Acquired - Netflix (Part 2)

0:00Oh 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 know like that David It's just for you. Oh, man. That's great. That's great. I 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 2009, shortly before the epic launch of Quickster. So today we're going to dive in on the era of streaming and later original content.

0:55So David, I wanted to have a fun fact to start us off on Netflix. So as you remember, they were once a plucky start-up mailing DVDs to customers and a remnant of the pre.com bubble starting in 97. And they were doing this even before most people had DVD players. They were waiting for the DVD wave to crest. This company now accounts for 15% of all internet traffic. I know. That's in my show notes.

1:24Well, sorry to blow your cover early, but streaming movies and TV as a category actually now makes up 58% of downstream internet traffic and no single service accounts for more of that bandwidth than Netflix does. And at peak times, it can even account for 40% of the US's concurrent internet traffic. So you could imagine maybe 8 PM Eastern or something like that. Absolutely. Incredible.

1:52Yeah, and this is with some of the best compression and optimization technology that humans as a species have figured out how to do. The last episode was about a company fighting to get its first 500,000 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.

2:14And we've been just totally floored by how many of you have joined our LP community and our listening to the bonus show and are sending us really great questions for doing Q&A 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 them on. Yeah, it was super fun. We had Dan Hill 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 $30 billion plus.

2:50just so much to learn from him. 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 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 $5 a month or go to Kimberlite.fm slash acquired. That's K-I-M-B-E-R-L-I-T-E.f-M slash acquired. I feel like we really need a jingle for that. Did you do? We could just play that every time.

3:18Yeah, that's... Yeah, acquired needs better jingles period. That might be one of my holiday, 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.

3:42Yep, it's sort of obvious that AI is going to completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Legora 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.

4:09for 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. Lugora's bed 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.

4:38And 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.

5:05speak for themselves. When they have a head-to-head pilot with their top competitor, they win 70% of the time. Legora now has over 100,000 lawyers on the platform from 1,200 legal teams in 50 countries. And crazily, they went from 1 million to 100 million in ARR in about 18 months. Truly insane numbers. And that is the real test.

5:30Plenty 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 logora.com slash acquired, and just tell them that Ben and David sent you. All right, now onto the show.

5:54on to the show indeed David I texted you before this we have a little bit of follow up from from the last episode we have some awesome listeners that wrote us in about Netflix part one and since this is a two-parter we do get to actually go back and and make a few corrections the first one is actually on my carve-out from last week where I mentioned that the good place 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. So that was. What more shadowing for part two? I know. The other one is that we discussed that Blockbuster had an incredible business model where they only had to pay rack rate for DVDs. And then they could rent them as many times.

6:46as they would like. Thanks to on Twitter, Jim underscore Brown, 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 court case filings that I gave up on trying to actually find it out. But it's somewhere between $50 and $100 that they actually had to pay for every DVD rather than just getting to sort of buy them at store price in sort of a special deal that they'd orchestrated so that they could to generate the sort of high rental revenues that they got from each one of those DVDs. So good to know there and thank you to Jim for correcting us. And the third one is we had an anonymous listener send us some amazing facts about Red Box after we briefly touched on it in the last episode. So Red Box, as you know, from the last episode was actually originally a project at Netflix that an executive quit to go and work on full time.

7:43outer wall, which was Redbox's once parent company, was acquired for over a billion dollars in 2016 by the private equity firm Apollo Global Management. And Redbox is now a standalone company inside of Apollo. Turns out it's wildly profitable. They're actually working on starting a streaming service of their own, standing up a second attempt of that. But looking at their core business, it's not hard to figure out why they're wildly profitable. It turns out running a retail footprint of six feet by six feet.

8:13that 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 retail establishments, like. One way people always focus on improving the numerator there, but you could also lower the denominator. Yeah, they've sort of gained the system on that metric. But here's another crazy thing about RedBox right now. So in Disney's attempt to build their own relationship with customers through the, 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 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, I guess, Blu-rays, and bring them back to stock the machines. This is actually how Redbox acquires Disney movies to put onto their platform.

9:09which I kind of imagine are some of the most popular titles on redbacks for machines. I just think in general, I think we saw the company short last episode. 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 $1 what they used to do for $3 and in many ways easier because they sort of had more endpoints at more stores. Blockbuster's main business was sort of under attack there as well. So lots of kudos to Redbox for being a major player in this industry.

9:38Indeed, indeed. All right, so David, can you take us into what your 2007 rewind a little bit and start with streaming? Are you gonna like find some way to go to like early 30s? Not that far back this time, but we will pick up the story in part two as listeners. Remember in part one, we covered the story of quickster. I mean, Netflix from founding to 2009. And once again, also in part two, want to shout out the really excellent book, Netflix by Gina Keating, which provides a lot of the history and facts. And really for anyone who's more deeply interested in this company and this history, I can't recommend enough that you go read it. So we ended last time in 2009. Netflix, not yet quickster, had basically, you know, snatched victory from the

10:29the jaws of blockbuster. Do you keep calling it quickster because their whole business basically was quickster? Yes, this was quickster. Everything we discussed in the last episode was quickster. They just reached 10 million subscribers. It's 2009. The recession has beset the US and the world recently. 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 at C read Hastings in the Netflix management team. They see this and they know that they're going to have to adapt and they're going to have to embrace this new title wave of streaming that they see coming. So to rewind a little bit, how did streaming kind of come about? So really, I mean, I think you can point to, this was our first episode. It was our first acquired episode, right? Disney picks are. Yeah, first or the second, I can't remember.

