Netflix (Part 1)

In a world ravaged by late fees and lack of rewinding, one man two men from a sleepy California beach town make a stand against tyranny, daringly dethrone an evil empire and… oh who are we kidding, they just copied Amazon’s business plan for books and applied it to movie rentals. But as always there is much more to the story than that! We dive into the fascinating, true, and oft-untold history of Netflix in our first two-part special on Acquired. Part 1 covers Netflix’s original DVD rental business from founding to 2009, and next time on Part 2 we’ll cover the (rocky) transition to streaming from 2010 to present. Buckle up for a wild ride! Sponsors: Vanta: https://bit.ly/acquiredvantaServiceNow: https://bit.ly/acquiredservicenow26Legora: https://bit.ly/acquiredlegoraStatsig: https://bit.ly/acquiredstatsig26 More Acquired! Get email updates https://www.acquired.fm/email with hints on next episode and follow-ups from recent episodesJoin the Slack http://acquired.fm/slackSubscribe to ACQ2 https://pod.link/acquiredlpMerch Store https://www.acquired.fm/store! © Copyright 2015-2026 ACQ, LLC Links:Netflix’s original logo https://vignette.wikia.nocookie.net/logopedia/images/4/41/NetFlix_1998_logo.jpg/revision/latest?cb=20120213032242Carve Outs: Ben: The Good Place https://www.netflix.com/title/80113701 on… Netflix! David: The Broken Earth Series https://www.amazon.com/gp/kindle/series/B01NGTJDSR/ref=st_kb_B01947LZ8A by N. K. Jemisin

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Rosenthal?

  Yep. It's so funny. All the reviews of the iPad, people were like, you can't hook up USB storage to the iPad. I'm like, I haven't used a USB thumb drive in like five years. I don't care.

• 0:14Ben Gilbert?

  My biggest complaint is the lack of scuzzy.

• 0:22David Rosenthal?

  That's a teaser quote right there.

• 0:35Ben Gilbert?

  Welcome to season three, episode eight of Acquired, the show about technology acquisitions and IPOs. I'm Ben Gilbert.

• 0:43David Rosenthal?

  I'm David Rosenthal.

• 0:45Ben Gilbert?

  And we are your hosts. Today, we are talking about a company that somehow, somehow, David, we have not covered on the show yet, Netflix. And we're breaking this one into two parts. Today, we'll be covering the founding of the company up through the IPO and the waning years of their DVD business. And then next episode, we'll pick up at the takeoff of streaming and original content. So David, I could not believe this when diving in that the Netflix IPO was 16 years ago and it was founded 21 years ago.

• 1:14David Rosenthal?

  Yeah, crazy. All these fang companies, they're getting old.

• 1:19Ben Gilbert?

  I know. I mean, I just, I did not realize that it was a pre.com bubble. In my head, it was sort of like Facebook era, not Google era or Amazon era.

• 1:27David Rosenthal?

  Well, this is why we have to do this as a two parter because, you know, when we first started researching this, we didn't think of it that way. But like, there really are two different companies here. There's Netflix pre-streaming and Netflix post-streaming. We're going to cover the pre-streaming today.

• 1:44Ben Gilbert?

  Well, listeners, we announced on the last episode that we had formally launched the Acquired Limited Partner Program. And we've been totally floored by how many of you have joined our LP community and are listening to the bonus show. So if you'd like to join us and get an extra episode in between every normal Acquired show, you can click the link in the show notes to join and support the show for $5 a month or go to kimberlite.fm/ acquired. That's K I M B E R L I T E dot FM slash acquired. On last week's bonus show episode, we talked about the elusive concept of product market fit and the practices, structures, and mindsets that successful companies do differently before and after this stage. All right, listeners. Now is a great time to tell you about a longtime friend of

• 2:26Ben Gilbert?

  the show, Vanta. AI has scrambled the whole security picture. It used to be that you prove that you were secure once a year on audit or a static PDF, then everyone would nod and you're done. But in an AI-first world, that doesn't hold up anymore.

• 2:41David Rosenthal?

  Yep. Your risk surface changes every week now. A vendor turns on an AI feature, or someone writes in a new model without telling IT, and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote-unquote "shadow AI" running with no security review at all.

• 3:02Ben Gilbert?

  Right. And that's where Vanta comes in. They're the leading agentic trust platform, meaning they've built the thing that closes the gap. And the way that they close that gap is Vanta Agent. Think of it as a GRC engineer, that's Governance, Risk and Compliance, except that it's software and it doesn't sleep. It finds the issues, drafts the fixes, and cuts the time that you'd spend on vendor assessments in half.

• 3:24David Rosenthal?

  In half! Which is exactly why more than 16,000 companies today run on Vanta. Companies like Ramp, Cursor, and Snowflake all stay audit-ready and catch the risks that crop up between audits across every vendor, every AI tool, the whole environment.

• 3:42Ben Gilbert?

  And that's the real value. Trust has to be continuous now, which is why Vanta automates your security, your compliance, and the work to earn and prove trust. We're huge fans of Vanta over here, and literally hundreds of Acquired listeners have become Vanta customers at their companies over the years. So you can get $1,000 off Vanta at vanta.com/acquired. That's V-A-N-T-A dot com slash acquired for $1,000 off, and just tell them that Ben and David sent you. All right, David, you're ready to take us in with the acquisition, I suppose the IPO, history and facts.

• 4:17David Rosenthal?

  Well, there will be lots of acquisition offers back and forth as we go here, but...

• 4:21Ben Gilbert?

  There were, which I didn't know until I started reading, uh, Dave and I both read this, uh, there's a great book.

• 4:27David Rosenthal?

  By Gina Keating called Netflixed.

• 4:29Ben Gilbert?

  Netflixed.

• 4:30David Rosenthal?

  Yeah. This is really fun. When we were discussing what episode to do for this one, we were like, okay, we're getting kind of towards the end of season three. We want to do like a big, important splashy episode. Let's do one of the Fang companies, Netflix. I thought, you know, Netflix seems pretty straightforward. Like Reed Hastings, like very solid dude, you know, is for sure. But like, you know, it doesn't seem controversial. Like this seems pretty straightforward. As always with these companies, once acquired shows up on the scene, there is so much more to the story.

• 5:03Ben Gilbert?

  There is. All right. Stop teasing us and go in.

• 5:05David Rosenthal?

  All right. All right. Okay. So as we mentioned upfront, this is part one. We're going to cover Netflix from founding through about 2009 on this episode. Part two, next time, we're going to go 2010 to the present. But let's start with the founding. So as I was alluding to, most people know or think they know the founding story of Netflix. Nothing too controversial. It's the classic Silicon Valley startup story. We go back to 1997. A successful, former enterprise software guy from Santa Cruz, of all places, is fed up with movie rental late fees. These are the VHS days still. And kind of sees the power of the coming wave of the internet,

• 5:49David Rosenthal?

  sees Amazon that's taking off, sees the potential to disrupt bricks and mortar retail, and starts what would become Netflix and becomes himself, you know, paragon of Silicon Valley statesman. Of course, I'm talking about Mark Randolph. Not Reed Hastings.

• 6:09Ben Gilbert?

  This is a true statement, the illustrious CEO of Netflix.

• 6:13David Rosenthal?

  The illustrious CEO of Netflix. There's, I texted Ben when we started researching this and reading Netflix. The parallels to Tesla here are like unreal. It's pretty awesome.

• 6:24Ben Gilbert?

  So Mark Randolph, the reason that is true is he was the CEO of Netflix for the first year while Reed Hastings was finishing up graduate school at Stanford.

• 6:33David Rosenthal?

  Yes, but really he was the founder and CEO of Netflix. I think it was closer to two, but I'll have to go through my notes here as we, as we dig through.

• 6:41Ben Gilbert?

  Let me give you two other wild Mark Randolph facts from his background. One is that he helped to found Macworld Magazine.

• 6:48David Rosenthal?

  Yes.

• 6:49Ben Gilbert?

  Love that. And two is he is currently on the board of Chubby's Shorts.

• 6:54David Rosenthal?

  Yes, yes. And Looker, I believe, data analytics tool. And Looker actually came out of Netflix, I think, which would make sense. Okay, so here is the official story. If you listen to Reed Hastings, if you listen to Netflix, the official founding story, the lore. We're going to give you that, then we're going to tell you the true story. So official story, Reed Hastings, he has been a successful technology entrepreneur in the enterprise space. And he has an epiphany for what would become Netflix. He's returning an overdue movie to his local video store. Now, originally, the version of this story that he would tell is he was returning it to a Blockbuster. That gets changed not to a Blockbuster after a lawsuit between Blockbuster and Netflix.

• 7:37Ben Gilbert?

  And you know how your founding story can just change?

• 7:39David Rosenthal?

  Yes, just change.

• 7:40Ben Gilbert?

  Can just not, it just changed whether it was true or not.

• 7:43David Rosenthal?

  We've seen this many times. So he's returned the movie to the local video store. And he's so fed up, he comes up with this magical subscription model alternative when he's on a treadmill at the gym. This isn't just like, Lord, like I'm actually here, I'm going to quote from Reed Hastings saying in print to Fortune Magazine in 2009. Quote, "The genesis of Netflix came in 1997 when I got this late fee, about $40 for Apollo 13." Remember Apollo 13? So good.

• 8:11Ben Gilbert?

  Great film.

• 8:12David Rosenthal?

  "I remember the fee because I was embarrassed about it. That was back in the VHS days and it got me thinking that there's a big market out there. I didn't know about DVDs and then a friend of mine told me they were coming. And I ran out to Tower Records in Santa Cruz, California and mailed CDs to myself, just a disc in an envelope. It was a long 24 hours until the mail arrived back at my house. I ripped them open and they were all in great shape. That was the big excitement point."

• 8:39Ben Gilbert?

  Another, another fun element on this story is the reason that he talks about being on the treadmill is because he, he also talks about how gym memberships, you pay monthly, whether you sort of use it or not. And he was like, oh, I can totally apply that. It was like the very same day that I was upset about my late fee for Apollo 13, I happened to be going to the gym later, thinking about their business model. And it's like this completely convoluted, apocryphal story invented purely to explain like, what is the Netflix business model and what was the opportunity to be found?

• 9:08David Rosenthal?

  You know, we, we've talked about this a bunch on the show, but like, I actually don't think there's anything wrong with this. Cause especially in the early days of a company, you need to communicate your value prop and stories are how you do that. So,

• 9:20Ben Gilbert?

  Yeah. And something like this happened. It just wasn't as clean.

• 9:23David Rosenthal?

  Yeah. So, okay. What's the real story? One note, as we dive in here, it is helpful to be familiar with Bay Area geography when discussing Netflix. So for those of you who are, you will intimately understand this. For those of you who aren't, we will try and guide you along the way. So it was 1997. Reed Hastings was involved, but as also of course was Mark Randolph. And they knew each other because they worked together at a company called Pure Atria, formerly Pure Software in Sunnyvale, California.

• 9:58Ben Gilbert?

  Which merged with Atria.

• 10:00David Rosenthal?

