Introduction

It was back in the VHS days of 1997. Reed Hastings was in his study, caught in deep thoughts. Recently he had bought a movie for rent. He had misplaced it somewhere and had attracted a late fee of $40. This greatly annoyed him in many ways. First, he had no way of telling this to his wife without making himself look like an idiot. Second, it was annoying to accept the arrogant business model of the firm, which rented the movie.

He could see at the back of his mind, that there was an opportunity in this situation. As he started investigating the possibilities of movie rental business, he was introduced to the DVD technology by a friend of his. Though the technology was still very immature, the potential seemed to be huge. He decided to test his idea.

Reed went to California and mailed the DVDs to his home address and rushed back home. Within 24 hours he received them in mint condition. He knew he was onto something. In August 1997, Reed launched the website of Netflix. By the day of the launch, Netflix had employed 30 employees and made 925 works available for rent.

Who is Netflix?

Silicon Valley is known for disruptive innovations. There are a handful of stories of technological and business excellence that emerged from this part of the world. Netflix is one of those players who believes in disruptive, innovative methods of management and has been practicing them to great effect.

Netflix was established as a subscription based digital distribution service. Despite challenging economic conditions and presence of giants like Blockbuster, Walmart and so on; Netflix has become a leader in the internet streaming and DVD by mail services.

Just to put the massiveness of Netflix’s business on the internet into perspective, they contribute to 28% of the aggregate network traffic in all of North America! Netflix is also a huge contributor to the open source community.

When one looks at the speed at which Netflix has grown since 2005, it is evident how effectively the firm has managed to scale up to the massive change. The subscriptions have raised from around 4 millions in 2005 to 50 millions today. Although there is skepticism about Netflix lately, I think the company is still serving the customers just as well.

History of Disruption

Netflix was founded in 1997 in California by Marc Randolph and Reed Hastings. They started off with a traditional rental services, served through web site. Business model was the traditional rental model charging $4 per rental.

The early sign of innovation in Netflix showed up when they dropped the traditional rental model to make way to a subscription based model in 2000. This was the beginning of flat rate unlimited rentals without due dates, shipping & handling fees or late fees.

They launched a promotional offer in partnership with Toshiba America, to give away three DVD rentals to the customers who bought Toshiba DVD players. There were many more revenue sharing and other models which Netflix used to good effect.

In 1998, Netflix sold 10,000 copies of president Bill Clinton’s testimony in Monica Lewinsky case for 2 cents per copy. Now, that is smart marketing!

Another point to note is how new the DVD technology was. No seller sold DVDs in their store. By targeting such a market so early, Netflix managed to build a strong subscriber base later. They had to conduct over 200 mailing package experiments before settling for a safe shipping option. They even offered new DVDs at a discount of 30% during the initial days.

Innovative HR Management

Background

Reed Hastings had founded a company before starting Netflix venture. Pure Software was a successful company in terms of technological feats. But, Reed Hastings’ experience with Pure Software was this – as they tried to systemise everything, with more employees joining in, things started going wrong. The perfect procedures they had devised were far too restrictive and killed the culture of innovation. The company became increasingly bureaucratic. When he founded Netflix, the idea was not to fall into the perfect procedure trap.

Policies

Hire “A” Players, Tolerate And Reward Them

Patty McCord, ex Chief Talent Officer of Netflix, who co-devised the HR strategies of Netflix says that hiring excellent colleagues to work alongside your employees is the best thing you could do to motivate them.

Most companies spend large amount of resources in writing and enforcing HR policies to deal with the problematic 3% of their workforces. Netflix, try hard not to hire such people instead.

One of the major advantages Netflix has achieved by their hiring policy is a mature workforce. Their workforce communicates openly with the bosses, peers and subordinates.

Leave Policy – Use as Many as You Need

Employee maturity has also helped them have a lean set of policies. Take for example, unlimited paid time off. Netflix has adopted the informal, unlimited PTO policy with minimal set of guidelines. Managers and employees are expected to work out the leave plans between themselves. The hourly workers have more structured policies. Finance and accounting workers are guided to plan their vacations not to jeopardise the quarterly peaks. Leaders are advised to walk their talk by taking vacations and publishing the details.

World’s Smallest Expense Policy(Probably)

They could also do away with the formal travel and expense policy. The policy is just five words long – “Act in Netflix’s best interests.” and encourages the employees to spend company’s money as if it is their own. There were exceptions where some employees spent more than expectations, but with clear expectation setting and some talks, they could get most employees to comply.