11:26Instagram or Pixar or whatever. Yeah, there's one and two, but anyway Disney in 2006 had acquired Pixar and that of course brought Steve Jobs became the largest single shareholder in Disney and Steve Jobs joined the Disney board and after that happened in a couple years following Disney made a made a pretty unprecedented move. They brought all of their video content to the iTunes 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.

12:10download the entire file to your computer. In the beginning, there wasn't even a video iPod. I like the disdain that you say for computer. It wasn't some like archaic device. It is, it is. I say as I'm talking into one, but I'm rapidly trying to move everything to iPad. And so that really kind of started to open the industries. This was the first, like this was real.

12:34content, mainstream content that now could be available digitally. The other thing that happened right around this time is US broadband penetration finally passed 50% and then kept growing and became really ubiquitous. This whole business whether downloads or streaming would have been impossible in the dialogue days for broadband finally enables it. So Netflix, of course, and read Hastings in the management team, they see all this happening and they know they need to do something.

13:03In 2007, 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 DVR company. So you know, those like set top boxes that were like T-vos. So he had founded a competitor to T-vO 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 buy and put in their homes next to their DVD players. And initially the vision was it would have a hard drive in it.

13:44and just like when you would download a Disney movie of iTunes under your computer, you would download 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 before streaming it really was like it was basically a NAS, like a network store, you know, just keep a bunch of stuff at home. Well, it was a replay TV. It was a DVR. That's what it was. It was a hard drive.

14:12They realize, though, that actually with broadband, you have to wait to download the movie when you're in this old paradigm that actually just streaming, they have the technology to do that, and that would be better. So they pivot the project into that. The box is coming along, but read in the management team, they start to get worried, though. This is late 2007. They worry that if they release their own box, they see that there's...

14:36fights 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.

14:49and reads 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 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 probably want to do on TVs, you guys are plugged into TVs, and he's realizing like boy, these negotiations are not gonna go well. If I have a competitive device to you guys.

15:23What does he do? We've seen this before. He tells Anthony, yeah, we're going to have to cancel the project just so like they did with Redbox. And he says, 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 know sort of how this process works. They're in the third phase. So it's.

15:40DVT design and validation testing, verification testing, like the whole team has been over in China, like manufacturing these things. They've done several reps. They're coming off the line. I think they have a hundred or 50 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. Of like, you know, this thing's baked. It's baked. Yep. And in a classic, you know, Netflix management team, re-daistings booth. Nope, we're changing our mind, as we will see. But what would convince us 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 talked about where they decide, okay, they spin the company out, and they name it.

16:35Roku. Roku actually was a name so would had had essentially a shell company after the after selling replay TV and are moving on from. Replay TV had started a company called Roku, which I believe in Japanese means six is the number six. And it was that this was his sixth company that he had started. Something like that. And so 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 2008. And it goes on to great success and is now its own public company, IPOed earlier this year.

17:15But 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 concept. They sign up Microsoft and Xbox as a device partner. Streaming comes that summer to Xbox 360, Netflix streaming. And then they start, you know, going to PlayStation, they go to all these connected devices, knocking them down one by one.

17:37Can we just pause and reflect for a moment? What an unbelievably gutsy management decision that is. You have this whole arm of your company. For listeners who are interested, we'll put a link in the show notes. The team, a month before canning it, or maybe a couple of weeks before canning it, did an all hands where a group of employees did a parody video of the Dharma initiative from Lost, which was huge at the time, of these secret Project to build I can't remember what they called what the sort of secret project name was All I remember about lost is that it was it's like such a period feast now

18:15Oh, the code name was Griffin. So it was like the Darwin initiative logo with Griffin in the middle. But this video is amazing because 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 read Hastings, 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 going to 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 the dime, boom, it's its own company that goes on to be wildly successful. I mean, it's really amazing. I don't know if this says more about me and me living under a rock or just that this history of Netflix is not told that both Red Box and Roku come out of Netflix. It's crazy. They've had more spin-offs than they have their own acquisitions. I think they've only ever acquired one company.

19:11I know what their first was, I don't know if there were other ones after that, and their first was quite recent. But the Roku thing, just one more note on this, I try 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...

19:30Obviously, they have a large dependency on Netflix's business. It mentions in two places a lease that they shared with Netflix in the early days, but it doesn't mention anything about Netflix as part of the founding story of the company. Read Hastings nor Netflix appears on the cap table when they're going public of major shareholders. Which is interesting, because Netflix invested $6 million when they spun it off. But I wonder if they'd just been deluded so much.

19:58One other thing, that's $6 million. I tried to find more information on that to figure out if there was a valuation on the company, what it looked like. There's a form defiled 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 read hastings. Maybe it was some kind of proxy thing because I assume it was Netflix. It's scanned improperly. You get to read half the previous page and half of the next page while you're looking at this document.

20:27and 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 billion and a half dollar market cap public company. Crazy. So that's the story of the genesis of the one half of the streaming business for Netflix, which is the distribution, getting content into people's homes.

20:55But 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 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...

21:17Content will be at shows 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 2008-2009, when they're just getting started here, the content companies don't really...

21:35see the future as clearly as Netflix sees it here. You know, these are the days when cable network content deals are like still huge and the vast, vast, vast majority of these content companies revenues. So they've used streaming as just kind of like a nice add on. So the first deal that content deal for streaming that Netflix actually does is with stars that pay TV cable network.

21:58This is a total steal so they do a two-year deal in October 2008 with stars to get all of their content for $25 million so this is TV shows movies their back catalog everything that they have the rights to Stars quickly comes to regret that but it's only a two-year to stars to stars 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 is I'm mostly conjecturing here, but I I'm Recalling my old days as a media TMT investment banker around this time I believe the way it works is that stars hadn't negotiated with the With the content production company Disney Fox, you know whoever NBC who had originally made the movies and TV shows They had acquired the rights to show them on cable and I believe

22:48It also included streaming or whatever the language, but it wasn't really something that was contemplated then, but they had the right to then resell those rights. That's a theme between music and movies. Really, all media is like, 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 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.