  Which merged with Atria. Yeah. So what was, what was this company? It was a publicly traded company. It made bug detection software for developers. Tools company then.

• 10:10Ben Gilbert?

  We should also say, this was Reed Hastings, he founded this company also. He founded Pure Software. And for Reed, this was his second job. He did a job for three years and then decided, I'm going to start a company. David, I don't know if you're, are you going to touch on his, his background before starting Pure?

• 10:28David Rosenthal?

  Not really. Not really. So go for it.

• 10:30Ben Gilbert?

  All right, so Reed Hastings is like an unbelievable human being. So he went to school to join the Marines and ended up dropping out instead to completely flip tracks and join the Peace Corps. And after he finished the Peace Corps, went and took his first job, then his, his second job was starting Pure.

• 10:49David Rosenthal?

  And in between, he did a master's in CS at Stanford. I think he went to Bowdoin undergrad on the East Coast. But yeah, that's, that's how he got out to the valley.

• 10:57Ben Gilbert?

  So he's running Pure. It's going well. It was sort of predicated on a, a simple notion that he had around building a better debugger. He's starting to amass a large team, you know, they're, they're taking all this money. They're getting ready to go public. He tells the board, hey, I want to not be CEO of this company. I, I've never been a manager, you know, it's kind of like, I think for the benefit of myself and all the other shareholders, we really should get a CEO. The board says, no, you should remain CEO. And he ends up basically learning on the fly and then, you know, successfully manages to both IPO this company and then merge it with Atria.

• 11:30David Rosenthal?

  Such like the opposite of what was usually, what boards were usually doing in the day and age, which was firing CEOs as soon as they humanly could, or firing founders. Okay. So as Ben alluded to, Pure Atria at this point is publicly traded. It's basically a roll up. They'd acquired Atria, they'd acquired a bunch of companies that are all in the space. They're rolling up and consolidating. Randolph, Mark Randolph, had been at one of the small companies that Pure Atria had acquired. And after the acquisition, he, Reed, uh, kind of takes a liking to him and he gets promoted. He becomes head of marketing for the whole combined company. So they're working pretty closely together. So it's 1997. One final piece of this roll up is happening though, and that's the biggest piece, which

• 12:14David Rosenthal?

  is there's a huge merger that's about to happen between Pure and Rational Software, which is the biggest competitor in the space. They've just announced they're going to merge, public to public merger. It is actually going to be the largest merger in Silicon Valley history at that point in 1997, valued at just under a billion dollars. Yeah. Cute, cute, just under a billion dollars.

• 12:38David Rosenthal?

  And Reed Hastings is finally Going to get his wish. He's going to be fired as CEO, not fired, but he's, he's going to be redundant. He's not going to stay with the company. Neither is Randolph.

• 12:48Ben Gilbert?

  And it's interesting to note here, Hastings is really bummed about what has happened to the culture. And it's important to think about as we talk about Netflix later. Hastings says that pure, like a lot of these other companies went from being a heat filled, everybody wants to be here place to a droneish, I'm quoting here, when does the day end sausage factory? And he says, we got more bureaucratic as we grew. And, and his thinking at that time is whatever I do in the future, when the next thing I have to start, we have to think of systems so that we don't end up like that.

• 13:17David Rosenthal?

  Yeah. And that will come back into play. Reed is about to become hugely wealthy, like he's still very young, hugely wealthy. And, and his plan is to basically ride off into the sunset. He's reapplied to Stanford, this time to do the graduate program in education, which is a fantastic program. By the way, a lot of people do GSB and the education masters jointly. Reed's going to go do this one year grab program in education with the intention of he's going to become an education focused philanthropist for the rest of his life. Randolph, though, he, he's not so, you know, not about to become so wealthy. He, he has to keep working. So he decides what he wants to do is he wants to start a company and he really admires Amazon, which is public at this point, been around for a few years.

• 14:01David Rosenthal?

  And he thinks that there's a really good opportunity to do, just like Bezos was thinking, he was looking at all the categories he could attack. He chose books. Randolph thinks, well, I can just choose another category and run the same Amazon playbook. And it just so happens that in addition to working together, Reed and Mark both live in Santa Cruz. So this is, I said, Bay area geography is going to become important. Santa Cruz is a sleepy little university slash beach slash surfer town over the Santa Cruz mountains, which separate Silicon Valley. The valley is on the inland side of the mountains from the Pacific Ocean. Santa Cruz is on the ocean side. The mountains are awesome and it's beautiful, but like they're very high and it is very remote. Like if you live in Santa Cruz, you do not live in Silicon Valley.

• 14:46David Rosenthal?

  And it takes about an hour to commute back and forth, but just. Like the whole vibe is like beach town, surfer town, not, not, you know, everything we think of as Silicon Valley. So as a result, Reid and Mark are often carpooling together back and forth between Sunnyvale, where Pier is based, and Santa Cruz. And so Randolph just starts like spitballing ideas with Reid during their car rides. He's like, what about this category? What about that category? What about that category? And he's convinced he wants to do this. So he starts a shell company. He calls it Kibble Inc. Because the idea is get the dogs to eat the dog food. So Kibble, Inc., dog food. Yeah. Anyway. He starts a shell company. They're spitballing stuff. He starts thinking about, as Ben alluded to, he'd worked at Macworld.

• 15:29David Rosenthal?

  He had also worked in the direct mail industry. That's how he got into marketing. He's presumably, we don't know this for a fact, but because of that, very familiar with the AOL, Prodigy, CompuServe, customer acquisition techniques that I think we've referred to in the past of just mailing out tons and tons of CDs to potential customers. I mean, how many AOL CDs did you have mailed to your house back in the day?

• 15:54Ben Gilbert?

  Oh, my gosh. And the best thing was every time you'd go to like a movie theater or something, there'd just be another box full of them at the desk.

• 16:01David Rosenthal?

  The whole country in like, you know, when would this been? Like 95 to 99 was just saturated with AOL coasters.

• 16:09Ben Gilbert?

  I'm going to fill somewhere now. Well, the important thing that I want to say about Randolph here is basically his background, you know, before Puratria, he's a publishing guy. He knows the publishing industry inside and out. And kind of stacked on top of that, he's a data and analytics guy, which didn't really exist in meaningful form. You know, there was no digital data and analytics then. So he was frequently tasked with things like surveying audience and trying to understand who are our readers. His philosophy, as he's spitballing a lot of these different ideas here, is thinking about, how can we automatically, probably through the user interface of some product, build a data and analytics suite?

• 16:48Ben Gilbert?

  And how can we build sort of intelligence into the UI to automatically do things that make the experience of consuming better? It's funny to see all these different threads that become massive pillars of Netflix today that are in sort of the backgrounds of these founders.

• 17:04David Rosenthal?

  Like you said, those become the pillars of Netflix from Mark Randolph's history and background to Netflix today. So inspired by this, he hears about this coming new video format called DVD. It's just, just getting launched. It's in the, the movie studios and electronics manufacturers are just rolling it out. It's being launched in a few test markets. And of course DVDs come on optical discs that are the same form factor as a CD. And so Randolph's like, oh, well, maybe we can mail these things. So they do go, he does go to a local record store, not Tower Records in Santa Cruz, buys a CD, goes to a gift card, buys a very like large like

• 17:49David Rosenthal?

  birthday card and stuffs the CD in it and mails it to Reed Hastings' house. The next, you know, day or two, when they're meeting to commute together, Reed's got the mail.

• 17:58Ben Gilbert?

  Is it gonna come?

• 17:59David Rosenthal?

  Yeah, he's got the envelope and he's like, it came. It's fine.

• 18:04Ben Gilbert?

  Dude, this, this blew my mind when I read this story. Today, when we think about the old Netflix, we're like, oh man, it started in that era of DVDs as if it was so long ago. It started before DVDs and they had to proxy, like, can we mail DVDs by mailing a CD? Because neither of them had ever touched a DVD before when they had this idea. I mean, talk about like being on the very tip of a wave and then, and then sort of riding it the whole way. Like they were betting that DVD was going to succeed and that, because they evaluated would this work with tapes and they were like, nope, shipping costs are too high.

• 18:36David Rosenthal?

  Shipping costs are too high and just logistically, like you gotta store them and catalog, like the CDs are tiny, although not as tiny as bits. So Netflix, it's, it's born, it's off to the races. So, so what happens? Reed is like, great, I'm going off to Stanford, but I've got all this money. I think I'm going to dabble in angel investing. I'll fund this company. So just like Elon did with Tesla, Reed leads the first round of funding in Kibble Inc., which in a little bit becomes Netflix. Reed invests $2 million. Randolph becomes the CEO. Reed is just an investor and on the board. They recruit the initial team, they set up. Their first office in Scotts Valley, which is still on the Santa Cruz side of the mountains, just a little bit north of the town of Santa Cruz.

• 19:21David Rosenthal?

  And the idea is, yep, we're running the Amazon playbook, except instead of attacking Borders and Barnes and Noble, we are attacking Blockbuster. It turns out that unsurprisingly, it's actually a pretty good idea. So the home video industry at this point is now bigger than box office for film and television, or I guess mostly film at this point. It's enormous and the rental segment, so there's both sales and rental of home video. The rental segment is completely dominated by Blockbuster. There's Hollywood Video and a few others, but like Blockbuster is the 800 pound gorilla.

• 19:56Ben Gilbert?

  I want to quote the S1 here because for entrepreneurs out there who are listening, the moral of this story is you never get to stop justifying your market size to investors. It's going to be in your seed pitch deck, it's going to be in your A pitch deck. And the second paragraph of the S1, and when Netflix goes public, the first paragraph describes what they do, the second paragraph is in 2001, domestic consumers spent more than $32 billion on in-home filmed entertainment, representing approximately 80% of filmed entertainment, blah, blah, blah, goes on to talk about exactly what David just said, that the largest portion is rental. I was reading the S1 and I was just chuckling that like the story at any stage is always the same, what do you do? Why could it be huge?

• 20:38David Rosenthal?

  Because you're TAM.

• 20:39Ben Gilbert?

  Then how are you differentiated? Yeah, like just, it never ends.

• 20:43David Rosenthal?

  The more things change, the more they stay the same. Quick aside, because I think there's an important point here. This whole business of movie rentals is in the first iteration of Netflix's business and the Blockbuster business is enabled by a Supreme Court ruling around copyright law of what's called the first sale doctrine. And it basically says that once you buy a copy of any copyrighted work, whether that's a book or a movie or whatever, you can then do whatever you want with it. You can resell it, you can rent it out, like it's yours, you have then cleared the copyright. That was established well before any of these businesses, but the important point in here is that like regulatory issues and lobbying and getting regulatory issues favorable to your business are very, very important.

• 21:24David Rosenthal?

  Like Silicon Valley now knows that, but for a long time forgot that. And like this whole industry is enabled by a Supreme Court ruling.

• 21:32Ben Gilbert?

  And fortunately, in a very sort of Bezos way, where Bezos always credits the infrastructure that was laid before him that allowed the company to exist, the internet, UPS, et cetera. Like, you know, this wouldn't have been possible if what they had to do was go and lobby and get laws changed at the outset. Infrastructure had been been laid for them.

