumors had been swirling that week that Blockbuster was exploring a prepackaged bankruptcy filing—a rumor it would later deny. Hastings was always quite circumspect in talking about Blockbuster during the thick of their battles. I was never sure whether he wanted to avoid telegraphing anything to investors or to Blockbuster about his state of mind with regard to their competition.
“Now let’s talk about your archrival—Blockbuster,” I said.
“Who?” he asked, feigning ignorance. “Our archrival is Redbox. Blockbuster is heading down.”
I laughed in surprise. I couldn’t help it. He was making a rare joke about Blockbuster—something I had not heard him do since first dismissing Blockbuster Online five years earlier.
If Viacom had let Blockbuster spend the money to attack Netflix earlier, or had not extracted a $1 billion dividend, or the “good-bye kiss,” as Hastings put it, “things might have been different today.”
“How do you feel about the rumors that Blockbuster is exploring bankruptcy?” I asked.
“A mix of sadness and elation,” he said. “Sadness because they are decent people, and they have been working hard, and elation because the company that has been trying to kill us for so long is dying.”
“That’s a sad thing to see all those stores close and the jobs lost and we are doing fine,” he added. “I felt more aggressive toward them when they were killing us, but now I wish them the best. We have our next round of foes.”
He mentioned that exit surveys Netflix conducted on subscribers who canceled revealed that a growing number were transferring their movie renting habit to Redbox kiosks. By the end of 2009 Redbox had deployed twenty thousand kiosks and were disrupting the market enough for Movie Gallery to cite the kiosk company as the primary reason it failed again after emerging from its 2007 bankruptcy.
Redbox would be a tough competitor, he said.
• • •
AT THE PARTY in Los Gatos the night after our interview, Netflix staffers flowed out through the ground-floor kitchen, through a lovely tented area in the courtyard of the faux Mediterranean villa, and enjoyed hors d’oeuvres and wine. Hastings had a fake tattoo with the number ten million inscribed inside a heart on his face for the evening. It was perfect moment—an idyllic if brief resting point.
Mixed with the satisfaction and pride in reaching a benchmark that many experts once believed did not exist in online rental was a sense of a job left undone. Another unlikely prize waited unclaimed—twenty million subscribers by 2012. The forecast, made nearly a decade earlier, was suddenly feasible again. They had three years to double their subscriber base.
How far and how fast could they take the company? No one wanted to waste a second, and despite the grueling hours they had already put in, no one wanted to miss what happened next.
CHAPTER FOURTEEN
TRUE GRIT
(2009–2010)
THE TIGHTENING OF THE CREDIT market in late 2008 made it tough for Jim Keyes to amend and extend Blockbuster’s credit lines for a fifth time in three years to carry out his store expansion plan. A year into his tenure, Keyes was consumed with revamping Blockbuster’s stores into “full-service entertainment destinations” where, he envisioned, customers would drop in for pizza and a Coke, or buy a book or a flat-screen television or hang out with their kids on weekends while waiting for a movie to download.
Blockbuster Online dropped below 1.6 million subscribers before Keyes stopped reporting subscriber numbers, telling investors the metric was not material to Blockbuster’s financial results since digital downloads and streaming made up only $1.5 billion of the $25 billion universe of DVD rental and sales in the United States. “So the bottom line is, the focus on subscription service, we don’t think is a relevant measure for the Blockbuster business. It’s a data point, an interesting one, but it is not one that we think is of great meaning to our future,” he said.
Unfortunately for Keyes, as year-over-year store revenue comparisons continued their steady march into negative territory, the rest of the world had stopped debating whether digital media would be significant. Variety lauded 2008 as “the year when global revenues from digital media exceeded revenue generated by movie theaters and home video combined.” The entertainment trade magazine cited a study by the London research firm Strategy Analytics in early 2009 that showed that online and mobile channels accounted for $90 billion in worldwide revenues, while global filmed entertainment generated $83.1 billion.
“We’re starting to see now that digital media is becoming a significant part of revenue for a lot of companies, Martin Olausson of Strategy Analytics told Variety. “A few years back, everyone was still discussing whether movies would be distributed online. That’s not a discussion any more.”
Still Keyes remained resolute in focusing what little capital Blockbuster had on the stores and on publicly assuring Netflix that he had no designs on its subscribers. “We don’t want to try to aggressively steal share from Netflix. We think that would be an expensive proposition,” Keyes said.
Nor would Blockbuster compete head-to-head with Redbox. Keyes weighed a vending operation for two years while wondering how to keep the machines’ one-dollar-per-day rentals from cannibalizing the stores’ sales. He approached Lowe with an idea for an in-store–kiosk partnership that the
latter turned down as ludicrous. They were competitors fighting over the same turf.
By the time Keyes licensed Blockbuster’s brand to NCR in 2009 for kiosks that he planned to park mainly outside Blockbuster stores Redbox had deployed more than twelve thousand kiosks in major grocery and convenience store chains. “Our vending approach would be more a satellite operation for the store,” Keyes told investors.
The Blockbuster store was still an important part of the entertainment lifestyle of mainstream America, especially since digital rental was too complicated and confusing for most customers, Keyes insisted. “As long as we change the product assortment to meet the changing needs of the customer, our stores will remain relevant.”
Blockbuster was a relic, and Keyes’s strategy was doing little to change that impression. A popular YouTube video posted in 2008 by The Onion poked fun at the chain’s stubborn refusal to embrace the digital age. The video purported to show a Living Blockbuster Museum in Auburn Hills, Michigan, where tourists learned about the “hardships” that Americans faced before the advent of Netflix and iTunes.
I never learned whether Keyes saw the video, but it seemed clear that he never got the message about Blockbuster’s slide into obsolescence, even after a couple of his major initiatives failed.
Stocking Blockbuster stores with games proved too expensive in light of the company’s strained cash situation, and the download kiosks that had appeared in a few stores had few movies to rent, because the studios had not worked out how to encrypt them. None of the content was available in high definition.
As soon as the content started rolling in, however, Keyes predicted confidently that customers would line up to load movies onto their thumb drives and “take them home and put them in their set-top boxes, or whatever.”