23:16totally. This happens and Netflix also does a deal in 2008 with NBC Universal for streaming access to some of their content including Saturday Night Live. I believe streaming the day after on Sunday. Once again, just like we saw with Netflix in part one, this is like instant product market fit. So you know, everybody who as is any inkling of watching video on a, you know, computer or mobile device that is emerging at any screen at this point. So, you know, mostly millennials and younger, but but lots of other people too. I mean, YouTube has been around for several years at this point. They just go.

23:55nuts 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, the old paradigm is you only want video when it's on TV. 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 2008, previous to that, I wasn't able to do Netflix's, what do they call it? Like instant watch or watch now.

24:25feature. I think it was instant queue. You had your regular Netflix queue for DVDs. And then the instant queue was your queue of what you wanted to watch, you know, lined up via streaming. You're so right. Yeah. 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 only worked in one browser. And you needed silver light. So like think about sort of this.

24:52Oh my goodness. The way that this works today and the way that it used to work, it was just the clu-geist way that you could imagine trying to like, it would take 15 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 refer to it. Yeah.

25:09This is, you know, 2009, 2010 Netflix is just, 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 bananza, just adding subscribers, like there's no tomorrow. And so much so that by 2010, Ben gave the stat that today Netflix is still 15% of all US internet traffic. Back then in 2010, they were 20% of all US internet traffic. Oh wow.

25:38Internet grew. Yeah, I assume. Well, think about how much more streaming video there is now versus in 2010. Right. Yeah. It probably wasn't 68% of the internet or 58% of the internet then. Yeah. Yeah. Of course, there was YouTube, much smaller than it was. But there was no, there was no Amazon Prime streaming. There was no Facebook video. There was no Snapchat. There was no Instagram, nothing. Infrastructure-wise, there also wasn't gigabit to the home then. Yep.

26:05Yeah, yep, and Netflix already knew this was the future. This is like not just the future. This is now so they they realized 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 2010 a remember their their first deal with stars was $25 million they sign an $800 million deal, five-year deal with Epic's EPIX. Now, Epic's was a joint venture between Paramount, which is part of Viacom. Lionsgate, Paramount was the film 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 on Wall Street, they were facing bankruptcy, and so they

27:03desperately needed this cash. And it was this Netflix deal that between Netflix really keeps a lot of these companies alive through the recession. Everyone else sees this and they start coming back to 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 and they start spending a lot of money acquiring all this content. So there's four shadowing there. Netflix spending a lot of money on content. Okay. All right. It's coming back.

27:31but a quick real quick detour about the media industry. So all of these content production companies, the media industry has been around for 100 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.

27:48or 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 in bed together. Also going on 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 $100 a month for my...

28:13cable subscription. So you've got 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, wait a minute. Yeah. This is the thing accelerating our death. Like can we have a conversation from yeah, exactly. So they 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 people's homes.

28:42most people in the US at this point in time 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 when a cable from Comcast from whatever from the cable model. Quick side note, do you know about fast.com? So forever I use speedtest.net to test my sort of upload and download Netflix.

29:05was 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 ran a big campaign and encouraged users, by the way, fast.com is a great way to check your upload and download it as far sort of like simpler and lighter than speed test.

29:35They encourage consumers, hey, if you ever feel like, gosh, it might, why is my Netflix slow? Go to fast.com and compare that against however fast you think your internet should be. And you'll get a reading of what your ISP is actually treating us as in terms of upload and download speed. Interesting. Well, of course, then what you are referencing here is throttling. The cable company is the...

29:57ISPs, they start throttling Netflix because it's a competitive threat to their whole business model. So what does Netflix do? Read Hastings is like, I can play politics. I know how this works. Remember back to part one and his day is on the California Board of Education. He starts a pack, a political action committee called not to support a particular political candidate. It's called Flixpack and it's to lobby the FCC.

30:24to set up net neutrality rules. So if 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 2010 and it was because of this. And it was because of Netflix that really remember all these campaigns about net neutrality and stop soap and all this stuff. Who's behind it? David, some of us wrote a big...

30:4940-page thesis paper on network neutrality in 2007, so hipster net neutrality. You were just ahead of the curve. I was. It's the only time my life I can ever claim that. And I remember these huge, huge fights. And then finally, at the end of 2010, Netflix wins, and the FCC approves rules essentially preventing ISPs from blocking content. That's under attack again today. I don't know actually the details of the latest FCC ruling.

31:17this year or last year in the Trump administration. 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, me too. So I cannot speak authoritatively on this anymore. Anyway, so 2010 basically goes really well for Netflix. I'm spending a lot of money, but they're growing hugely. 2011 also starts on a very positive note.

31:41they finally launched international expansion. Now, international was hard to do with the DVD rental business because you needed basically cooperation of the national post office and all this infrastructure and everything, but streaming, it's just bits, it's not atoms, and turns out a lot of the world speaks English, too, and watches US made Hollywood video content. So first, they expand first in Canada, naturally.

32:05and then before the end of the year in Mexico and Latin America. And this becomes a huge, huge growth driver for them over the subsequent throughout the 2010s. Now international is a bigger business for Netflix than their US business. So all going well, they're still kind on the top of the world here. And this is 2011. 2011. Yep. I don't think we talked about the Chaos Monkey and the last show, correct? No, I don't know. We didn't talk about the Chaos Monkey here. Go for it. All right. So this is the time that Netflix decides We're fully 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 watches Netflix today sort of knows, like, it is remarkably bulletproof, like, that it kind of always works. And how is that?