• 21:52David Rosenthal?

  Go vote. It's important. Hopefully you already voted in these elections.

• 21:57Ben Gilbert?

  Yeah. I assumed that they had to pay some form of royalty back to the content holder every time they rented it. I mean, then Blockbuster, like before Netflix comes along and you're just fat and happy Blockbuster, that's kind of an amazing business. I mean, you buy this little store, it's not that big of square footage. You pay 15 to $18 or whatever for a movie, and then you rent it out for what, like $3? $3? And you run it 50 times or something? It's an awesome business.

• 22:23David Rosenthal?

  It's the same business as scooters today. You know, you buy a scooter for 300 bucks, you rent it for a couple bucks per ride, and you do thousands of rides, and that's a good business.

• 22:33Ben Gilbert?

  All right, listeners. Now is a great time to thank our longtime friend of the show, ServiceNow. If you are running a large enterprise, AI agents are likely spread across every team, and deploying them is no longer the hard part.

• 22:47David Rosenthal?

  Yeah. The hard part is knowing what permissions they have, what employees are using them for, or what decisions AI is making. AI security for an enterprise at scale is not a small concern. Like, the risks are real.

• 23:01Ben Gilbert?

  Exactly. And the challenge with AI is governing it, securing it, measuring it, and making sure that it actually delivers value. That is why ServiceNow built the AI Control Tower.

• 23:11David Rosenthal?

  Yep. AI Control Tower gives enterprises a single place to see, manage, govern, and optimize AI across the entire business. And it works with any AI, not just theirs. Every device on your network, every permission across every system, every AI agent, visible and secure in one place.

• 23:29Ben Gilbert?

  And ServiceNow can do this because they've spent more than 20 years building the operational backbone of the enterprise. The workflows, governance, approvals, security controls, and institutional knowledge that power how work actually gets done across IT, HR, customer service, finance, and security.

• 23:45David Rosenthal?

  ServiceNow already runs more than 100 billion workflows annually and trillions of transactions for more than 85% of the Fortune 500. So when companies need a place to govern AI at enterprise scale, they're building on a platform at the center of how their business already operates.

• 24:02Ben Gilbert?

  And in a future that isn't going to be one AI, it's going to be thousands of AI agents working across every function of the company. But the question is, who's managing them all?

• 24:11David Rosenthal?

  So 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/acquired and tell them that Ben and David sent you. Okay, so they're getting started. Randolph goes to a conference in Las Vegas, the Software Video Conference. He meets a guy named Mitch Lowe, who's going to come back into the story later. Mitch owns a 10-store video rental chain, small rental chain in Marin County, just north of San Francisco, again, Bay Area geography. This is about as far on the opposite end of the Bay Area as you can get from Santa Cruz. We're talking like two and a half hour drive with no traffic. Mitch is entrepreneurial. He owns these video rental stores, but he's also working on a software tool, a CRM tool for video rental stores. And Randolph's

• 24:56David Rosenthal?

  like, oh, man, you are like the industry expert. Like, I need you to come in and like, join the team. He eventually persuades him to do so. I assume Mitch then moves from Marin to Santa Cruz because you cannot do that commute every day. But he joins as the video acquisition chief. So he's now going to be in charge of like, inventory and stocking and like, what DVDs Netflix is going to buy. And so it's kind of just like Stitch Fix like that we saw there, like, getting that early industry DNA on the team like, really has a big impact. Together, they and they'd hired a couple people from Pure, a couple folks that they'd worked with in the marketing department there. They all said on the settle on Netflix as the name. And Ben texted me the original logo. We're gonna have to tweet this and link to it in the show notes. Let's just say you don't want enterprise marketing people designing your consumer

• 25:41David Rosenthal?

  product branding and logo.

• 25:45Ben Gilbert?

  I think, I think show notes can be a full HTML, so we'll just try and embed this image in the show notes. If you swipe over or tap over to it, it is awesome. And the best thing is it was

• 25:54David Rosenthal?

  used for three years.

• 25:55Ben Gilbert?

  It was 97 to 2000. And you know, Netflix on their next rev kind of nailed it and is basically the same logo they use today, except with a little bit of a nice brand refresh. But like, the, the first one is it's got this little like swooshie thing and it's very late 90s.

• 26:12David Rosenthal?

  Yep. So it's purple. It's bad. It's bad. Okay, Netflix. So what did they do? This is, this is brilliant. And I think this was driven by, by Mitch Lowe. DVDs are just getting launched. Like they're like, most people don't have it. Player machines don't exist out there. How did they do like, get their initial customers, do initial customer feedback? They, they borrow a page, future page from Xiaomi. They go online into product discussion forums of enthusiasts for like movie technology and like DVD product forums. And they just start talking about Netflix there. And like, people love it.

• 26:50Ben Gilbert?

  Things are like 600 bucks. Like getting a DVD player was like, ooh, I'm buying a Cadillac.

• 26:54David Rosenthal?

  Like over a thousand bucks at this point.

• 26:56Ben Gilbert?

  Geez.

• 26:57David Rosenthal?

  In 1997 dollars. So like, the people who are buying these things are super techie, super early adopters, like the perfect market to adopt Netflix and give, you know, feedback here.

• 27:08Ben Gilbert?

  Isn't it 640 by 480? Like it's, there's not a lot of pixels.

• 27:12David Rosenthal?

  Like, yeah, I think that, I think it might even be less. Like, you know, it's for show research here, we didn't even go back and watch DVDs. Like, I don't, I don't have a DVD drive anywhere. I don't know if you do, like.

• 27:24Ben Gilbert?

  No, I sold my old Xbox and I have no, I actually have no means to play any discs.

• 27:28David Rosenthal?

  Yeah, me neither. Well, wait, stay tuned for part two. So they officially launched the product in April 1998. And remember, they've been building all this momentum and, you know, early customer lists from these product forums. And it's just like, they nail it. Like, the market is still tiny, but like, talk about product market fit on day one, the servers crash, there's tons of demand.

• 27:54Ben Gilbert?

  You could buy DVDs from them, right?

• 27:57David Rosenthal?

  Yes, you could both buy and rent. Yeah.

• 27:59Ben Gilbert?

  Yeah. I mean, the magic that they came up with was the business model of rather than paying per DVD, you just pay a certain amount and then you can either keep two or keep three, depending on what, what plan you opt into. But I didn't realize when they started, you could also just order DVDs from them and pay for them and keep them.

• 28:16David Rosenthal?

  Yeah, totally. Well, that part of the business is going to come up again in one sec. The other perfect part of the timing here is like the consumer electronics manufacturers were so powerful this time. We're talking Sony, Toshiba, Panasonic, like all these Japanese and some US, I forget which ones are US companies. Anyway, like these guys are dominant. They're so, and, and they know that DVD machines, like that's their next drug that they're going to sell US consumers. So they're pushing it hard. Best Buy is pushing it hard. Circuit City is pushing it hard. Netflix goes and they do deals with these consumer electronics manufacturers to get Netflix promo coupons inserted into the boxes with DVD players. Like, talk about an awesome distribution hack.

• 28:59David Rosenthal?

  Like, it doesn't get any better than that. And this was a big part of their customer acquisition for many, many years. And it works like amazingly. The, the only downside is they're giving away a free month of Netflix as the promotion. That ends up coming back to bite them in terms of that cost them a lot of money, which we'll see in a sec. Blockbuster, while all this is going on, they're initially like, oh, DVDs. That's like, nobody's going to use that. Like, you know, we're just going to stick with VHS.

• 29:29Ben Gilbert?

  It feels short sighted to me in a different way than we normally rip on big companies that get disrupted. Like, if you were to tell Blockbuster at that time, streaming video on the internet will be the thing that ends you. Like, it's not that surprising for me that they would scoff at that. And like, it just didn't feel like, it just felt like that was too far away and would people actually do that? And, but like, just switching the size of the box and like, switching to a thing that plays videos better. And like, come on, all electronics come down over time. How, how could they not believe that this was going to be a big change for their business?

• 30:06David Rosenthal?

  Well, okay. Let's be really fair to Blockbuster here. So I went into research here thinking Blockbuster, oh my God, these guys are idiots. Like this is like, you know, classic case of corporate hubris, getting disrupted. Not the case at all. Blockbuster management, until the very end is, we'll see, is actually super competent and like really good. And the reason here that they didn't go into the market as fast as Netflix is there was a format war. So DVD and Divx were battling it out against one another. And it wasn't clear in the beginning who was gonna win.

• 30:38Ben Gilbert?

  Whoa, I forgot about Divx.

• 30:40David Rosenthal?

  Yeah, Divx.

• 30:42Ben Gilbert?

  That's like way lesser known than even like Betamax or HD DVD or any of these alternatives.

• 30:46David Rosenthal?

  It was the Betamax of the optical disc era. So Blockbuster was kind of waiting on the sidelines to see what would happen before they made the big bet and threw their weight behind it. Netflix bet the company on DVD over Divx. I don't know why. Maybe they just were like, oh, DVD, we'll go with that. But fortunately, it worked. So that's-

• 31:05Ben Gilbert?

  And Divx ended up becoming like a digital, like a, not stream, but like, it was like a-

• 31:09David Rosenthal?

  Yeah, it was like a file encoder format and-

• 31:12Ben Gilbert?

  I used to have like a Divx player on my Mac that I could like play Divx files if I was downloading them from the back of a truck somewhere and...

• 31:23Ben Gilbert?

  Oh, the early 2000s.

• 31:25David Rosenthal?

  So Blockbuster isn't in the DVD game yet. Netflix is the only game in town. They've got promos in all the boxes with the players that are shipping. The first four months after launch, they do 20,000 rentals. They're already at a million dollar revenue run rate. Like, that's super impressive. Even today, like startup you launch here at a million dollar revenue run rate, four months in, like, super impressive.

• 31:48Ben Gilbert?

  And super capital efficient, considering they were buying all these DVDs. Like, I can't remember, what did they, they had only raised the money from read to date, right?

• 31:55David Rosenthal?

  Yeah, only the $2 million. Well, capital efficiency, yes, yes, yes. But with all this growth, like, they are just burning huge, like, like, they're, they're, they're really in a rock and a hard place. Because they have to buy the DVDs. That's capital efficient. But the operations, this is why giving away those free rentals, the free month of rentals, which is gonna end up being a couple, like- They have to package these things in mailers. They have to ship them. They have to do all the labor to do that. They have to do the customer support. It gets really expensive to operate this. And the more you grow, the more expensive it gets. They realize that the, Netflix actually had this perverse aspect of their business model in the DVD streaming era,

• 32:36David Rosenthal?

  that their very best customers who use them the most, cost them the most money. So they realized pretty early on.

• 32:43Ben Gilbert?

  Before the streaming era?

• 32:44David Rosenthal?

