Business World

Friday 28 October 2016

Talkin' about a revolution: Reed Hastings lays out Netflix's next moves

With Netflix about to raise its fees, the company's CEO spoke to Donal Lynch about breaking China, cracking Hollywood and the meaning of 'Netflix and Chill'

Donal Lynch

Published 17/04/2016 | 02:30

Reed Hastings by Jon Berkeley
Reed Hastings by Jon Berkeley

In a vast, factory-like complex on the outskirts of Paris, an impressive roster of stars are gathered into splendidly lit, faintly IKEA-ish huts. Ricky Gervais, John Lithgow and Eric Bana are among the 'talent' who wait inside as a stream of journalists are brought in to briefly speak to them. Security is tight, everyone is frisked and there is a canteen with staff wearing Orange Is The New Black-style prison jumpsuits. It's the interview equivalent of factory farming and it gives an insight into how Netflix ripped the rug out from under conventional TV and movie providers. Like the streaming service itself, the process is quicker, cheaper and more remorselessly efficient than anything Hollywood ever dreamt up.

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But any stray 'Netflix and Chill' T-shirts (which they don't make, I'm told later) would look highly ironic in this setting. Chill it ain't.

Presiding over everything is the company's CEO, Reed Hastings, who takes to the stage to address the crowds of hacks and 'social media influencers' - who get their own (plusher) digs - with the passionate hyperbole of a televangelist. He preaches the gospel of Netflix, which has placed the world's population "at the start of a global revolution," he tells us.

It almost sounds like the Arab Spring - until you remember he means more people watching TV, rather than spreading democracy.

At eye level, Hastings has more the aura of a Bond villain than a preacherman. He is deeply alpha. You can almost detect the musk of private jet off him. He smiles widely and laughs a lot - which is understandable, given his success. A decade ago, Netflix was a DVD rental business, seemingly destined to become, at best, the next Blockbuster. Now it is by a country mile the dominant internet television service with 76 million users worldwide, and it delivered the best return of any stock last year. In the first quarter of 2016, the company is expecting 6.1 million new subscribers. Its market cap has doubled from around $20bn in January last year to $41bn today, putting it in the running to overtake the daddy of entertainment companies, Time Warner (which owns HBO and the Warner Brothers Hollywood studio and is valued at $53bn).

In January Netflix launched simultaneously in 130 new countries, bringing its total to 190 countries - which is pretty much everyone except China. Investors were understandably giddy about this, especially as the company once again surpassed expectations for subscriber growth.

The success has made Reed very wealthy. This year he will receive $900,000 in annual salary, down from a baseline salary of $1m in 2015 and $3m in 2014. However, his stock options allowance tops the overall remuneration package out at more than $19m.

There is perhaps only one potential stumbling block for Netflix's push for global domination: many people in the world still can't afford the high-speed broadband one needs to actually use Netflix.

Breaking down the world by region, 47.3pc of people in Arab states, 36.9pc in Asia and the Pacific and 20.7pc of households in Africa have internet access, according to recent International Telecommunication Union figures. Developing countries also tend to have younger populations, which have traditionally been where Netflix has done best.

So is he worried about all those young people who won't have the opportunity, at least in the near future, to be part of his global revolution?

"No, not at all, the internet is growing in every country because it's so important to entertainment and infrastructure. So we are part of that ecosystem. Internet growth has been fast and we expect that to continue."

To fall in line with the market's 15 times earnings multiple, Netflix, by some estimates, requires an extra $2.9bn of income. Given its 10-year average margin of 6pc, that equates to around $50bn of revenue. To keep up with its own blistering pace in the long term, the company would probably have to sign up two-fifths of the world's homes.

Only rising subscription fees will lower that daunting number. These are coming. Ireland will be one of a number of countries in which Netflix's subscription fees increase later this year. From now on, new subscribers will have to pay €9.99 per month for the company's two-stream HD plan, which was previously priced at €8.99. As a "thank you" gesture to loyal customers, existing users will initially be shielded from the increase, but can expect to pay the same rise from August.

Hastings says that the price increases are so that the company can "invest even more in original programming" and adds that, in fact, the company is not concerned with increasing the average revenue from each customer (which currently stands at about €7 per subscriber worldwide).

"We do need to grow revenue, but that can come through growing members. The key to us is just to have great shows that people can talk about and growth will flow from that."

The other fly in Netflix's ointment is China - the only major country in which it is not yet available. A year ago the company announced that it wanted to "complete" its global expansion by the end of 2016.

At the time Hastings told investors in his letter to shareholders that the goal was to "successfully operate a small service in China centred on our original and other globally-licensed content".

So, as things stand, what's the long-term strategy to get the seal of approval from the Chinese government and tap into those billions of households? And does he see parallels with other large American companies in China?

"Starbucks is very successful, Disney is very successful and Apple is very successful in China," he replies. "Any company has to be very patient. That is very important. Think about Apple; the iPhone was out for six years before they got into China. They were very patient, they didn't complain. The key is to think long-term and take your time."