32:52Well, Netflix invented something that you can find on GitHub now that's part of a larger suite of software that's open source in 2011 called the Chaos Monkey. And what the Chaos Monkey and 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.

33:19Yeah, and what it would do in the philosophy behind the whole thing was what better way to 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 some of the original things that they did were the experience 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 it's just crazy impressive mentality that, you know, back in 2011, they're pioneering sort of like a, it's actually, it's used in a ton of companies now. There's that book famously named Chaos Monkeys about Silicon Valley in general. It's sort of a brilliant infrastructure decision and just showed the sort of level of talent in the engineering department there.

34:15They 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, you know, was still sensitive. It's very, it's very humane. It's a humane chaos monkey. Yeah. Well, an apt analogy for what's about to happen here. I feel like this is also the story of the...

34:34business side of the Netflix house, which is like, there's a chaos monkey running a monkey and they keep shooting themselves in various body parts, but managed to persevere at a very, very robust as a business. So summer 2011 now, this is when the dominoes start to tip the other way. They make an announcement. So again, we're now a couple years into this streaming business. It's again, instant product market fit. People love it. It's 20% of the internet.

35:03They 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 subscribed to Netflix. It's just one product. It's like prime. We're just going to throw stuff in to sweeten the offer. Exactly. Summer 2011, they change the pricing structure. They issue a press release 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.

35:35Come on, don't, don't bury the lead. Like PR rule number one, if you're about to announce something that consumers ate, do not make the title. You're gonna love this. I thought you're accusing me of burying the lead. No, the lead comes later. Separate press release. But yes. Yeah, no, I'm saying, yeah, that Netflix, that press release hardcore. Yeah, this is gunshot wound self-inflicted number one. So what did they do? They, they changed the pricing. They're pricing tiers to, so they, they now have three options.

36:02you can subscribe to just DVD rentals, and they build that as a price cut. So cheaper than what just subscribed 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 for also cheaper than the price of the old bundled Netflix plan, or you can have the bundle. You can have both...

36:23And that goes up I think like 20% of price or 20 or 25% or something like that. People react very negatively to this quote-unquote price cut. So negatively they lose a million subscribers basically instantly. Now they've grown a lot so it's not like losing a million subscribers back in part one was like losing 20% of their business. But still like it's the stock price takes a beating. It's still very significant. People are very upset.

36:48My father was one of them and I don't know if he still listens to the show but I distinctly remember him like boycott a Netflix for a year or two before he signed back up and it was furious about this. Again, this is the recession. Like it's 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. They're stock plummeted too. I mean, I think Netflix has always sort of been valued on their subscriber growth and actually more recently really on sort of what their projected subscriber growth will be next quarter. And this was to have a down quarter where they actually lost subscribers. It was like,

37:42What the only time this had happened in the past is what we saw in part one when when black bus to launch total access So what are they gonna do? Hastings has a plan of course now which I know I forgot to mention earlier at the end of 2010 also something you know long time coming for shadow that we knew happened but sad for Netflix their great hero, Barry McCarthy, retires and leaves the company. He decided not to leave his friends in the knife fight against blockbuster, I'm sorry, against Amazon when they thought that Amazon was coming in and so now they're safe so he can leave. He leaves and he takes some time, he becomes an investor with TCV and then does his short stint at clinical and then joins Spotify as we talked about in that episode, but back to Netflix. So there's no, no Barry McCarthy.

38:28read, 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 the streaming is the future. He is going to open their eyes to this. He just needs to push harder. Isn't that first press release? They about the price cut, quote unquote, they got so much negative reaction. Kind of at the end, he said, you know, and This is a precursor to we are going to spin off the DVD rental as a separate business eventually. He decides that the way to fix all of this is explained 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 going to do this.

39:11So the plan is that they're spinning off the DVD rental business into Quickster and a long time Netflix executive who we didn't talk about in the last episode, Andy Renditch, who ran, I believe ran all DVD operations. He's going to be the CEO now of Quickster.

39:27And he'd been there for like 12 years. Yes, he'd been there for a long long long time. How are they going to do this? They're going to do what you know all the hip kids are doing these days. They're going to make a video and they're going to post it on YouTube and it'll go viral and everybody will understand, you know, the vision. It's going to be, this is like the 7-11 dude a blockbuster coming back me like the kids, they're going to come, they're going to eat pizza, the blockbuster stores.

39:50Was it party on the block? Rock the block. Rock the block. This is the rock the block moment for Netflix. They're going to post a viral video on YouTube. Well, they make a video. Read and Andy, they make a video. And it does go viral in September 2011. Hashtag winning. Hashtag winning. But it goes viral for the...

40:14wrong 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 ever. It's still there. So I thought it would be on YouTube somebody else and many people have mirrored it and copied it 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. Imagine the least like cool most fake like corporate like dad thing you could ever imagine and then multiply by 10. That's this. It's so bad. And it's 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. They're like patio furniture outside the Netflix headquarters and read is wearing like a like a teal like shirt. He's got his go T and like most people never seen read in person at this point. Listeners if if

41:09If this is ever us, and we become tone deaf, maybe we are already. Please write us emails. Please acquire dfmgmail.com. Oh, don't worry. If we do something like this, I wouldn't be worried about getting feedback because within days of this getting posted, read on his personal blog, he gets 30,000 comments on his blog, basically just trashing him for 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 Fred Armason, the, you know, the Portlandia guy. He's Andy, I think, and I forget who does, does read. We'll link to this in the show notes too. And it's just like, it's so funny. You know, this stock price get crushed, the first press release this time.