  Before, oh yeah, before the, in the DVD era. Because if you're constantly rotating discs in and out, you're costing Netflix a lot of money in operations to do that. So they, they figure out that they need to funnel customers to really obscure niches of like back catalog titles. Because those don't turn over as much. Like, I might really love some like random thing. It's unlikely somebody else does. So I'm gonna rent that, keep it for a long time. And then I don't have other demand for that, that unit. So that's how they start working on the recommendation algorithm and the personalization. As a result, it's not big new releases that drive Netflix in the early days. It's the back catalog.

• 33:23David Rosenthal?

  So Bollywood movies become huge. And this is funny. Softcore pornography becomes huge, as with all video formats. The aphorism that pornography drives innovation, also true here. It's gonna come back in a sec. So they raise a series A. There is a $6 million series A from IVP in August 1998 to finance all of this. Reed is still finishing up at Stanford. He's just the investor, the angel investor. He's just on the board. He's not super involved. Once he finishes his masters, he gets into, you know, education philanthropy as he wanted to. He also starts this thing called TechNet,

• 34:01David Rosenthal?

  which is a lobbying group for the technology industry. It's still the largest tech industry lobbying group. I didn't realize Reed Hastings started it, like, pretty cool. So he starts that. He's running that. January 1999, a couple of things happen. One, there's some, Reed is very liberal in his politics and other people in tech, at least at that point in time, and still weren't. And they were like, you're running this lobbying group. You're very liberal. Like, I'm conservative. Like, this should be more bipartisan. So Reed ends up leaving TechNet. He wants to get back into the entrepreneurial game. He's like, oh, Netflix, my angel investment is kind of working. I'm gonna go spend some more time there. He basically just shows up and announces like, okay, now I'm gonna be co-CEO with Randolph

• 34:41David Rosenthal?

  here. And Randolph is apparently not super happy about this, but like, you know, the company's growing. So and Reed is great. So like, everybody kind of gets along. And they initially divvied up that Randolph's gonna be in charge of marketing and content acquisition. And Reed is gonna be in charge of engineering and ops. This is where Reed really starts building like a world-class technical team, technical and ops team at Netflix.

• 35:07Ben Gilbert?

  I think this is the time when they actually name their algorithm, the Cinematch, and they start having a company-wide metric around what percentage of the long tail of the DVDs are we actually successfully managing to get people to use their, use one of their slots on?

• 35:22David Rosenthal?

  Yep, yep.

• 35:23Ben Gilbert?

  Obviously, we'll get into the Netflix, the challenge way later. But this is really when it starts to become really, in a lot of ways, pioneering modern data science and data engineering.

• 35:33David Rosenthal?

  Yep. And remember, they're still in Santa Cruz and Scotts Valley at this point. So Reed shows up, and he's like, okay, a few things need to change around here. So, one, even though they just raised this Series A, they're still burning cash so fast because they're growing so quickly. They realize they need to fundraise again really quickly, or like, do something, or they're gonna go bankrupt. So the first thing that the board and Reed and Mark think is like, ah, we should, maybe we should just sell the company, like, do a quick flip here. They, and who would be the natural acquirer? None other than the inspiration for the company, Jeff Bezos. So the two of them fly up to Seattle, they

• 36:14David Rosenthal?

  meet with Bezos. This is, this is 1998 still, I believe. Bezos is like, oh, you know, this is interesting. Okay, Amazon is public, they've made some acquisitions at this point. Bezos is like, I'll give you $12 million to buy the company, which I assume must have been right around the post-money for, or maybe even less than the post of the raise that they just did. Netflix is like, come on, like, no, we're not gonna sell the company. But how about we do a cross-promotion deal with you guys, where we've got this business where- Or selling DVDs. We're realizing that that's not super core to our subscription model. How about we give you that? So whenever anybody on any Netflix customers want to buy DVDs,

• 36:59David Rosenthal?

  we'll just kick them over to Amazon to buy DVDs. And in exchange,

• 37:02Ben Gilbert?

  I think this happened to me once.

• 37:04David Rosenthal?

  Oh, really?

• 37:06Ben Gilbert?

  I'm now like recalling, it was in that era of Amazon doing these weird partnerships like when

• 37:10David Rosenthal?

  Yes, Toys R Us and Target and all that. Yeah.

• 37:14Ben Gilbert?

  Yeah. Oh, man. It's crazy imagining Amazon today doing some gigantic co-branded corner of their, their store like that.

• 37:22David Rosenthal?

  Serious? Well, especially given what we'll see in part two with Amazon and video. So in return, Amazon is going to advertise Netflix on the homepage. Remember, this is the era of portals and Yahoo.

• 37:34Ben Gilbert?

  Which is now the most valuable real estate in technology.

• 37:38David Rosenthal?

  Crazy. So that happens. On the back of that, they start fundraising. And as they go out to fundraise, Reed is like, okay, like, I'm the successful past entrepreneur here. I'm going to take over as the only CEO. I'm going to do this fundraiser.

• 37:49Ben Gilbert?

  Need to be the face of the company. Come on, investors at this point need to bet that I'm going to do it again.

• 37:55David Rosenthal?

  Yep. He also, he's like, and we got to move out of Santa Cruz. We're going to move to Silicon Valley. So they compromise. They move to Silicon Valley, technically, but they move to Los Gatos, which is like as far south as you can possibly get in Silicon Valley. So probably another 30 plus minutes south of Palo Alto and Mountain View, I would say. And Netflix is still there today and lots of people, especially as the company's grown, now live in San Francisco and work in Los Gatos and spend two hours a day on 101 commuting. Incredible.

• 38:27Ben Gilbert?

  This is a good time. So it's a pretty special company to work for. When you think about, why do people do this two hour commute? I'm actually not sure when this notorious deck started in its first revision, but the Netflix culture is extremely unique. In the early days, and I don't know if the early days was right around this time or even earlier, Hastings decided that he needed to be able to communicate to new hires all the ways that they were very different and very opinionated in a culture. And he wanted to preserve this in a way that would scale because it didn't at his last company. To illustrate the point, there's two interesting things that I'll mention from Netflix's culture, one of which is that Hastings doesn't ever refer to it as a family. It's not welcome to the family. The more appropriate analogy is a sports team that we don't have unconditional

• 39:10Ben Gilbert?

  love for each other. We have conditional love. We have really high standards and it's a really high performing team. And to the degree that in a family, you can sort of love someone even if they're not an amazing employee on a team, you don't. The second tidbit is that out of respect for everyone else on the team, they hold every seat to a really high regard. And so you you will be let go from the company if you are not performing really well. And it's not because they're punishing you for that or anything. It's out of respect to everyone else who is still at the company because they deserve to work with an A player. And they say, they take the burden on this and say, we're extremely generous with severance, but we're extremely opinionated that, you know, you need to be an extremely high performer to have that seat. Otherwise, you

• 39:54Ben Gilbert?

  need to make it available for someone else out of fairness. I've always thought like, the way that all this is sort of like phrased and they came up with this is so both opinionated and thoughtful and every little detail considered. Now Hastings has released the deck on SlideShare and I think it might be like the number one viewed deck on SlideShare.

• 40:15David Rosenthal?

  Many years ago, it was released on SlideShare and it's still like, yeah.

• 40:19Ben Gilbert?

  Yeah. And so like, it was this internal thing that they evolved over and over and over, and then finally decided we should make this available for public consumption because it's a great recruiting tool. I mean, for the right set of people, like

• 40:28David Rosenthal?

  That's why they did it, yeah.

• 40:29Ben Gilbert?

  It's moth to a flame. Yeah. Yeah. So one of the things that makes them different.

• 40:32David Rosenthal?

  You see Reed's personal history and shaping reflected in this culture, like as all companies, right? Or like, like my partner Riley at Wave is, he always says, like, company cultures are like reflections of pure reflections of the founder, you know, personalities. And, you know, Reed is a guy who was in ROTC, was going to join the Marines and then instead did the Peace Corps and then, you know, went to Silicon Valley and became an engineer and then a CEO and then a philanthropist. Like, it's just all like, this dichotomy like baked in there. Very cool. In addition to all of those things, he is also a fundraising machine. Remember, he has orchestrated the largest merger in Silicon Valley history at this point. So basically every VC, and this is

• 41:17David Rosenthal?

  before the dot com crash, they're like, oh, Reed Hastings, you're raising like, how much money can I give you? He raises, within a few months, raises $100 million.

• 41:28Ben Gilbert?

  Or rephrased from our last LP bonus show, how large of a percentage ownership can I have in your company?

• 41:35David Rosenthal?

  Yes, exactly. And I don't care what the check size is.

• 41:38Ben Gilbert?

  Right.

• 41:39David Rosenthal?

  He raises $100 million, mostly from TCV. And we'll see, TCV ends up being an enormous shareholder in Netflix and IPO and several other firms. One of the first hires he makes after becoming full CEO of the company is acquired superhero who has showed up in, in at least one other episode.

• 42:00Ben Gilbert?

  Spotify episode.

• 42:00David Rosenthal?

  Probably many more. Barry McCarthy, who he hires as CFO of Netflix and Barry becomes critical to Netflix's success. And then does his short detour at Klinkle before going to Spotify.

• 42:15Ben Gilbert?

  Yeah. Fast forward through that or DVD skip through that. So Barry's fame from folks who have listened to the Spotify episode is that he's the guy who sort of conceived of and then executed the plan for the direct listing where Spotify did not actually issue new shares at IPO. They had a direct listing.

• 42:35David Rosenthal?

  Huge, huge hire. As well as several other folks, they hired Tom Dillon from Seagate to run ops for the company. Remember ops is super important here. And then together, this new leadership team, like they all kind of figure out like, sort of similar to Amazon and Prime, that delivery speed for rentals, movie rentals, DVD rentals, when you order them is huge. And that the faster they can get from you clicking a rental online on Netflix to getting the DVD in your mailbox, that drives customer loyalty, that drives retention, but most importantly, that drives word of mouth and organic distribution. Like when you click rent.

• 43:13Ben Gilbert?

  It's kind of a magical experience.

• 43:13David Rosenthal?

  And you get, remember this is, yeah, 1998, 99, you get that DVD in your mailbox the next day. You're going to tell all your friends.

• 43:22Ben Gilbert?

  It's funny like how archaic it feels now because now I'm like, how could it not be, you know, actually instant? But I am remembering, I'm trying to think what year it was, probably 2000, it was the summer of 2008. Because I was doing my internship in North Carolina for Cisco and my roommates and I did a Netflix plan for our apartment. Because none of us were 21 yet. And so we were like, what do we do every day after work? And so we just got a really fat Netflix plan. And like, it was pretty amazing that like, we'd hear about a movie from a friend over the weekend. We'd like click the button and then we were watching it Tuesday night and sometimes even Monday night. And it's like, it's funny to describe that as a magical experience, but it totally was.

• 44:03David Rosenthal?

  And this is all thanks to Dylan and McCarthy and Reed and then the rest of the company, of the company, of course. But they figured this out and they realized that this is the key, one of the key levers to their business. So they started building distribution centers, not just like randomly like, oh, we're going to build them in big cities and geographical density. They start like, they get really analytical about it. Like, where's our customer base? Where's it growing? Where are our word of mouth hotspots? Let's build distribution centers close to them and get these DVDs to them as fast as possible and grow demand kind of organically this way. Also helps them better manage inventory, everything. And then of course, this leads to the recommendation algorithm becoming super, super important.