Netflix is unlike other TV companies in that it doesn't release viewing figures. This has the dual effect of allowing shows to "breathe" (as Hastings puts it) and causing nosy journalists to wonder if shows that meet with a poor critical reaction do just as badly with audiences.

What kinds of metrics does the company use to ascertain how well or badly something is doing?

"We look at things like how is the show received critically, is the show offering a brand halo to our company and our subscribers. We look at how people complete the show as a signal for how intense the joy is for the show.

"We also look at the reverse - did a lot of people bail out of the show? The creatives love this because it takes away that pressure, that all-night wait for ratings. The shows are allowed time to develop and become a better show. We've never had a show not go to a second season yet. It means writers don't have to write for their life and create cliffhangers that don't really make sense. It also creates mystery and excitement."

What about efforts to move beyond the tech savvy, youthful 'Netflix and Chill' brigade and tap into an older audience? "We have more shows with 70-year-olds than anywhere on the planet: think of Longmire, for instance, and Grace and Frankie. If you look at the ratings decline by network, the ones that have held on the best are the ones that have targeted people who are still watching linear broadcasting. With Netflix we have to make it important enough for them to try - in the same way that looking at pictures of their grandchildren made it important enough for them to use the internet."

What about moving into different genres? Would they do live streaming or begin to bid for sports rights?

"We are trying things out," Hastings explains. "If Chelsea [Handler] succeeds we will do more talk shows. Documentary series is another great example; when Making a Murderer did so well, that obviously focused us more on that area. But, as regards big sporting or other live events, I think not." He foresees a day, he says later, when movies will be legally available to stream in the same week they appear in cinemas.

A head for figures and a patient disposition probably come naturally to this Bostonian who started out as a maths teacher. He has said that part of his entrepreneurial spirit was formed when he was a student.

"Once you have hitchhiked across Africa with 10 bucks in your pocket, starting a business doesn't seem too intimidating."

He would go on to attend Stanford University, where he did his masters in computer science. Early on in his corporate career he invented a tool for debugging software and the success gave him the confidence to start his own company, Pure Software. The company did very well but Hastings found it overwhelming, later saying that at that point he was "under water and in over my head". Twice he tried to get his own board to fire him, but he stayed on. In 1996, Pure Software announced a merger with Atria Software - but Hastings left the new company soon after the acquisition.

The idea for Netflix came, so he tells me, when he was hit with a $40 late fee for returning a copy of Apollo 13 to the video store. That was 1995. Two years later he co-founded the company with Marc Randolph, sometimes described as the "forgotten co-founder", although Hastings namechecks him during our interview and confirms, "He started it and I funded it."

The new company would offer a mail-order DVD service. It launched in 1998 when it cost 50c to rent a DVD and the company had only 30 employees. Hastings was likely already seriously wealthy by this point in his life, but he gamely paints a picture of plucky poverty and start-up derring do. "The first two years with Ted [Sarandos - Netflix's head of content] we had to work out of his bedroom, and when we'd meet studio heads we'd go to the local coffee shop. That might be why so many people we met underestimated us."

Blockbuster, for instance, could not see why Americans would want to send away in the post for a DVD when about 95pc of them lived within a five-minute walk of a Blockbuster.

In fact, in the early 2000s (when it controlled the market in rental DVDs) Blockbuster had the chance to buy the then DVD-by-mail rental company for $50m. It passed in what was maybe one of the greatest fails in business history. Netflix went public in 2002. Blockbuster ended up filing for bankruptcy in 2010, when it lost $1.1bn. The company at the time was valued at around $24m, while Netflix's worth had risen to around $13bn.

We're less than halfway into our allotted interview time, but the bell is about to ring and Hastings has to go. Everybody is all talked out, while below us the stars have gone home - and the factory is about to be dismantled.

Spilling the beans on Netflix and Bill...

One of the more amusing stories from the early days of the company centred around the time Netflix accidentally sent customers DVDs containing hardcore Chinese pornography instead of Bill Clinton's grand jury testimony about the Monica Lewinsky scandal.

Producing a DVD of Clinton's testimony had been a bold enough move in the first place - but the accidental porn glitch elevated the whole episode into company legend. Hastings smiles ruefully at Sarandos when I mention this, but says it hasn't made things awkward with Democratic party bigwigs. He's been for dinner at the White House.

"Not at all. It's been 17 years since that happened."

And, speaking of awkward, what does he understand by the phrase 'Netflix and chill'?

"It means 'do you wanna have sex?' But you knew that, right? You just wanted to hear me say it. If we got behind it, it wouldn't work. The fans got behind it. We don't produce 'Netflix and chill' bumper stickers."

Is the phenomenon a symptom of the recession years, when nobody had money to go out and score the old fashioned way?

He throws his head back, laughs, and dishes a sarcastic rejoinder: "Oh sure, because when times are good nobody has sex!"

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