41:59It gets crushed even for like Netflix and Quickster basically become the laughing stock of the internet. Hey, a lot of their big bets pay off. A lot of them don't, but they take big bets. They take big bets. This is one they really should have thought through a little more.

42:14before the July press release they were trading at $305 a share after the quickster announcement they're down to $65 a share so they lose like was that 80% of their value as a company in like a couple 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. Customers, when they announce that they spin off and do it, you have to have a separate account on quickster and Netflix, separate billing, separate cues that you manage, separate customer service, like a separate company man. What do you expect? Talk about like a terrible experience.

42:57This is like the kicker here. Netflix didn't even grab the quickster Twitter handle. So there was some dude out there who had the quickster Twitter handle. And fairly he was like a pot smoking like soccer player guy and he's like just started trolling Netflix and is like publicly extorting them and like, you know, so bad. So bad. What is the net of this? What what all happens within one month?

43:24It was September when they do this ill-advised YouTube video announcing Quickster. Within a month, they cancel Quickster. They completely unwind the whole company. Andy Rendage, the 12-year-next Netflix veteran who'd been tapped to CEO, he's gone. He resides, he leaves the company. Everybody, half the people who'd gone over to Quickster, they get laid off, they're gone. They just completely... This is one thing about Netflix and read is they make big...

43:52Decisions, they make them confidently and you know, if they're the wrong thing, then they pull the plug. So they they pull the plug on QuickStay. All right, listeners. Now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would not and you're done. But in an AI first world, that doesn't hold up anymore. Yep. Your risk surface changes every week now.

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45:47Another bad thing for Netflix. Oh, well, bad thing at the time. I think good thing in the long term happens for them in 2011. Amazon, they didn't launch the Netflix competitor in the DVD streaming and the DVD rental era. They launched the Netflix streaming competitor. Amazon instant video and they get into the streaming game. And then early in 2012, they also do a deal with epics, the joint venture that Netflix has done a deal with. Spend I think about the same amount of money, about a billion dollars, get all the same content.

46:16And so now, not only is 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're a prime subscriber already, like, Netflix is like, oh, yeah, yeah, you were paying for Netflix. Like, now I'm going to 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 2012 is a tough, tough year for Netflix. I didn't go back and verify every quarter, but I believe they missed their subscriber targets every quarter of the year. The stock price is totally languishing. Still around the $60 share. You know, one thing they do start in 2012, though, that is a name no one will recognize, but foreshadows everything to come is Netflix produced their very first show called Lily Hammer. Yes, they do, which was a soprano's clone. I don't think it does, but I don't, I don't, never.

47:14I've never watched it, yeah. Yeah, but Harbinger of good things to come, but one more bad thing in 2012. Let's go back to the bad stuff. Let's keep ripping on Netflix. It'll just make their rise so much better. This was another unbelievable thing that, 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.

47:39Carl Ikehn, who comes in to, you know, the stock prices languishing by the end of 2012. Who returns but acquired Superbill and he's like, Barry McCarty's gone. Great. Take another go at this one. Take another go at this one. He is back in the movie business game.

47:58He announces that he has accumulated a 10% equity stake in Netflix on the public markets. I believe this is October 2012. And he's going to start getting involved. I love how this happens, too. In public companies, you can just slowly buy and buy and buy and buy. And then you don't want to announce that you're buying, so it'll move the stock price. And then suddenly you just say, hey, guys, you may not know this, but through various sources, I have a 10th of your company. Yeah.

48:23Incredible. He thinks that really what Netflix should do, they've been so much mismanagement here, but there's so much value in streaming as the future. They represent strategic value. They should sell themselves to a media company or to another tech company. Do you know if he held, is he still a major Netflix shareholder? He held until 2015, and then he announced in 2015 that he had liquidated his whole stake. I believe it was about halfway through 2015. He made a ton of money. A ton of money.

48:53But the only, I guess, good thing for people who dislike Carl Akener, if you're on the superhero side of the house here, is he misses out on a ton of gains still. He believed in 2015 that Amazon was going to crush them, and, well, that hasn't happened. So he missed out on the majority of gains that he could have had. But 2012, despite all this bad stuff that happens, Netflix now, 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. And this is really what saves the company. They realize they start seeing the data for 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,

49:48They stream for a long time and if they're watching a TV series or something, they watch just episode after episode and up until this point, the media content industry operated on this assumption. I remember this of appointment viewing. People tuned in at 8 p.m. on Wednesday to watch the latest episode of Mad Men or whatever. With linear television, that is still what works. All the top shows on linear TV are still exactly that and actually most of them are alive.

50:17It's just all sit around these like stand alone like half an hour or one hour like get your fix and then tune in next week. And they realize that 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 these self contained, you know, two to three hour films, but really, really long-form episodic content that people can binge-watch. Television at this point, they're kind of like the little sibling of the media world. It was the big blackbuster movies that everybody wanted to make. Yeah, so...

50:56This brings back an interesting and classic acquired fashion, jumping forward to tech themes, 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 1985 out of the top 25 movies, the number that were sequels, it was like three.

51:18And if in 2015 it was the exact opposite like 22 were either sequels or 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. They're reusing IP from children's stories or bringing back movies from the 80s and 90s. So the experimentation needs to go somewhere, it's kind of the same thing as like startups, like the sort of the lean startup, where do you sort of prototype whether IP is good or not? So it sort of opens up the opportunity for this golden era of television or golden era of TV shows that attracts really top notch

52:04both writers, directors, 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 Netflix is sort of the place where you could actually facilitate that format.