• 44:44Ben Gilbert?

  Did you ever manage your Netflix queue? I'm like remembering old features now that were like critically important to the service. Did you, were you, were you a subscriber back then?

• 44:52David Rosenthal?

  No, I subscribed way later. I'm not, I don't watch a ton of movies. So it was, I was not in the target market.

• 44:59Ben Gilbert?

  I remember being obsessed and actually comparing my queue with friends. There was two things that were important to like compare with friends. One was like all my ratings. I'm like a completionist. When Twitter was not algorithmic, I tried to read every tweet. And I think I did between like 2009 and like 2017. And so like, I tried to like rate every movie I'd ever seen and find it on Netflix and rate it. And like, I had a group of friends that totally prided themselves on doing that and being very opinionated about each of these movies. And the other thing that I definitely remember is I built up this huge queue that I was constantly adjusting of like, which movies were going to be sent to me when and like, how much did I want to prioritize moving something through the queue? And I thought, I mean, both of those systems were just genius because they were, I know Netflix wasn't measuring engagement,

• 45:41Ben Gilbert?

  but engagement ended up being a proxy for how long am I going to stay a customer? And like, both of those things like lit up my brain in all the right ways of, oh, I have to go and update this piece of data on Netflix.

• 45:52David Rosenthal?

  And lay the groundwork for Netflix today and streaming. One real quick funny aside, I mentioned pornography being a big part of Netflix in the early days. Reed in 2000, he gets appointed to the California Board of Education. He's like, um, we need to get out of this pornography thing. So let's just, let's just, that never happened. So another thing you will never find in Netflix history, but did drive a bunch of their growth in the early days. Okay. It's 2000, growth is great. Everybody's high-flying, high-fiving. They got an A-team, you know, built at the company. They filed to go public. McCarthy's going to take them public. They have 120,000 subscribers.

• 46:31David Rosenthal?

  They're shipping 800,000 DVDs a month. Everything is great. But then the dot com crash happens before, before they can actually get out and get public. They postponed the IPO. But again, they're still growing. And again, as they grow, they're burning all this capital, so much so that they've burned through the $100 million that they've raised. Fortunately, the existing investors were so excited before the IPO, they wanted to buy in and get more of the company and get a pop. They invest another about $50 million before the IPO and before the crash. Turns out to be super necessary capital. But the crash happens and like, they're like, I don't think we can survive. Once again, they try and offload the company and sell it. This time not to Amazon. They go to Blockbuster.

• 47:14Ben Gilbert?

  Blockbuster.

• 47:15David Rosenthal?

  And this is where Blockbuster enters the story. So they go to Dallas where Blockbuster is headquartered, Dallas, Texas. They meet with them and they're like, you know, we need to sell the company. We, you know, we want to sell it for 50 million. Fifty. This company's raised like 150 million at this point. Like, imagine if this transaction had happened. Blockbuster's like, eh, you seem kind of desperate. I don't think so. We're just going to crush you.

• 47:38Ben Gilbert?

  Unreal. Absolutely unreal.

• 47:41David Rosenthal?

  Totally unreal.

• 47:43Ben Gilbert?

  So for the companies that made it through the dot com burst, you look at Amazon, you look at Netflix, you're like, wow, they were really smart, really good capital allocators, were super nimble, were able to make it through this. Like Netflix tried to get out. They were like, look, we'll just cut our losses and go be part of Blockbuster.

• 47:58David Rosenthal?

  Totally. And again, Blockbuster are not idiots. They're, they're really not. Like, they, at this point, see DVDs. Are already in the market and they also see the online subscription business model and how good it is. They're like, this is why they don't buy them. They're like, we could spend $15 million on buying you, or we could spend slightly less than that and just copy you and build you and use the Blockbuster brand. And they build Blockbuster Online, which is a clone of Netflix. And it's really good. Like, you know, initially, it's not so good and Netflix kind of makes fun of them. But like, eventually, like, it gets really good.

• 48:30Ben Gilbert?

  Yeah, like, the website was terrible. There's actually a really good, I recommend, so friend of the show, Cara over at Wondry, they did an episode, or a little series called Business Wars, that was about Netflix versus Blockbuster. And there's some epic episodes in there about Hastings and the rest of the Netflix team, sort of like loading up the Blockbuster site when it first launches and laughing at how terrible the website is and they can't even like-

• 48:53David Rosenthal?

  They got Accenture to build it. They didn't hire their own engineers and like, but they overcome it. They actually make it good.

• 48:59Ben Gilbert?

  I mean, well, think about this. It's Netflix, but if you actually want a video tonight, you can just go return it to Blockbuster and then get a new one, rather than waiting for this whole mail thing.

• 49:08David Rosenthal?

  Well, well, that comes up in one sec. So initially, Blockbuster Online is a true Netflix clone. It's separate, separate business, separate office building from Blockbuster, no attachment to the stores, because they franchise the stores. So the franchisee owner of the stores, they don't want Blockbuster Online to be cannibalizing their business. So that kind of becomes an issue in a bit. Netflix, though, they're like, all right, we can't offload this thing. I guess we're gonna have to soldier through. So they do, this is, we're gonna say these things, but like, I want everybody to like, really think about this. They do a 40% layoff, a 40% riff of the company. Four out of 10 people, they lay off. Remember, just a couple of months ago, they were gonna go public and everyone

• 49:52David Rosenthal?

  was high fiving. Having lived through my first two years in the working world of the 2008 recession, like, I know what this feels like, like- Bad times are bad. Like, we have been in good times for the last, you know, 10 years. Imagine that, like 40% of your coworkers just gone in one day and Netflix does this. But this is what they have to do.

• 50:13Ben Gilbert?

  And the way that they did it too, he called a immediate urgent company meeting. They made this decision. He calls an immediate company meeting and says 40% of you are going to be laid off today. And then people go back to their offices to wait and see if their manager comes to talk to them or not. Harrowing.

• 50:32David Rosenthal?

  Totally harrowing, but managed about as well as you can. And, um, you know, it's just like in times like this, it's either the company's going to die because you're going to go bankrupt or you need to cut the burn. This is wartime, you know?

• 50:45Ben Gilbert?

  And this was also is interesting, uh, reading that Netflix book. The way that Barry McCarthy sort of was looking at this is we need to do this to prepare for the IPO. Not only from a cash burn perspective, like we've got, I think they ended up IPOing with $15 million in the bank. So they definitely needed that, that mezzanine round that they thought was just going to be to, uh, let those investors buy a little extra equity, but it was really about, uh, what story were they going to go tell the street? When they, when they worried about IPO in 2002. Yeah. And, and I think they weren't quite profitable when they IPO'd, but it was, they were on track to be profitable the next year. And, you know, they needed to show that even if they were a very lean organization and they needed to be, to be in this dot com burst era,

• 51:29Ben Gilbert?

  that they could still execute their business.

• 51:31David Rosenthal?

  Yep. And also when it comes to this, I mean, like such kudos to, again, a terrible moment, but like so many other companies would have been like, let's cut 10%, then let's cut another 10% and like thousand cut your way into it. McCarthy and Hastings are like, no, we're cutting to the bone. We're doing it right now.

• 51:47Ben Gilbert?

  This is one example. There's another example we'll get to in this episode. And then there's a third example that we're going to save for the second part of this, this Netflix set. But Reed Hastings and Netflix management are awesome at executing these like, we made a decision. We're going to go hard at it. I know it seems insane, but we have very sound logic for why it needs to happen and it's happening. I'll foreshadow that the next two are related to, uh, either spin offs or spin outs from Netflix.

• 52:18David Rosenthal?

  Indeed. Well, okay. The next year, May 2002, they finally do the IPO. This is still nuclear winter for the tech world, but they need the cash. They've gotten to profitability. They're like, we're just gonna do it. We're gonna go public. They raise $82.5 million in their IPO at a market cap of just over $300 million. So they sell over a quarter of the company in the IPO. I mean, like, can you imagine that these days? It's like 7 to 10%, like, you know, like.

• 52:49Ben Gilbert?

  Well, and it's not, they're not IPO-ing for $300 million.

• 52:52David Rosenthal?

  Yeah, I know. I know. Crazy.

• 52:54Ben Gilbert?

  Yeah, I joked to David and I messaged last night like, wow, that's a really nice, nice Series B post.

• 53:00David Rosenthal?

  Yeah, seriously. Seriously. But the business is capitalized and then, you know, they have no debt. They, they, they don't need to raise any more money and they don't. They eventually do take on debt, but I believe not until the streaming era.

• 53:13Ben Gilbert?

  I think they did a tiny secondary the next month and just sold a little bit more in sort of a additional stock offering. But yeah, to your point, nothing meaningful for a while.

• 53:23David Rosenthal?

  Yeah, they're fully capitalized. So remember Randolph, the original CEO? And, and Lo, the guy who was running the, the video stores in Marin? Now that the IPOs happened, they're like, okay, great. We're gonna go focus on new things like initiatives within the company now. And they start testing kiosks, Netflix kiosks that they're gonna put in grocery stores. And they're like, this is gonna be a great new growth initiative. And Hastings and McCarthy, they're like, guys.

• 53:49Ben Gilbert?

  And actually Hastings at first agrees about the problem they're trying to solve. So an important detail is that Netflix is convenient in a way because you don't have to leave your house, but it's inconvenient in a way that you can't have it now. Like they constantly were struggling with this existential problem of instant is not a part of our value proposition to date. And so, you know, this is sort of Lo and Randolph's brilliant idea of like, maybe, maybe this is the way to solve instant.

• 54:16David Rosenthal?

  Maybe this is the way to solve instant. Maybe it is. But eventually McCarthy and everybody, they're just like, guys, we just did a 40% riff. We finally got public. We gotta stay focused. There are no new initiatives that we're doing right now. They kill it.

• 54:29Ben Gilbert?

  And wait, wait, before they kill it, though, this is great. Lowe and Randolph are so obsessed with this idea. The two of them, so they've convinced a grocery store, a single grocery store in Las Vegas at Smith's Grocery Chain to work with them to do this. And this is so awesomely startup-y. They decide it's not worth our investment in figuring out how to actually build a vending machine that's going to vend DVDs. So we are going to task a Netflix employee to just stand there behind a little like kiosk. It's a store within a store after the checkout of the Smith's Grocery Store. And just like, people can come and they will just do it manually and the employee will hand you the DVD, which is just awesome.

• 55:11David Rosenthal?

  That's so great. Do things that don't scale.

• 55:14Ben Gilbert?

  I know. Lowe and Randolph actually got an apartment and moved there for a month to kind of like be a part of standing up this operation. I mean, they were stoked.

• 55:22David Rosenthal?

  That's awesome. It is awesome, as we will see. But you can also understand why McCarthy and Hastings are like, guys, guys, not now.

• 55:32Ben Gilbert?