Performance Evaluation

Netflix follows no formal performance review cycles either. The trouble with performance review cycles in most companies is that they are like rituals and not frequent enough. Often employees tend to get the feedback at the end of the cycle as if it were a verdict and can not do much about it in the current cycle. Instead, employees and managers are advised to treat conversations regarding their performance as an organic part of their work. The idea is to eliminate the fear of litigation.

In Netflix, non-performing employees or employees with irrelevant skills are asked to leave with a generous severance package without too much red tape. This eliminates the long processes of Performance Improvement Programs which usually still end up in the termination of the employee.

A more informal 360° feedback was devised. People just need to identify what each of their colleague should start, stop or continue. Initially they were anonymous. Later, many teams have started doing it face to face.

Also, there is no culture of a comparative evaluation of the workforce. This type of evaluation which puts people on various ranges of a bell curve, often promotes competition between the employees. This internal competition is not the ideal way to gain best organisational results.

Promotions are awarded on two conditions.

• First, the job has to be big enough. Just because there is an incredible manager in a team does not necessarily mean there is a need for a director there.
• Second, the person in question must be a superstar in his existing role.

Building High Performing Teams

Netflix strives to find the best people and create a strong team with them. One thing that has helped them to achieve such hires is the compensation policy. On top of being one of the most attractive salary payers, they let the employees choose their pay components. For example, an employee can decide how much of their compensation should be covered by stocks. There are no vesting periods. The idea behind this is to eliminate the “Golden Handcuffs”. There is no point in holding an employee hostage by means of compensation tricks when they want to work for someone else.

More importantly, the managers are scrutinised less on their coaching or reporting skills. Their most important performance criterion is recruiting high performing teams.

Creative Culture

In Netflix, employees are encouraged to be creative irrespective which function they work for. There is no penalty for making errors as long as they are not about critical customer data or erroneous financial report. However it is highly expected the that the errors are addressed and resolved rapidly.

One example of creativity at Netflix is how their customer service employees are encouraged to be themselves. In 2013, a Netflix support member called Mike made it to mainstream news, won a visit to their headquarters and an iPad mini, just for being himself. In a regular company, enacting the persona of a Star Trek character while at a support job, is going to attract disciplinary action up to termination. But in Netflix, the employee was recognised for this. The rewards were personalised and inspiring too.

Employee Retention And Compensation

Netflix’s goal is to pay each employee at the top of the market for that employee. To achieve this three tests are recommended. They are

• Pay more than any other company is likely to pay.
• Pay as much as a replacement would cost.
• Pay as much as you would pay to retain them, if they had a better offer.

Creative Business Models

Background

When Netflix came into the market, all the major players were dealing with physical stores for renting VHS. This is an example of physical landlord business model. This seemed to be an appropriate model till 2000, when broadband penetration was very low. Beating competitors like  Blockbuster, was not easy. Netflix tried to find other models to build its business.

Business Models

Focus On Newer Technology

Netflix recognised that VHS was an ageing technology. Sensing this opportunity, alternatives were evaluated. As a result, the business model was devised around the newer technology of DVDs. With this came the challenge of gaining market. It was clear that Netflix would not capture a profit making market as quickly as it could have, if it had gone with the traditional market. But, in the long run the move paid off and Netflix has become one of the market leaders.

Better Ways To Rent

The disruption in the delivery of rental services was phenomenal. While the competition still operated in physical store model, Netflix embraced the technology for its services by going with an online rental service. It clearly identified the customer inconvenience and addressed it. This helped Netflix in controlling the costs, which were used creatively in its pricing strategies. It also helped them in the years to come to expand their reach without much fuss.

Pricing

The competition was charging customers on a per day or per week basis in 1997 when they entered the market. There were high late fees beyond the designated rental periods. Netflix decided to change that and offered unlimited duration rentals at a fixed fee. This model was possible because of the costs saved with the online operations. In all the communication channels, customers were heavily educated about this model.

Partnerships

Since DVD was a nascent technology still, finding customers who would want to rent DVDs was not easy. Netflix managed to partner with top makers of DVD players like Toshiba and Sony early on and provide special offers to their customers.

Newer Models Of Delivery

Ever since the broadband penetration has significantly increased, Netflix has quickly pivoted its business model. Now their focus is on the streaming content instead of DVD rentals. This lays down a good foundation for the future source of revenue. It has already shown better results in the past two years, while players like HBO seem to be playing catching up.