52:21Ben you referenced Lily Hammer in 2012, 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 need to pump more, you know, episodic series based, quote-unquote television content into the streaming platform. So they make Lily Hammer, they released it in 2012, and then in 2013 they do two things. One, They bring back, I remember when this happened, 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, or it's the 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 what you felt like you did. Well, such a good example of giving people what they want, you know, for this new platform. And then the other thing they do, they debut in early 2013.

53:18is 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...

53:29binge watch the whole first and second seasons pretty aggressively. And it 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 $100 million 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 2013. In 2012, the company had $290 million of cash on hand.

53:58and they had committed a hundred million to creating just this two seasons of this one show. A few more stats on this, so even the total current assets, including their entire content library, prepaid content, short-term investments, all of that was just over two billion. So what a colossal bet for the company. If you go into today, they have...

54:20$3 billion in cash alone, close to $9 billion 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 they, I mean, one, as we've seen time to time again with this company, when they swing, they swing hard.

54:43But this was one unlike the Quickster debacle. Like, this was so informed. Like, of course, they couldn't know what was going to happen with House of Cards, but it was informed by all the advantages they had. So they knew, you know, Kevin Spacey, we've learned a lot more about Kevin Spacey since 2013. But at the time, he was this like actor that everybody kind of 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 cast Kevin Spacey. Dude, what are you talking about? K-packs.

55:12case in point. You don't want to cast Kevin Spade. You know, he's not Leonardo Caprio here. K-packs was great. Don't hate him. Maybe there was less of us that loved it, but it was great. Well, he didn't have massive feel to the traditional Hollywood movie studios. However, Netflix saw that people...

55:30because 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 on. That's so powerful. And watched them, and they're like, okay, there's something going on here. And then House of Cards had been a British show that they re-adapted to the US, and the British show was on Netflix, and they were like, man, nobody knows about this thing, but 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

56:00release, I believe this is the first time this had ever happened. It released all 13 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. You're not going to miss the ability to draw out this whole thing over a period of time. Completely huge win for Netflix. It was David Fincher, too, right? He did.

56:22directed it or wrote it? Yeah, I think so. He was super hot at the time because he had just done the social network and the girl with the dragon tattoo. Yep, that's right. That's right.

56:32huge 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. 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 $300 before the whole quickster debacle. So they're finally getting back up. And then they followed, they realized this is gonna work. So then this is the beginning of going all in on this content.

57:02and acquisition and production strategy. Later in the year, they do a deal with Marvel. Before Marvel gets acquired by Disney, to create episodic TV content around Marvel Superheroes. This is like Daredevil. There's Luke Cage and all the stuff you see on Netflix. This is where all this comes from. In 2014, they realized, man, we've got this flywheel effect here where the more...

57:28great 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.

57:49capital like this is we have a very predictable subscription based business if we can forecast our subscriber growth accurately and bend 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 2014 they basically changed their whole capital market strategy they'd been you know, like most tech companies at this point, no debt completely equity financed and cashflow positive. They start raising debt and investing it in a content. It's a point where now today they have over eight billion dollars in debt. 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-delutive capital, so nobody's equities get pushed down. The people who are issuing you debt are very happy to give it because you can provide them

58:38Incredibly high certainty about what your ability to repeatedly sort of generate cash on cash returns from you investing that that again 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 oversimplified. 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 20% per year. It's like, how much debt can we have? You know? Yeah. So they start slowly. They do, I believe, a $400 million bond deal in 2014. And then they start getting bigger and bigger. It's the point where their most recent bond deal that I think they did this month in October 2018 was $2 billion. And they have $8 billion in total debt outstanding.

59:30which is a huge amount for a tech company. But again, based on the cash flow dynamics and the subscription dynamics of this business, as long as they can accurately forecast subscriber growth. Yeah, 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 LP show, the going sideways and sort of explaining what that is, when you rack up a lot of debt with a belief that you're going to have very predictable cash flows, and then there's something 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 want to just keep stacking it. Yep. I mean, that's the danger of debt. So far, though, it's worked really, really well. So, you know, to wrap things up and get us to today, summer of 2014, as they're investing heavily into this strategy, they passed 50 million global subscribers, 36 million in the US 14 million internationally, then in

1:00:282016 in January they make a big announcement at CES that they are launching worldwide in 150 countries. I believe literally every country except mainland China, North Korea, and one or two others. Crimea. Yeah. Crimea and Syria. Yeah. And of course, it's all English-based. They haven't actually translated Netflix into all these languages yet, although they start that project. And now I believe they have translated into many of these languages. They passed 75 million subscribers globally. During the year in 2016, they released 126 original films and TV shows series, more than any other content company out there, period, any other cable channel or network. Now, actually, I don't know if that includes like, I believe it's less than the big conglomerates like Disney as a whole or Viacom as a whole. But of any one like division, like Netflix is the largest single content production company. And then the irony of Ironies is in 2016, they actually do finally successfully execute the spin-off with Quickster.

1:01:32They 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 to the online DVD rental 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? It is a DVD.com, quote, a Netflix company. So I believe it is 100% owned by Netflix and a wholly owned subsidiary. And it has something like they do like 120 million in revenue a year and like 60 million in.

1:02:03profit or cash flow. So nice. Classic growth stock value stock value stock. And things just keep going from there. So this year in 2018, they passed $100 billion market cap. There've been several stocks blitz over the last few years. So the stock price isn't quite the same. But now in October 2018, They just announced earnings and they now have just under 60 million US subscribers. So if you go on a household basis, assume there are 100-ish million US households that's 60% of the US market larger than any cable company in America, Comcast, Time Warner, you know.