  The second thing that happened before they killed it is that Lowe went and talked to the CEO of McDonald's and was basically like brokering a deal. It was like, then he came back to, and this guy freaking loved it. McDonald's was like, we want to roll this out at all of our, you know, a little extra revenue for the people that are hanging out in our stores we're in. And so Lowe brings this back to Hastings and Hastings is like, are you freaking kidding me? Like, our first brand impression with the majority of America that doesn't use us yet is not going to be in McDonald's when they're waiting in line like that. No, absolutely not. And so part of killing it was like, look, we don't have the headcount for this. We don't, we can't split our focus like this. And now you're coming to me with McDonald's? All right, David, take the curtain off.

• 56:16Ben Gilbert?

  What did this become and how did it become that?

• 56:18David Rosenthal?

  So Randolph and Lowe, they're demoralized. Netflix has changed so much. Randolph, you know, he started this thing, he was CEO, like, you know, it's, it's time for us to go. They go. Randolph gets full time into investing and as we talked about, Chubbies and, and Licker and all that. Lowe, he can't stop thinking about this kiosk thing. He's like, I'm gonna make this happen. He's like, I'm gonna start a company. That company becomes Redbox.

• 56:45David Rosenthal?

  Which

• 56:46Ben Gilbert?

  Wild.

• 56:46David Rosenthal?

  Wild.

• 56:47Ben Gilbert?

  Which is now an actual, very significant competitor to Netflix.

• 56:51David Rosenthal?

  Yeah. I actually don't know what's happened to it now. Like, does it still exist in the streaming world?

• 56:56Ben Gilbert?

  I think it is now part of something called Outer Wall, which is they own Redbox, Coinstar, Eco ATM, Gazelle, a bunch of these other things. Outer Wall stands for the outer wall of the grocery store. And it was basically rolled up. I think it's actually a Bellevue-based company.

• 57:17David Rosenthal?

  Yeah, yeah, because Coinstar was in Bellevue.

• 57:19Ben Gilbert?

  Yeah, yeah, yeah. I think maybe Coinstar expanded to become Outer Wall when it rolled up all this other stuff, something like that. But Redbox is now part of that, that private equity family.

• 57:29David Rosenthal?

  Yeah, crazy.

• 57:31Ben Gilbert?

  All right, listeners. Now is a great time to talk about a new partner of ours here on Acquired, Logora, the agentic operating system that is redefining how the world's best legal teams work.

• 57:44David Rosenthal?

  Yep, 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. Logora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry?

• 58:01Ben Gilbert?

  So the founders did exactly what great founders do, operate with obsessive customer focus. They embedded inside a massive law firm for months. They sat with the lawyers just watching how the work really gets done.

• 58:16David Rosenthal?

  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. Logora's bet 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.

• 58:40Ben Gilbert?

  And they recently launched Logora 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.

• 58:59David Rosenthal?

  And Legora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Legora numbers essentially speak 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.

• 59:29Ben Gilbert?

  Truly insane numbers. And that is the real test. Plenty 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 legora.com/acquired and just tell them that Ben and David sent you.

• 59:54David Rosenthal?

  Okay, so back to Netflix. We're now in March 2003. Things are going great. The company hits a million subscribers. They announced this on their earnings call. Everyone's high-fiving once again, as we'll see, this doesn't last long. McCarthy, he's like, this is great. I've gotten, landed the plane. I really want to go be the CEO of my own company. I'm gonna leave by the end of the year and do that. But you know, I want to give everybody plenty of notice, want to give the street notice. So he announces that. Almost immediately afterwards, Blockbuster fully launches, they've been testing. They fully launched Blockbuster Online. The week that they launch Blockbuster Online to the general public, Netflix market cap drops 60% in one week, like a rock.

• 1:00:39David Rosenthal?

  And as we said, like, it actually becomes a pretty good product. Plus, they have all the marketing power of Blockbuster. And so what happens is very quickly, all of the market going to subscription-based online movie rentals, DVD rentals, Netflix was the only player until now. Every new customer in America who came to do this. I had to do Netflix. Blockbuster gets 50% of new signups. So of new people coming into the market, which is where the vast majority of the market is still coming in, Blockbuster takes 50% share immediately.

• 1:01:09Ben Gilbert?

  Yeah. And if you think about the, the timing on this, so when, when Netflix IPO, they had 500,000 subscribers. It's interestingly not that big of a number on the number of movies. It was 11,500 movies, as they say in their S1. So it's now 2003. Netflix is barely profitable. They just turned their first quarter profit. Blockbuster launches this. This is exactly at the crest of the DVD wave where when Netflix is reporting earnings, sort of the quarters before Blockbuster, they're like celebrating on the earnings call. Like there is now $200 DVD players. America is buying DVD players. Our bet was right. This is just fueling our business. This is amazing timing. And so for Blockbuster

• 1:01:51Ben Gilbert?

  to just nail it and, and, and launch it exactly this time is like-

• 1:01:55David Rosenthal?

  This is kneecapped them.

• 1:01:56Ben Gilbert?

  Yeah. This, this million subscribers that they have up from 500,000 at IPO is, you know, there's what 200 million households in the U.S. or something like that. Like anything that happened before is irrelevant and what matters now is new signups in the future.

• 1:02:11David Rosenthal?

  Yep, exactly. Not only does that happen, they've got a second problem, which they're even more worried about. They get word that Amazon, their one time potential acquirer, is gonna come into the market and is working on building a Netflix competitor. Remember, not streaming, we're still in the DVD rental market. They announced this, they're like, we gotta be honest about this with the street. They announced this on their Q3 analyst call, that they think Amazon is coming. They're gonna get ready for it. And McCarthy says, I'm not leaving. I'm staying. I'm gonna stick it out and fight here. He actually says, and I quote, "On the, on the investor analyst call, you don't leave your friends in the middle of a knife fight." This is just awesome. What a hero.

• 1:02:53David Rosenthal?

  And he literally like swashbuckling comes, rides back in in anticipation, not of Blockbuster, not in reaction to Blockbuster, but in anticipation of Amazon coming in, because I think Amazon's going to follow the Amazon playbook and just undercut everybody on price. Netflix cuts their subscription price by almost 20%.

• 1:03:13Ben Gilbert?

  For the first time, it's like sub $20 for the, the, the big plan.

• 1:03:17David Rosenthal?

  Yep. Unfortunately, this turns into a full on disaster. A, Amazon actually never ends up entering the market. They do in Europe, but not in the US. Blockbuster sees this and they're like, oh, Netflix is starting a price war. So now Blockbuster and Netflix get locked into a price war. And Blockbuster further undercuts Netflix and things go like haywire. Cause remember the cash burn cycle is super important here.

• 1:03:46Ben Gilbert?

  And Blockbuster has a much healthier balance sheet at this point, too. So Blockbuster is like, wait, Netflix just cut prices? Why? Like, we can outspend them. Okay, I guess we'll cut prices.

• 1:03:58David Rosenthal?

  Yep. Well, they can and they can't, as we'll see. So McCarthy and Hasty, they're like, okay, we need to model out exactly, because Netflix has a bunch, or Blockbuster has a bunch of debt from their old stores. And they used to be part of Viacom and then they'd spun out. There was a whole complicated transaction. So yes, they have resources, but they also have debt covenants. So they model out in detail what they think the Blockbuster online business is. How long they think they can survive at this lower price? And with all the promotions they're doing, until they trigger their debt covenants. And so they're like, okay, we think we have about six months.

• 1:04:33Ben Gilbert?

  David, can you go into what, what debt covenants are a little bit?

• 1:04:37David Rosenthal?

  Debt, if you have debt, there are agreements on the debt called covenants that basically say you have to maintain certain financial health, metrics of financial health. If you don't, if you trigger those debt covenants, then you, the lenders, the people who own your debt can put you into default and push you into bankruptcy. So it's like, you don't want to do that. Now you can go back and renegotiate with them. Anyway, lots of detail in all this. Happens with Blockbuster.

• 1:05:04Ben Gilbert?

  And just to drive the point home and put a super fine point on the, um, on the cash cycle here. Yes, there's been a million subscribers acquired. They hope to acquire, you know, another hundred million in the future. They're dramatically accelerating marketing spend to be able to bring people on at a faster rate every quarter than they had been before. However, since the first month is free, they make no money on people for at least a month after they acquire them. And they're spending more money than ever before to get nothing for that first month. So it's like, you know, the, to your point, that timing is tricky.

• 1:05:36David Rosenthal?

  Plus there's advertising dollars that you're spending to get those new customers. So what does Blockbuster do? They run a Super Bowl ad. And Netflix is like, oh my God. Um, but they keep cool heads. They're like, the market is still growing. We're still getting subscribers. If anything, Blockbuster is just educating the market. They don't cut prices further. They don't get further drawn into the price war. And it basically works because we will see here, the, if Barry McCarthy is the acquired superhero, the acquired supervillain steps into the scene here, Carl Aiken.

• 1:06:12Ben Gilbert?

  Of Marvel fame of, uh, where else has he showed up in our episodes so far?

• 1:06:17David Rosenthal?

  I don't think we've talked about, remember he was with Apple with a lot, like this guy. Oh my God. Hedge fund billionaire, activist shareholder. He gets super involved with Blockbuster. He buys about a 17, either 17 or 19% stake on the public markets in Blockbuster, starts agitating, fire, files a proxy battle to basically at the Blockbuster annual shareholder meeting to, uh, elect a separate slate of board directors that are all of his cronies. He wins. Crazy. Again, Blockbuster is actually like being smart here. Their management is actually pretty good. Carl Aiken just like replaces the whole board with like Aiken cronies. He starts bringing his son to board meetings who's just like,

• 1:07:00David Rosenthal?

  some 26 year old dude. And he's like, you should give product feedback. It's insane. It's insane. But fortunately the, the Blockbuster management, they managed to kind of like keep things on track and they. Decide with all this going on, they need to raise prices back up. So Netflix and Blockbuster both raised prices back up. The tide is rising. Both companies are coexisting here in the market. Things go pretty well. Netflix is still the leader. They end 2005 now. They have over 4 million subscribers. They have a market cap of over a billion and a half. So up, what's that 5X from the IPO three years ago? They launched the Netflix Prize in 2006 that you alluded to, which is, we probably don't have time to cover it in a full detail here.

• 1:07:42David Rosenthal?

  Maybe in the, maybe in part two, but super awesome, get a ton of PR.

• 1:07:46Ben Gilbert?

  Can any brilliant computer scientists out there beat our algorithm by, was it 10%?

• 1:07:52David Rosenthal?

  10%, yep, yep.

• 1:07:53Ben Gilbert?

  Yeah.

• 1:07:54David Rosenthal?

  Everybody thinks that like, it's gonna happen very quickly. Ends up taking like three years before it finally does get, uh, it's 2009, I think, when the, when the prize was finally awarded. But anyway, all this is happening. Blockbuster, like they're still growing, but they realize like the bricks and mortar business is, is, you know, not long for this world online. And we're now in the mid 2000s. They really need to go all in. Management decides on, online. And they think, what is, what is the one thing we have that we can beat Netflix on? They've realized that the turnaround time on rentals is super important. And this is actually pretty brilliant. They come up with this concept called, that they market as total access, which is essentially you sign up for. Yeah, this is at the, at the end.