The turnaround of 2012

Background

2011 was not a great year for Netflix. They suffered a major loss of subscribers. The main reason was the decision to spin off a separate subsidiary called Qwikster for DVD delivery business. Qwikster was not only to take up the business, but was also allowed compete on pricing with its online streaming function. As a result, the stocks went down significantly and Wall Street experts had started predicting a demise of the company in the near future. But in the year of 2012, with some smart moves, Netflix managed to bounce back strongly.

Strategic Moves

Invest Into Transitions

Netflix knew that the DVD business was ageing. But they had to build the streaming business first before killing DVD business. So, Netflix started diverting the income from DVD business into the development of fast growing, but low margin streaming services. This enabled them to grow the revenue while still making the transition from DVD business from streaming successfully.

Most companies value their core business so highly that they are reluctant to adapt to the market changes. This may happen due to various reasons, like the lack competency in the new approach, dominant logics or blind spots. But Netflix could overcome all these to grow its future business. They were able to add 2 million streaming subscribers for every 400,000 DVD subscribers.

Kill Products That Are Not working

Netflix successfully forecasted the change in the market and did their planning. The focus was on capturing the growing market than just optimising and sustaining the existing market which was destined to slow down in the future.

Strategic Vision Instead Of Tactical Moves

Netflix made major investments into Big Data technologies around 2011. This was done aiming at providing a better viewing recommendation to the users. This helped them in improving the user experience, and driving the long term growth rate higher. Other than this, they also made significant headway in providing very highly available services to customers with their streaming servers deployed in the Amazon Web Services cloud.

Create Own Content

When Netflix was renting DVDs, they could buy the DVDs at any retail store and rent them to their customers. But in case of streaming, the story was different. They had to bargain for the licenses with the makers of the contents. But the bargain position of the company is much weaker in this case. There was not enough incentive for the owners of digital videos to carve a deal with Netflix.

While they are still trying to deal with these tough negotiations, Netflix are creating their own content for streaming. The shows like House of Cards and Is the New Blade have been critically acclaimed and have contributed to the growth of business. This also reduced the immediate dependency on the owners of digital videos by some margin. Their expertise in Big Data analytics greatly helped here. They were able to analyse the viewing pattern and design their contents effectively.

Results

Netflix could turnaround the story very quickly by these moves and the subscriber base started growing again. The below chart represents the growth rate observed in the period. In addition to this Netflix successfully made a transition to a newer business model of streaming videos.

Conclusion

The business models of Netflix have been innovative and have disrupted the industry norms multiple times. Their human resources policies are also in line with their reputation for out of the box thinking. The slides that were published by Netflix about their culture has gone viral. There have been so many discussions about it all over the place. But, not many companies have followed the suit to implement those ideas in their own organisations.

The reason could be, there are some challenges in applying these innovative new principles into practice.

Hiring “A” Players

This is indeed a great advice for any company trying to compete with the industry leaders. But, the challenge is the cost associated with it. Most companies cannot afford the top of the market pay these A players demand. Most companies typically try to stay at 75 percentile on this front. This usually does not attract the top talent. Hence, most companies still prefer to hire the average employees and train them to be experts in their day to day jobs. So, hiring the top talent is ideal only if

• You have resources to compensate them
• You are competing in a highly competitive, creative, ever changing market

More Focus On Results Than Behaviour

This is a type of leadership that is recommended only when you have a workforce which already knows what to do. This can happen in two ways.

• By hiring the perfect fits
• By extensive training

As discussed in the earlier section, hiring the perfect fit often involves high costs which most companies cannot afford. Hence they may resort to second option of training and then setting result oriented goals to the employees.

Another prerequisite for result oriented leadership is the organizational context is well set for the employees. Therefore, the companies who have not invested enough to communicate organisational goals and values better not take up this strategy.

I think this where Netflix shines. They hire top players to find better fit for the job. They care to set the context more than setting up controls to get things done. Hence this strategy of result orientation goes well with their culture.

Minimal Policies

This again is an approach that treats the employees as full grown, sensible adults. This does save a lot of maintenance costs of the huge policy documents and their enforcement. But the contention is that, not all kinds of businesses can afford to allow this. For example a bank cannot live without a clear cut leave policy. Also, if your firm is running on a tight budget, it is hard for you to tolerate odd cases of excessive spending. These situations invariably lead to policies and enforcements.

The other assumption is that the employees are indeed responsible. This can happen only when you have built your culture in line with such employees already, and you hire only those people who perfectly fit your culture. This again points out the ability of Netflix to be consistent with their culture from all angles. That is the reason why a “no policy” policy works well for them.