Netflix didn’t screw up

Sep 26, 2011

A Netflix co-founder applauds Reed Hastings, even as Wall Street and customers pillory him.

By Marc Randolph, contributor

Netflix CEO Reed Hastings announced last week that the company would be splitting off its DVD rental service into a new business to be called Qwikster. Last time I checked their blog post on the subject, there were 27,183 comments. Approximately 27,181 of them were negative.

Wall Street didn’t approve of the move either, and the stock is now trading at less than half the price it was two months ago. Even my own friends are sending me puzzled notes, wondering if the “wheels are coming off the cart."

They are all wrong.

Not only am I completely in support of what Netflix (nflx) is doing, but I think it is one of the smartest, most disciplined and bravest moves I’ve ever seen.

Just to be clear, I haven’t worked for Netflix for years. So I have no inside knowledge of what specifically led to this particular decision, I haven’t talked to anyone there about it. Everything I know about it I picked up from the same sources you did.

Nonetheless, I understand what they did and why they did it as completely and thoroughly as if I had been sitting around the conference table myself. Plain and simple, this move was all about focus. Relentless focus. A focus that has been deeply embedded in the Netflix DNA since day one

Here’s an example of what I mean.

When Reed and I launched Netflix in 1998, it was a very different company from the one you know today. The Queue, Unlimited Rentals, and the No-Due-Dates-No-Late-Fees model were still more than a year away. Our rentals were standard a-la-carte rentals. They had due dates. We charged late fees.

Oh... we also sold DVDs.

In fact, we sold bucket loads of them. So many, that by the end of our first summer, I would guess that 95% of our revenues were coming from the sales of DVDs. Although this did pay some bills, it was obvious to us that this was not a sustainable business. It was inevitable that at some point in the near future we would have Amazon (amzn) entering the DVD business. And then Walmart (wmt). And then just about every mass market retailer in the country. All of which would have crushed our margins and slowly but surely driven us out of business.

Not only that, but even while the going was good, it was hard not to let the tail wag the dog. Despite knowing that the true future of the company was rental, it was hard not to spend time focusing on the area of the business where most of the money was coming from.

Most importantly, by trying to run a business that did two things well, we inevitably were forced to make an endless series of compromises that resulted in us doing neither of them well. Our landing page and sign up flow had to accommodate two different paths. Our checkout process needed to handle two types of transactions. Our shipping process had to accommodate two different types of products (one that had to come back and one that didn’t). Our content system had to accommodate titles we could only rent, ones we could only sell, and ones where we could do both.

In hindsight, it seems like such an obvious decision to stop selling and focus on renting. But wow – for a young CEO like myself — turning away from the source of 95% of our revenue was just about the hardest thing I had ever done.

Needless to say, it worked. Not only did walking away from 95% of our revenue have a way of focusing the mind on the remainder of our business, but the benefits began showing up everywhere – even in places we never suspected.

By freeing our designers from having to create a sign-up flow that accommodated two types of business, we were able to cut out steps, clarify instructions and simplify the process. Conversion went up.

By spotlighting a narrower benefit, we were able to clarify our positioning, resulting in more effective external marketing. Our acquisition costs went down.

By focusing on a narrower set of problems, it made engineering much more productive. It made QA testing simpler. It made metrics more intuitive. And it paved the way for us to implement a process of rapid iteration and testing that ultimately uncovered the big innovations that ultimately led to the Queue, Unlimited Rentals and No-Due-Dates-No-Late-Fees.

The success emboldened us and we gained confidence in this approach, each time finding that narrowing our focus expanded our opportunities. I could probably come up with 150 examples, with each new success giving us renewed confidence in the benefits of folding partially successful hands in order to double down on more promising ones.

At every product meeting, in addition to figuring out what to do, we made sure to devote time toward deciding what not to do. We referred to it as “scraping the barnacles," and, like boat owners, found that if we had the discipline to regularly remove all the small things that inevitably accreted to our hull over time, it would have a noticeable effect on how fast we could move through the water.

I suppose it’s only fair to mention at this point, that not everyone liked our decisions to get rid of these “barnacles.” For example, since early on nearly 3/4s of our customers were buying DVDs from us, it probably is safe to say that they were none-to happy that we stopped selling them. Ditto for the customers who loved renting a-la-carte only to see us drop it and focus on the all-you-can-eat program. While I’m at it, I’ll throw in an apology to the tens of thousands of other early Netflix customers who were part of price programs, feature test, and other business experiments that we ultimately decided to discontinue. But as hard as each decision was in the short-term, I never questioned whether it was the right thing to do for the long-term success of the company.

So even though I haven’t been at Netflix in a long time, I can easily imagine the growing frustration they must have felt these last few years as they made decisions they knew were suboptimal for the streaming business in order to maintain compatibility with the DVD business. How to work out pricing that covers multiple use cases. How to come up with messaging that embraces two different ways to receive movies. How to manage the significant differences in the content available between the two services. How to simplify the landing page and sign up flow.

Well no longer. Not having to worry about compatibility between the services makes it infinitely easier to optimize every decision around the real prize, which is clearly streaming. Pricing. Messaging. Content. Sign-up-flow. All better now.

Are customers upset? Undoubtedly. And I’ll be the 27,184th to say that the communications surrounding both the price increases and the Qwixter launch were ham-handed, tone-dea, and have unquestionably damaged the brand. But should fear of either of these things have prevented Netflix from taking this step and ensuring that their streaming service has every possible advantage going forward? Absolutely not.

In his blog post, Reed apologized for not communicating well, not for having made the wrong decision. I agree with him on both counts.

But what is truly mindblowing, is that when I was CEO trying to screw up my nerve to walk away from selling DVDs, I risked alienating tens of thousands of customers. Reed is showing that he has courage and conviction to do the right thing despite having tens of millions of them.

This is why this guy is the best entrepreneur on the planet.

Marc Randolph (@mbrandolph) is a veteran Silicon Valley entrepreneur, high tech executive and startup consultant. Most recently Marc was co-founder of the online movie and television streaming service Netflix, serving as their first CEO. He blogs at www.marc

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