How I Did It: Reed Hastings, Netflix

The founder of Netflix on developing a passion brand, and sustaining it as passions change.

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As told to Patrick J. Sauer

Every day, a million red envelopes, carrying a million DVDs, circulate through the veins of the United States Postal Service, spreading cinematic joy. (Fargo to Fairbanks! Bustin' Loose to Tuscaloosa! The Onion Field to Vidalia! The Battle of Algiers to Kennebunkport!) It's all thanks to Netflix, brainchild of Reed Hastings, who in 1997 saw a way to combine Americans' love of movies with their love of not getting off the sofa even to go to the video store. Netflix launched its Internet-based subscription service in 1999 and signed up 239,000 movie lovers in the first year. Today it has nearly four million subscribers who choose from 50,000 titles. The company, which went public in 2002, expects to report $687 million in revenue for 2005.

Hastings survived a serious challenge from Wal-Mart in 2005--the giant blinked first, or yawned--and now his focus is Blockbuster. Hastings likes to point out that Netflix is already four times bigger than Blockbuster in the online segment and is continually investing in marketing. You may have noticed the ubiquitous Netflix pop-under advertisement; it's the reason the company was second in online advertising dollars spent last year.

Netflix was originally a single rental service, but the subscription model was one of a few ideas we had--so there was no Aha! moment. Having unlimited due dates and no late fees has worked in a powerful way and now seems obvious, but at that time we had no idea if consumers would even build and use an online queue. It was still a dial-up, VHS world and most video stores didn't carry DVDs, so we were able to sign up early adapters. By the time there were enough DVD owners, we had gotten better and better and broadband had grown.

I founded Pure Software in 1991 around a debugging tool for engineers; I was an engineer myself. We doubled our revenue every year, but my transformation from engineer to CEO was when Morgan Stanley took the company public in 1995. We went from one great niche item to a broad portfolio of products, significantly improving the quality of software. We were then acquired by Rational Software in 1997 for $750 million, which gave me the means to start Netflix.

Management was my biggest challenge; every year there were twice as many people and it was trial by fire. I was underprepared for the complexities and personalities.

I didn't see the dot-com crash coming. It's hard to know when you're inside the bubble.

For some people, high school graduation is the peak of their life and that's unfortunate. It's the same thing for taking a company public-- sometimes that is the peak of its life, which is unfortunate because the real promise lies ahead. It's gotten substantially harder and more expensive since Sarbanes-Oxley, but I find running a public company to be a lot more fun and exciting. What you do matters more to the world, there are more stakeholders, and management performance is more visible. The only negative is that we now get sued once a quarter. You become a magnet for frivolous lawsuits, but they get dismissed and it's a fairly minor tax.

There are three types of customers at Netflix. One group likes the convenience of free home delivery, the movie buffs want access to the widest selection of, say, French New Wave or Bollywood films, and the bargain hunters want to watch 10 or more movies for 18 bucks a month. We need to keep all the audiences happy because the more someone uses Netflix, the more likely they are to stay with us.

At this point, our movie buyers are very good. We constantly invest in and improve our technology. Using all of our measurements, we know within a 10% range whether a movie will be a hit with a subscriber. We recently added a component called Friends, which allows fellow movie buffs to share reviews and recommendations, and we are always expanding our search capabilities. Movies can be looked up in more than 200 specific genres ranging from British humor to 15 varieties of anime to steamy romance.

The average subscriber cost is $3 to $4, so we're significantly ahead on the cost curve. Netflix has to be the leader in technological advancements to maintain our annual retention rate of 97%.

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