That Definitely Worked

I just finished reading Marc Randolph’s memoir of the early days at Netflix called That Will Never Work. I should start by coming clean. Marc is a friend. He was an early Context client and, being a truly intellectually curious traveler, he and his family have done tons of tours with us over the years. I’ve also been a big admirer of Netflix from beginning and have learned a lot about entrepreneurship from speaking with Marc and watching their moves.

So, maybe it’s no surprise that I loved That Will Never Work. Marc’s a good storyteller, and the early days of any company are full of stumbles, miscues, and mistakes that make for great reading.

One of the big surprises in the book (spoiler alert) is that the oft-told story that co-founder and current CEO Reed Hastings dreamed up Netflix when he racked up exorbitant late fees from the VHS tape he’d rented is just that—a story. It sounds good and makes a good origin story, but the truth is more prosaic. Reed and Marc invented Netflix in tandem as they carpooled from Santa Cruz to their jobs in Silicon Valley. Reed was the skeptical, analytical guy; and Marc was the creative, shoot-from-the-hip guy. Marc was in charge of coming up with ideas, while Reed was in charge of testing them. While they wound their way through California traffic each day Marc would throw out ideas for new businesses, and Reed would tear them apart.

The list of early ideas is pretty funny: customized baseball bats, personalized shampoo by mail…. When they finally hit on renting DVDs there were a lot of reasons to think it wouldn’t work. (The book’s title comes from the reaction of Marc’s wife, Lorraine, when he pitched her.) For one, DVDs had just been invented. Few people owned a DVD player, and video stores didn’t stock them. When Netflix launched in 1998 there were less than a thousand titles in existence.

Origin stories are great, and a good business needs a great idea. But what interests me a lot more is what comes next: the execution, and how founders have to be nimble, creative, and at times both fearless and crazy to address the curve balls and challenges that come up. Thankfully, about 90% of the book deals with this stuff.

Killing Your Darlings

One story in That Will Never Work really resonated with me. After a couple of years of operation Netflix realized that most of its revenue came from selling DVDs, not renting them. At first you might think, so what? Revenue is revenue. Who cares where it comes from. But it bugged Marc and the rest of the team. The core thesis of the business was renting, and they believed that the rental business had a bigger moat around it than selling (i.e. It would be harder to replicate.) Indeed, their problem acquiring customers for it probably underscored this. Selling DVDs, conversely, was easy. It would take very little time for a real retailer—let’s say, um, Amazon—to start selling DVDs and completely eating market share.

But it wasn’t clear how to get rentals working. So, they huddled and brainstormed and churned through dozens of ideas—mostly bad ones—until they hit on three things that, in retrospect, seem so obvious but at the time were considered pretty nuts. The first was to let people rent four movies at a time. In one fell swoop this squashed one competitive disadvantage they had against video stores: Now their DVDs would already be in the customer’s house and there would be zero waiting for the next movie. (I leave Netflix’s culpability in causing binge watching for others to assess.) 

Secondly, they built a queue called Marquee, in which a customer would list all the DVDs she wanted to see. As soon as she returned one, the next would be sent, which meant that she didn’t have to come back to the site and rent a new one. It lubricated the repeat process, which is gold in a business, and as a result created a firehose of movie content, constantly streaming (long before actual streaming) into the customer’s DVD player.

And, lastly, they priced this all as a subscription model, doing away with a la carte renting. Of course, there were plenty of customers who  loved a la carte renting, and were pissed that they now needed to shell out twenty bucks a month just for access to Netflix. But, in the end, these were all magic bullets that propelled the company down the path that it’s on today.

That Will Never Work

For the last several years, in addition to investing in other successful companies Marc has been advising entrepreneurs. It’s no surprise that That Will Never Work is packed with all sorts of useful advice about staying focused, being fearless about tough decisions (like killing a la carte rentals and pissing off a handful of customers in the short term to the delight of many, many more over time), and spending a lot of time on culture and people. There are a lot of good lessons about the latter, including picking a topnotch HR lead. In the case of Netflix, this was Reed’s doing when he brought in Patty McCord, an HR superstar who developed Netflix’s signature policies like unlimited vacation (which Context copied).

For me—and maybe this is due to where I’m at currently in the lifecycle of an entrepreneur—the most useful lesson Marc offers is about the importance of humility, and how as a founder sometimes you have to sublimate your ego for the greater good. For Marc, the story is pretty crushing.

It began with Reed popping into his office a few years after launch and clearly laying out how he thought Marc was mismanaging the company—replete with slide deck! Unsurprisingly, Marc got pretty pissed. But, once he cooled down and thought more deeply about what Reed had said, he began to agree. He doesn’t say this, but maybe the slide deck actually helped him organize his thoughts. In any case, he came to the realization that his skills were really well suited to the super early days when you have to scrappy, when people forage for furniture at the Salvation Army and sleep at their desks. But, Netflix had moved beyond that stage at this point and was maturing; and while Marc was a fine CEO, he believed that Reed would be an absolutely fantastic one, especially for the next phase, which would eventually include an IPO and immense scale. So, he took a demotion (and a haircut in options!) in order to put himself into the number two seat after occupying number one.

Wow. I don’t know if I could do this; and, I seriously doubt many could. But it was the right move. In the end, Marc spent the last half of his tenure at Netflix occupying the second position, from which he played a super strategic role as a partner to Reed and whisperer within the company on everything from culture to operations to vision. It’s unusual story, and doesn’t fit the common, ego-driven, hero narrative that we’ve come to expect from Silicon Valley. But, guess what. It worked. And, in a big way.