• 1:08:39David Rosenthal?

  You sign up for Blockbuster Online, which is essentially just a Netflix clone. And the, the extra that you get is, you can now return your movies to any Blockbuster store and exchange them for your next movies at the store. So this is like what Amazon is doing with, um, you know, Amazon Go and Prime Now. And like, this is actually like pretty visionary. It, it's risky because it does involve a lot of capital, a lot of ops. You know, it's, it's like, people are very skeptical that this could work. But if it does, Netflix can't match it. They have no physical footprint. And Blockbuster has stores all across America. Netflix is super, super scared when this happens. This is in 2006. So scared.

• 1:09:22David Rosenthal?

  That at Sundance in the beginning of 2007, well, and they get scared, it actually makes a huge impact. So Netflix growth flatlines. Not only do they stop growing, they start losing subscribers. This has never happened. Like, remember, they've just been adding subscribers, you know, quarter after quarter after quarter.

• 1:09:40Ben Gilbert?

  It's like watching Snapchat or something.

• 1:09:41David Rosenthal?

  Totally. This is like, this is the Instagram stories moment. And they're so worried. Sundance 2007, Reed Hastings meets with the Blockbuster CEO. And he offers essentially a merger of the two companies. And he says Netflix will buy Blockbuster's online business from you for $600 million. So it'll be essentially like, I guess, what's that, like two thirds Netflix, one third Blockbuster is the ratio. I assume it would be all stock and Blockbuster rejects it. They're like, no, man, we got you guys on the ropes. We have a structural advantage you don't have. We're back in the game. And then history like turns on a knife point. This is crazy. Like Blockbuster was gonna win if they could execute this.

• 1:10:25David Rosenthal?

  But Carl Icahn, oh my God, oh my God. This is literally, this might be the worst self inflicted wound in like the history of business. This makes like the Uber thing look like child's play. Carl Icahn and the Blockbuster CEO get into, right around this time, get into a huge fight over the CEO's annual bonus. And such a fight that the CEO resigns and, and I can puts him out. I can then hires a new CEO, this dude from 7-Eleven, who this guy-

• 1:10:59Ben Gilbert?

  And to be clear, this is Icahn scrutinizing the CEO's proposal for his and other executives bonuses and saying, nope, I don't see why you should be paying yourself that much.

• 1:11:09David Rosenthal?

  Yep, exactly. And the Blockbuster CEO is like, I'm like successfully navigating this. I'm about to beat Netflix. They just capitulated. They just offered a merger and I think I'm gonna beat them. And the-

• 1:11:23David Rosenthal?

  This guy who Carl Icahn brings in, I don't even remember his name, it's not worth it. Basically, like, we try to be pretty even and balanced on acquired. This guy is a total idiot. Like, he is a complete moron. This is, this is like, he doesn't, he says he doesn't believe in online businesses. This is 2007. Like, it's pretty clear that online businesses are a thing. Google has been public for three years. Like, you know, this is insanity. He doesn't believe in online businesses. He, his plan, he's gonna totally defund Blockbuster Online. He thinks Netflix is a joke. Nobody's gonna do it. He wants to bring back the heyday of bricks and mortar, wants to make bricks and mortar great again. He wants to attract-

• 1:12:04Ben Gilbert?

  Bring back coal, David.

• 1:12:06David Rosenthal?

  He wants to attract the kids to come to Blockbuster stores by selling pizza and soda at the stores. He has a plan for this. He calls it Rock the Block.

• 1:12:17Ben Gilbert?

  God, if you're Reed Hastings, it's like, you-

• 1:12:20David Rosenthal?

  This is like a gift from heaven.

• 1:12:22Ben Gilbert?

  You gotta hear this news and just have your jaw drop and be like, we're saved? We're saved?

• 1:12:27David Rosenthal?

  Here's the kicker. Here's the kicker. I remember this. I was working on Wall Street when this happened. Circuit City is like on the brink of bankruptcy. Best Buy does manage to survive this, but they're also at the brink of bankruptcy. Amazon is eating everybody's lunch. Again, online businesses, they work. This CEO of Blockbuster, he's like, we're gonna buy Circuit City for a billion dollars. You literally cannot make this stuff up.

• 1:12:57Ben Gilbert?

  You know what's better than, than, than one failing business? You put two of them together.

• 1:13:01David Rosenthal?

  We're gonna tie two anchors together and drop them into the ocean. Oh my God. It's, it's ridiculous. Everybody, it doesn't actually happen because even Carl Icahn is like, I'm not sure that's a good idea.

• 1:13:15Ben Gilbert?

  Have you have you been to one recently?

• 1:13:18David Rosenthal?

  Yeah, so basically, everybody good at Blockbuster, who was running the online business, they just resign. And it's crazy, like in the book, they talk about the guy who was running the online business. He was really good. After all this happens, Reed Hastings calls him up and he's like, hey, let's like get dinner. And they get dinner and they talk about everything. And then he invites him out to Netflix. He does like a town hall at Netflix and they talk about the whole history and what Blockbuster Online was doing when Netflix was going. It's crazy. They all resign. We know what happens. Blockbuster goes bankrupt. All of the momentum they had around Total Access, it just dies. They defund the whole thing. Netflix wins. And it's amazing because like all of this, again, once again, Netflix was at the brink of death. A miracle happens.

• 1:14:00David Rosenthal?

  All of the marketing, all the buzz around Total Access for Blockbuster, that just brings so many more people of the mainstream in America into this market. They all go to Netflix. So by spring of 2009, Netflix now has 10 million subscribers. They're thriving. Nobody's canceling during the recession. They're on the top of the world. It's amazing. And that is where we're going to leave part one, because there's another thing on the horizon coming. I thought Netflix was such a like, stable, boring business. So not the case. You can't stay on your laurels for long because streaming is coming.

• 1:14:34Ben Gilbert?

  What a good place to leave it. When we were going back and forth last night on where should we leave it? Should we, uh, should we go into quick stir or not? I'm really glad that we, uh, this feels like such a good place to, to hang.

• 1:14:45David Rosenthal?

  Oh, totally. I just like Circuit City, Circuit City. I mean, again, like the worst, the worst.

• 1:14:56Ben Gilbert?

  All right. I'm emotionally exhausted, but we have other sections.

• 1:15:00David Rosenthal?

  Should we do narratives?

• 1:15:02Ben Gilbert?

  Yeah. Going into narratives, I want to recap just a couple of things from reading the, the S1 last night, because I think they're interesting. So they sold 27% of the company in this IPO, raised $82.5 million. No net income yet, all only net losses, but about to have their first quarter of net income. The cap table is fascinating. So Reed Hastings owns 20% of the company, uh, which will get diluted down to about 15% after the IPO. TCV Technology Crossover Ventures in, in two different vehicles, I, I'm pretty sure I'm reading this right, has 46% of the company.

• 1:15:37David Rosenthal?

  Yeah, crazy.

• 1:15:39Ben Gilbert?

  Pretty rare to see that at IPO, a single firm with that much ownership. Totally different era. You look at what they did there, they were able to raise, you know, I think in that with, including that second little offering, close to $100 million. They made no real promises in their S1 about sort of what they were going to do with that in any substantial way. They sort of just talked about they were going to spend on marketing, they were going to spend on improving the technology, they were going to increase the selection that they had. I mean, it wasn't like, when we talk about what did they do with this, this capital? They run a flywheel business, so they just had to pour more money into the flywheel and have more money to be able to accelerate it.

• 1:16:23Ben Gilbert?

  You know, in, in looking back, we tend to do these, this narrative section where we do bulls and bears. Unlike other times, like Facebook or like the Snap IPO, it's not like there were people writing these articles of doom and gloom. I mean, it was pretty, hey, this thing seems to be going pretty well, it's pretty disruptive, it's not clear if it's going to work yet, but they're IPO-ing and it's not a huge IPO.

• 1:16:43David Rosenthal?

  Well, to jump into the bear case here, all that's true and like, yeah, I mean, if you really looked at it, like, this was a really good business. I mean, there was potential headwinds in the future of.

• 1:16:54Ben Gilbert?

  Oh, yeah. It was, it was, it was one of the only tech companies, uh, cause people just watched all these dot coms go bust. It was one of the only tech companies that was posting, you know, nice financials and was about to be profitable. I mean, it was like this huge, you know, wow, it's a real business, you should buy it.

• 1:17:10David Rosenthal?

  Yep. But I think the bear case is, is, yeah, people are just still so, you know, God, human psychology hangover from the, the IPO crash. They're all like, huh, this CEO like was the largest merger in, you know, Silicon Valley history in the bubble era and now like you guys are losing money and like, I don't believe in online businesses, you know? And also, to be fair, a fair bear case was, I don't know, don't count out Blockbuster. And as we've seen, Blockbuster very well could have won here. You know, hard to know. But yeah, the bookcase, like you said, like, this is a good business. Subscription businesses, like.

• 1:17:45Ben Gilbert?

  It could be a thing.

• 1:17:47David Rosenthal?

  If, if they work, if you can get them to work, they can be very challenging to scale. But like, this is why cable companies are so good. And cable companies will come back up in part two of the episode. Like, if you can get consumers locked into paying you a certain amount every month, like, you can build a very stable, very predictable, very good cash flow business around that.

• 1:18:09Ben Gilbert?

  Yep. All right, what would have happened otherwise?

• 1:18:13David Rosenthal?

  Let's do it.

• 1:18:14Ben Gilbert?

  I struggle to find any other way that this could have worked out for Netflix. I mean, they either would have ended up part of Amazon, and I'm not sure they would have maintained the brand, part of Blockbuster, and they would have killed it. That would have been a takeout.

• 1:18:30David Rosenthal?

  Carlikin.

• 1:18:32Ben Gilbert?

  Yeah. If they hadn't opportunistically raised some cash right before they thought they were gonna IPO, then they probably wouldn't have weathered the storm. If they didn't IPO when they did, then they probably wouldn't be able to properly fight Blockbuster.

• 1:18:46David Rosenthal?

  If they didn't do the 40% layoff, like, you know, yeah, just a lot of things went their way here.

• 1:18:52Ben Gilbert?

  Companies, it's skill and luck.

• 1:18:54David Rosenthal?

  Yeah, totally, totally. I think maybe there is a world where they could have kept, delayed the IPO longer. You know, they were at profitability. And that would have been the wrong decision, I think, because Blockbuster is coming into the market.

• 1:19:09Ben Gilbert?

  And access to capital in the private markets didn't exist like it exists today.

• 1:19:13David Rosenthal?

  Yep, totally. Yep, they had to do this.

• 1:19:16Ben Gilbert?

  Yeah. Tech themes?

• 1:19:18David Rosenthal?

  Let's do it.

• 1:19:19Ben Gilbert?

