Netflix's founders wanted to do something akin to Amazon in the video rental market. Neither Blockbuster nor Hollywood Video had shown interest in online rentals, but Amazon might. There was also the problem of VHS inventory, the medium of the day, costing $65 - 80/tape, along with high mailing costs. Then came DVDs and a $2 million backer. The founders decided their selling point would be boasting of the world's largest selection of DVD movies. Though they lacked industry experience, they found that in the president of the Video Software Dealers Association at a Las Vegas trade show - he owned 10 video stores and had just started a side business building Web sites for video rental stores. Netflix went live 4/18/98, receiving over 100 orders for 500 discs; they had 1,500 titles in stock by August (mostly older films). Fortunately, Blockbuster and Hollywood Video refused to stock the new format - giving Netflix an open field. Revenues hit $100,000/month after four months. Another 'gift' - Blockbuster had made a habit of disappointing customers by placing empty VHS boxes on shelves, and a later survey found customers had to return several times to get the (mostly) new videos they wanted. (New films cost $15 each.) Netflix' new recommendation engine instead tried to make recommendations that took into account movie availability as well as customer preferences.
Netflix was quite savvy in its intial marketing efforts - random testing various site formats, offers, etc., as well as conducting numerous customer interviews and even going to their houses to watch them use the site. Another ploy - paying a few web-based media taste-makers who periodically mentioned Netflix, a strategy copied from Amazon. They also got DVD manufacturers to put Netflix coupons in their DVD player boxes.
The bad news - Netflix was losing money - assembling and shipping orders cost $6; they were able to get this below $2 further refining their mail groupings to avoid expensive USPS sorts. Overnight delivery boosted acceptance; Netflix improve their ability to accomplish this by adding distribution centers. Their changing to monthly fees (vs. per disc) and allowing customer to build queues of wanted discs also brought very positive responses - volume tripled in three months. Still, the losses continued - $11.1 million in 1998, $29.8 million in 1999. Warner and Columbia studios agreed to lower DVD costs to $3 - 8 in return for revenue sharing, boosting new movie availability by 2 - 3X. Meanwhile, DVD players were rapidly growing in popularity; unfortunately, losses soared to $57.4 million in 2000 and the dot-com crash soured the market for raising more money.
Another early Netflix marketing strategy was competing directly with Blockbuster (20 million active users) in ads and interviews. 'There are 10,000 movies on DVD and we have them all - more than 10X the selection of the largest Blockbuster.' And, 'Everybody hates late fees (a Blockbuster practice) - we never have late fees.'
Meanwhile, Blockbuster tried to diversify against the day when it foresaw rental declining - restaurants, rides, games, clothes, magazines, books, candy, etc., but these expensive hedges all failed. In addition, stores were dirty and their merchandise was overpriced. The year 2000 brought new leadership - Antiocho. Viacom had overpaid for Blockbuster and the stock was going nowhere. Antiocho also got revenue-sharing deals with the movie-makers (60% for it, 40% to the studios) and began guaranteeing movies would be there. Coupons were introduced, along with giveaways and video game sales and rentals. Revenues increased 13%, along with active memberships up 7% after a year. Viacom's stock doubled, but still wanted to be rid of Blockbuster prior to cable-companies' getting volume in their video on demand product. Seventy-some solicitations raised $465 million. Blockbuster, however, only saw the online rental market as at most 3.6 million customers, extending Netflix's 'free ride.' Blockbuster also took a $450 million charge in 2001 to eliminate one-fourth of its tapes and start stocking DVDs. Stock high of almost $30 in 2002.
Over at Netflix, it laid off 40% staff - including the last of those who originally founded and led the company through its first days. A May 2002 IPO raised $82 million. By 3/2003 it had 1 million subscribers. Blockbuster finally took action - funding 4 people with $25 million late in the year to go after Netflix. However, the new venture was set up as a separate entity - it couldn't use Blockbuster mailing list, studio deals, or even mention that id didn't charge late fees; meanwhile, worried Blockbuster franchisees threatened to sue if the new entity competed with them. Blockbuster Online studied UTube videos of Netflix operations, hacked its fulfillment center city locations, and encouraged employee families to drop off Netflix DVDs, act confused and wander around the centers. Netflix then took down its identifying signs and stopped allowing people to look around.
Blockbuster Online's Beta test was practically identical to Netflix.com; Netflix's stock was at $5 in mid-2002 after news leaked that WalMart planned to compete (didn't do well, eventually closed down). Up to nearly $40 in early 2004. Blockbuster's Online debut set back Netflix stock to its IPO level of $15. The new site employed 750,000 lines of code, 500,000 Web pages, and was backed by 25,000 titles and ten distribution centers. But, Blockbuster stores were not linked to each other or Blockbuster Online. Blockbuster did away with late fees after repeated tests found it built their customer base. At that point it had less than $400 million in revenues, and the stock was down to $9. Carl Icahn's threat of a takeover diverted attention from Netflix and their own Online - he took three board seats; the firm was sued for some franchisees not honoring the 'No late fees' ads, and many others discouraged customers from using Online (corporate threats and incentives followed). Netflix, for its part, cut rates 18% to undermine a threatened Amazon entry into U.S. markets - it already was in the U.K.
Direct download was appearing on the scene but hampered by a slow Internet, the low quality of received video, and the extra step required to move the downloaded video from the Internet to the TV.
Blockbuster 'integrated' is video mail rental (Online) with stores by enclosing free rental coupons allowing recipients free rentals at Blockbuster stores. This brought a substantial growth in business, but also large advertising and operational losses. It was a war of attrition vs. Netflix, ultimately lost by Blockbuster because of the $1 billion debt taken on when it left Viacom. Antioco then resigned in a squabble with Icahn over his bonus payment; his replacement returned to failed policies - late fees, stocking extraneous items (eg. pizza, iPads, DVD players) and killed the promotional that was undercutting Netflix. Bankruptcy in 2010, then bought by Dish Network; at its peak in 2009 it had almost 60,000 employees - now about 15,000.
September 2011, Netflix announced plans to structure its DVD rental service as an independent subsidiary company (Qwikster), separating rentals and streaming. Extreme negative reaction (eg. would double IT complexity) led to dropping the plans. Stock dropped from $300 to about $65; now is at $87.
Netflix is now USPS' biggest customer and consumes 35% of bandwidth during evening hours. Icahn subsequently has called his Blockbuster investment his worst (lost 98% of about $191 million), failing because of too much debt, too many stores, Netflix's better business model, Redbox kiosks (12,000 when Blockbuster folded), picking the wrong successor to Antioco. He also admits that 'things might have turned out differently' if the blowup with Antioco had been avoided. Icahn now owns about 10% of Netflix. Stay tuned -