1:02:45what have you, Charter, and 137 million subscribers worldwide, which is just incredible. If you look at that sort of third quarter announcements, sort of play forward what it's gonna be by the end of the year, they're gonna do close to $15 billion in revenue this year, and over a billion in net income or profit. And I think this will be their first year that they do a billion dollars in net income. One of my other favorite stats on catching us up to today.

1:03:14in the first half of 2018, the stock doubled. So I think that was something like $70 billion of market cap were created. Like $70 billion market cap companies don't double in six months. Not that stock price is necessarily exactly value creation, but yeah, it's pretty impressive. Well, this is, you know, maybe something to get into here in tech themes.

1:03:42It's probably the right moment to transition into it. You know, for years, people have been talking about the Fang stocks and loving Netflix in with Facebook, with Amazon, with Google. But Netflix is actually much, for most of the last few years and even today, much, much smaller than those companies. And you know, I think that's how you can get such, you know, a doubling in market cap is, you know, they are only, quote, unquote, I think about $130 billion.

1:04:06market cap company, you know, compare that to the, you know, 500 million 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 5,500 employees where if you look at someone like an Amazon who has, you know, 8x the market cap, but they have 100x the employees.

1:04:27compared to the other thing stocks. They have remarkably few employees for their valuation, because you look at Microsoft that has 130 Amazon has over 600,000 Apple has 132,000 including retail, you know, even Facebook's over 30,000 Google at 85. I mean, there's no one that's down in this sort of like sub 10,000 employee category. I sort of wonder two things. One, is it because their product offering is so simple that most of these sort of product and engineering work that you would, you know, typically have big teams on it is a lot of sort of infrastructure and that they've really paired down 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. All right, listeners.

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1:06:51So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely at scale, go check out servicenow.com slash acquired and tell them that Ben and David sent you. Are we like ankles deep into into the water of tech themes now? Let's do it. We're doing this. All right. I mean, at this point, we're two and a half hours into history of Netflix. I think we can get a detector.

1:07:14There was a great tweet a while ago. It was from one of John Groober'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, we hope to not quake it there, but we do actually have a pretty good meaty tech themes part because I think whereas the last episode was really more narrative, this one, there's a lot of good analysis to be done on Netflix. And so I'll start with some of the more sort of like, things that are interesting to point out but not crazy analytical. One of them is there's a great business insider page and we'll link to this in the show notes that shows the evolution of the homepage over the years. I was thinking about it. It seems very obvious to go to Netflix now and just start watching. That's what you do. You go to Netflix, you start watching.

1:07:58but they had to do a ton of education over the years, both on the sort of innovative DVD model. 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 was confusing. And then on top it was like, or Instant like click here then downloads overlight and it is 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 it

1:08:38tremendous 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 in 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 was. So the things that they've done that have been less over time.

1:09:06DVDs are this subsidiary, they spun out the set top box, they said no to any machines, they deprecated a lot of these things that were brand, so like search on their site used to be FlixFinder and their algorithm used to be Cinematch and they like, it was all about having all these like, branded things that they were telling you about themselves, they in 2013 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 Steve Jobs coming back to Apple and pointing out the product matrix and saying like, we're getting rid of three quarters of this.

1:09:49Netflix 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 sparked was we didn't really talk about Amazon and the history and facts other than mention that they launched what instant video that became prime video. I think all that that really did, everybody was so terrified of it. And in 2012, that was part of why I 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, the streaming market is displacing the

1:10:36cable, all of video content consumption in America. That is a way bigger market than the DVD rental business. In a smaller market, still very large, yet smaller market like the DVD rental business, Blockbuster and Netflix fighting it out, eventually became a fight to the death.

1:10:56It's still, even though these companies are so big Amazon video, Amazon's video division and Netflix, like the market is so big, they're 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 and people are like, well, you know, I really want to like, I want to watch Man in the High Castle and I want to watch House of Cards. So like I'm just going to subscribe to both and like they're educating the market, you know.

1:11:26Both ways. So interesting to think about myself in that situation. 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 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 for whatever reason, Netflix is the default for me and it's only when I hit the wall if I can't find anything. Do I go over to...

1:11:51Amazon. 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 going to hit people have been forecasting this, but it hasn't seem to happen yet. Hit subscription fatigue, where it's like, look, I'm not going to do my HBO now and Netflix and Amazon and Disney effing. Like, you know, well, I think we'll have to see. Yeah. We'll have to see where that lands and see what people's comfort number is. Yeah.

1:12:17But it's interesting like to this point like it hasn't I don't think any of these companies have heard one another Amazon is definitely behind in subscribers I think that in the same research report that said that Amazon that Netflix was 15% of internet traffic the amount that you can attribute to Prime video I think is like or Amazon video at all is like less than a third of that interesting the other quick tech theme that we talk about all the time on this show but that this highlighted for me which Den Hill on the latest LP episode is talked about if you make something that people love.

1:12:51It can kind of overcome all sins, right? Netflix kept screwing up so many times about, 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 13 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.

1:13:18All 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 where 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 or spend to create all that risk so then all the marginal revenue goes to them but you know they have high capital cost, 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? Once we have this thing, how can we get the maximum mutilization out of that asset?

1:14:01kind of dives into two points that Ben Thompson of Stratekery 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 100 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 there's 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

1:14:45amortize the cost of that across nearly as many people. And so over time, 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? There's a tons of niche Netflix-produced niche content on Netflix. They just don't spend that much money. I feel like they're really good analytically at understanding what is the ROI in terms of either new subscriber growth or subscriber retention that we're going to get for this piece of content and for something like House of Cards that's going to be so broad-based and reach they can spend $100 million for something like a documentary on

1:15:40There's actually a pretty good like documentary on like the roots of hip-hop on 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 Might have watched that late one night Well, okay, so I'll throw out a little counter argument 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 of tons of people come and sign up for Netflix, it's because they have an orange as the new black that draws in all the people. You know, Netflix's strategy has been to stay away from sports and live and things like that that are not evergreen content.