  The first one that I'm thinking of is like, and we've beat this to death on this episode, so it's not gonna be like surprising to anyone, but Tabula Rossa, if you come up to me and said, what wave did Netflix take advantage of to, to really launch them as a company? I'd be like, streaming. But like, the fact that DVDs were a wave is still a little bit mind blowing to me that I, it's just very. I think how fast as humans, we forget the very recent past and what was a big deal and what wasn't is striking.

• 1:19:48David Rosenthal?

  Totally. And yeah, just timing, like not only a big wave, but like Netflix timed it so perfectly. And this is why we ended up breaking this episode into two. Like, these are two different businesses. The DVD part of Netflix and well, foreshadowing Quickster. They really are two different businesses.

• 1:20:04Ben Gilbert?

  Did you know you can still go to DVD? Actually, they bought the domain Netflix has DVD.com.

• 1:20:10David Rosenthal?

  Ah, no way.

• 1:20:11Ben Gilbert?

  And you can go and access their DVD offering there.

• 1:20:14David Rosenthal?

  Interesting.

• 1:20:16Ben Gilbert?

  Yeah.

• 1:20:16David Rosenthal?

  Wow. I wonder, I mean, there still are people who I think they still have a few million DVD subscribers to this day.

• 1:20:22Ben Gilbert?

  I think, and interestingly enough, from DVD.com, this is how muddled this stuff gets. You can rent Blu-rays.

• 1:20:30David Rosenthal?

  What about Dibix?

• 1:20:32Ben Gilbert?

  Doubtful.

• 1:20:33David Rosenthal?

  Doubtful. Okay, I have a couple. The biggest one, though, we glossed over a lot of stuff as we had to in this story. This is part of why we're doing our LP program and bonus shows is to get deeper into like, who are the people that like actually build these things? And what are the decisions along the way that like operationally helped make all this happen? But one thing that, again, we didn't get to cover as much in this episode, that I think is an interesting theme, both across Amazon and Netflix, is that the people in finance and marketing, and we did talk about McCarthy at Netflix, at these first generation internet companies were so good. Like Barry McCarthy, Joy Covey

• 1:21:15David Rosenthal?

  at Amazon, Leslie Kilgore, who ran marketing, analytical marketing at Netflix, like, we didn't get to talk about her, but there are so many people that are just like really, really, really good. They tended to come from like the CPG world, like from Procter and Gamble. And I think that's where Leslie Kilgore came from. I could be wrong on that. But there are a bunch of these folks at Amazon, a bunch of these folks at Netflix, and they're just so good. And I feel like that's like, that's like a piece of DNA that's now missing in the valley, is like this combination of finance and marketing, you know, and there's like growth, quote unquote, which is sort of the successor to this, but.

• 1:21:51Ben Gilbert?

  Cowboy marketing.

• 1:21:51David Rosenthal?

  Yeah, it's become so cowboy and it's become also just so dependent on Google and Facebook, like.

• 1:21:56Ben Gilbert?

  Although the good growth people would find ways and tell you that their way isn't dependent on Google and Facebook.

• 1:22:00David Rosenthal?

  Right. There are still, there are still good people, but you know, this is the. Barry McCarthy modeling out Netflix's online business to a T like he knew what month they were gonna have to raise prices. The Netflix program with consumer manufacturers of consumer electronics manufacturers to put the coupons in the boxes and modeling out exactly what was that was gonna cost, exactly what their growth rate was gonna be. You know, the going population and subscriber center by subscriber center with the with the one day delivery being driven by where word of mouth is occurring, like all that stuff, like that's the company building stuff that built Netflix into like a great business. And Amazon did the same thing. So that's what I wanted to call out here.

• 1:22:43Ben Gilbert?

  I have two trends that I want to call out that were stated in the S1 because one of the things you commonly see in these S1s is it's an area called trends, but it's basically, why should you believe that the wind is at our backs? And one is one that I hadn't really thought about that much, which was the very first one they call out is the shift to viewing in home instead of in theaters. And I had forgotten about this because this was like in the era, I think it was a little bit before the era where piracy really accelerated, people not going to movie theaters, but there was already a trend where people were like, gosh, why, you know, I can go rent it at Blockbuster. Why would I, you know, I'll wait to see it on video and it'll be cheap on video. And this was killing movie theaters, but this trend was starting to accelerate. And that was one thing that they cited that was like, look, no matter how people are renting

• 1:23:28Ben Gilbert?

  movies, like they're watching them at home and that's really helpful for us, which I thought was interesting. And the other that they cited was in slightly different words, but the paradox of choice that it was really hard. So there's one of two things will happen. You go to Blockbuster and you're mad that there's not enough selection or the movie that you want is out. Okay, if you go anywhere where there's infinite selection, then it's it's too hard to choose what movie that you want to watch. But they had Cinematch and the Cinematch algorithm was really good at telling you what movie you probably want to watch next. And so they actually cited that as a sort of trend and advantage to Netflix in their their S1 shareholders, which was interesting. And I've got a few more, but we're gonna save those for part two.

• 1:24:10David Rosenthal?

  All right. Should we grade this and we're gonna grade the IPO here?

• 1:24:16Ben Gilbert?

  Yeah. So I was thinking about this and I'm like, okay, let's say they didn't, because we've already covered like they needed the IPO to have the cash to be able to win the war that they won. And they were close to losing the war against Blockbuster. So even that aside, okay, why IPO? What's the point of that? You've got the cash position they're sitting in is 15 million in the bank. They're not going to be profitable this quarter, but maybe the next and it's going to be super thin. So like you need cash from somewhere. Why does this business need cash? And what is the flywheel? I think the flywheel is more spend gets you more customers, which gives you more leverage with content providers, which isn't really a huge factor in their business yet, but there's gotta be some element of yeah, buying, you know, they're already buying

• 1:25:01Ben Gilbert?

  DVDs in mass. So they sort of need to be able to do that to serve more customers and you can buy deeper in the tail when you have more customers.

• 1:25:08David Rosenthal?

  They eventually do do deals with movie studios as they get bigger to buy DVDs at a discount.

• 1:25:14Ben Gilbert?

  Yep. So that gets you more and better content, which then makes you able to inherently that improves the product offering, which then lets you go get more customers. And so, I mean, really it's a flywheel business that they're raising cash to pour onto it. So competitive stuff aside, they should have just gone out and raised as much as they possibly could have to be able to fuel that that flywheel faster. They sold 27% of the business. Like, good move. I mean, it's not like they could have raised any more and it doesn't feel like the stock price could have been any higher, given the macroeconomic climate they were in. So the way I look at this, they raised the most money they could, which was the good idea. Even if they didn't need it for competitive reasons, which they did, it was a good idea

• 1:25:58Ben Gilbert?

  timing wise and amount wise. So, you know, it's not an A plus for me because those are reserved for exceptional circumstances, but this is a solid A.

• 1:26:07David Rosenthal?

  Yeah, I think.

• 1:26:10David Rosenthal?

  One thing I wanted to add on to the flywheel aspect, we thought about this a lot at Rover, actually, which is not a subscription business, but has some of the same dynamics. With a business like this, a subscription business, once you grow to a certain point, as you're growing, you're spending a ton of money on customer acquisition, bringing new people in. And as we talked about in the early stages of the market, so much of the market has yet to come. There comes a point where you flip from all of that money that you're spending on customer acquisition, you're not making that back in terms of the revenue you're getting from your subscribers. You're spending more than the money you're getting back. But at a certain point in the market, in the adoption phase, that flips where you are now,

• 1:26:53David Rosenthal?

  you're still spending as fast as you can, but your subscriber space is so big, they're generating so much cash that you now, like, your economics tip over into the positive. Once that happens, you can super quickly go from like a cash burning business, as we saw, to like an incredibly immensely profitable, immensely big moat. Because for anybody else to come compete with you, they'd have to spend the same amount that you spent along the way to get there. Now Blockbuster could credibly do that, Amazon could credibly do that, but nobody else could. And once Netflix did that, that's when, as far as the DVD business concerned, was concerned, that's when they tipped into like, we are a awesome business, very stable cash flows.

• 1:27:36David Rosenthal?

  It's the same thing with cable companies, this is how they work, or worked. So yeah, I think it was like, they absolutely needed that capital to do that. I think, yeah, I debate A or A minus. Certainly A range, because they needed to, they executed, it was great, they did what they had to do. It's just the market conditions were so bad, like, selling that much of the company, like, you know, so not ideal, but I don't think they really had any other choice, so, I don't know, A or A minus. All right, carve outs? Carve outs. Okay, so mine, I'll go quickly. I can't believe it's taken me this long to read and then recommend NK Jemison's sci-fi trilogy, the Broken Earth trilogy.

• 1:28:19David Rosenthal?

  These books are amazing, amazing. If you haven't read them yet, if you're a sci fi fan, even if you're not a sci fi fan. So, three books in the trilogy, each one of them, the first one won the Hugo Award in 2015, I think, 15 or 16. The second one won the Hugo Award the next year. The third one won the Hugo Award the following year. So, so, so good. And just like a perfect societal commentary for, you know, the era we're into where like it's a persecuted people have an immense power that can save the world, but they're persecuted and like, so you have to give, anyway, it's really, really good. Must read.

• 1:28:58Ben Gilbert?

  I have one, I had a list of articles that I've read recently that I thought were good. And then I was like, you know, I should do one that's just like something kind of fun. And I thought it was going to be completely unrelated to the episode, but I'm now realizing it's not at all. There's a Netflix show that I've been watching called The Good Place. And it's with Kristen Bell. It is really goofy, but really good and really good sort of just like popcorn, you know, watch it for a half hour before you fall asleep. It's that, it's, it's basically like a heaven and hell thing where Kristen Bell lands in the good place. And she's looking around and she's like, oh, cool. I'm in the good place. So I'm not in the bad place then. And she's like talking to the administrator of the good place. And it's, it's just like, it's very tongue in cheek, but really good.

• 1:29:41Ben Gilbert?

  And when I picked it, I didn't realize that it was a Netflix show, but Netflix original content coming soon and, and in a next episode.

• 1:29:50David Rosenthal?

  Awesome. All right, listeners. Now is a great time to talk about one of our favorite companies, Statsig.

• 1:29:58Ben Gilbert?

  Yes. There is a reason why the best product teams rely on Statsig, whether they are iterating on their core product features or shipping AI-powered experiences at scale.

• 1:30:09David Rosenthal?

  Yep. In the crazy speed of today's AI world, shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next.

• 1:30:29Ben Gilbert?

  This is where Statsig comes in. It brings experimentation, feature flags, and product analytics into one unified system, so teams can ship safely, test rigorously, and directly link what they changed to how users actually behaved.

• 1:30:42David Rosenthal?

  So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, go to statsig.com/acquired to get started.

• 1:30:53Ben Gilbert?

  If you like listening to Acquired and you just want more, or you want to help us support the show and make it even better, and somehow we just keep doing more deeper research, and I've been super, super excited about the guests we've had on, so if you want to help us do more of that, you can become a limited partner. So go to kimberlite.fm, that's K-I-M-B-E-R-L-I-T-E.fm/acquired, or click the link in the show notes to join. Thanks, everyone, and we will see you next time.

• 1:31:20David Rosenthal?

  We'll see you next time with part two.