1:16:28Even though they want to create a green content 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 everybody's coming for. And so, 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 platform. But I felt it would be a failure not to point that out.

1:16:55Okay, I have another one that I've been like almost talking about that I want to I want to actually hit and this is another good strategy thing so Netflix's 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 they amass. 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 they can keep their prices the same

1:17:39and 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. Because 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 they have to spend more, but they just have this amazing characteristic where the product gets better. It's funny, I haven't quite thought about this, but it's a little bit like Uber, right? Like there are a few of these businesses out there that are truly special where you actually have a period in your

1:18:32growth curve where your customer acquisition cost goes down. Now, I don't know, I haven't done the analysis or math to know if this, what you're saying is true about Netflix, but it makes sense, at least intellectually. Like, Uber got to a point, I believe it's now probably their incremental cost of 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.

1:19:01I 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 marketplace or aggregator or platform businesses. When is it that they don't have that good enough?

1:19:31sort of like 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 at subscriber base by 30% year over year, give or take like 1%.

1:19:55basically every year they're growing 30%. Interestingly, the company's extremely data-driven about when to do marketing spend and when they feel it's a good idea to go and spend on customers. I think a lot of this stuff we're talking about is true in the abstract, like the product getting more valuable over time, new big hits drawing people in, but Netflix.

1:20:20based on their earnings reports appears to care about growing 30% you over the year and then flexing different levers to get there. So sometimes they spend more money on content, which for other companies, you could 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 an opportunity to create a superstar show, they go hard into it. If it works and they're going to hit their 30% 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. It's just kind of an interesting way to think about driving the business. And since that's been so constant, it's sort of clear what levers they're moving to accomplish what end. I'm so glad we took like all of this time to dive in the Netflix. Like I at least did not understand this company or its history at all before diving in here despite how nominally ubiquitous it is in Silicon Valley.

1:21:20One 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 as a fangs stock and like what are the fangs stocks? This is great yet another thing we'll link to in the show notes a great tweet today by Benedict Evans at Andrews and 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 also growing pretty quickly. Netflix is way smaller in terms of revenue than these other companies. Also, if less growth, revenue growth in Facebook does, less than Amazon does, we talk about them there one of those five, but it's kind of arbitrary and that's the point Ben is making. I think I've already put my old

1:22:17media, TMT investment baker have back on. I think maybe the justification for that is that 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 going to be. To the extent that they understand their churn rates and their grossed subscriber ads churn and then thus net subscriber, you know, growth or losses.

1:22:43Well, and can forecast that accurately. Like that is an incredibly stable and predictable business and that has value in terms of valuation versus like a, you know, an Amazon, well, prime as a part of it, but like you just bang 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 product, may not. You know, there's just more inherent unpredictability there. Yeah, still feels arbitrary.

1:23:11Sure. Well, that's why we're no longer investment bankers. Is there something worth grading in here? So we talked about grading the spinoff 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 DVD.

1:23:34rental 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 a for strategy f for execution like f minus for execution, but I don't know What's your take? Yeah, 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 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 than other than read Hastings feeling like he, you know.

1:24:24wanted to be, you know, push America and the public into his vision of the future, which was correct. It was just, you know, you just sort of waited a couple of years. Which gets into, 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 pulled 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...

1:24:48Apple usually gets these things right though like when they pulled the headphone jack like they release their pods You know, it's like here is a better alternative the thing is when when the quickster when they did quickster streaming wasn't It was better on some dimensions, but a lot of the content wasn't available. And so 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 they present you with the, if you buy the AirPods, they're amazing. They're way better. Yeah, that's a good point. Carvots?

1:25:22Carvots, mine real quick, I believe on the Zappos episode with Alfred Lynn. We did a Carvout of Justin O'Bern's Google versus Apple Maps. Deep analysis. You're remembering what Carvots were on what episodes? Yeah, man, we go deep. Next level. He did an awesome follow-up this month on the new Apple Maps, and is it now better than Google Maps? Spoiler alert.

1:25:48No. In some ways, if you're interested in forests. Yeah. In some ways, but yeah. Well, with the whole read, amazing work, 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 red hole, Kevin Rose. I used to be like a really big dig nation.

1:26:12fan, I think I watched every episode of Dignation. Yeah, when he was on tech TV, the screen series. Oh, yeah. And then G4. Oh, yeah. Oh, I used to watch that in high school. That was actually that show was like a big part about me wanting to like get into tech. And it was a cable channel like that. I know. Like that was on TV. Longtail content, cable channels, good businesses. I think this probably had a good amount to do with me getting into the tech industry too. I mean, I think 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? The more things change. Yeah. Well, he's got this great podcast episode where Kevin's very into sort of like quantified self type things. I know we don't use that phrase anymore because the way of his sort of passe and you know now it's digital health or whatever, but he's got this

1:27:09sleep PhD researcher on from UC Berkeley who's starting a company. It's absolutely fascinating learning facts about sleep. I think sleep is going to be the thing 20, 30, 50 years from now. I don't know when, but lack of sleep will be treated like smoking.

1:27:25some 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 start to become cancerous, for example. There's just a tremendous amount that sleep helps us repair. And there's another one specific thing that you mentioned that was fascinating was when you take 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 not doing your body, you're not putting your body into the state 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 listen to it and actually has sparked sort of a new area of interest and a set of sort of companies and ideas that I'm starting to look into. Awesome. All right, listeners.

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1:29:33Thank you so much 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 you later.