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They cornered the movie-rental market with four strategies that should be in every business’s queue. 

By Gina Keating


The odds were stacked against Netflix in 2004. The company had just reached 1.9 million subscribers and was reporting quarterly losses as often as it booked profits. Blockbuster, the world’s largest movie-rental chain, was on the verge of launching a competing online rental service, and retail giants Walmart and Amazon weren’t far behind in launching ones of their own. But Netflix used a set of customer-focused rules to battle industry heavyweights and transform itself from a slim-chance startup into one of the most successful technology and entertainment companies of the decade. Seven years later, the company seemed unstoppable: 25 million users and growing. But when CEO Reed Hastings ignored Netflix’s innovative management rules in a now infamous attempt to modernize its business, the movie-rental giant drew the ire of many of its customers and learned that ignoring their feedback can mean the difference between fortune and failure. Here are four rules straight from Netflix’s playbook that can give any business a competitive edge.


Rule One: Don’t just get feedback from your customers—use it.

The company that today serves 30 million customers hardly resembles the Netflix of 1997. Co-founder Marc Randolph, a marketing guy, can chalk up his customer-data-gathering savvy to his past experience in the mail-order catalog business. In those early days, he’d tweak catalog designs to see what was most effective with customers. It was time-consuming work; results often took weeks or months to measure. But as e-commerce emerged in the ’90s, he saw in the Internet a way to instantaneously adjust marketing messages and improve sales. Because of this, the Netflix website was engineered to double as a market research tool so that Randolph and his team could run tests and gauge the response to elements as significant as pricing changes or as small as the color of the buttons on each page—and make changes in real time.


From day one the website spit out data telling the marketing team who customers were and what they wanted. The team often called new subscribers to ask how they used the site. Some team members visited subscribers who lived near Netflix’s headquarters in Los Gatos, California, and sat with them at their home computers as they used the site. The goal? Creating the perfect customer experience. “Every customer you get, you’re never going to lose them,” Randolph told his team.


Rule Two: Not every part of your business is sacred.

Don’t be afraid to do what CEO Reed Hastings calls “scraping off the barnacles”—dumping busi-ness lines that do not advance the company’s goals. Netflix initially rented and sold DVDs. Their rental operation was no better than Blockbuster’s—both had late fees that customers loathed. As DVDs became one of the most popular consumer technologies in history, Netflix’s DVD-sales business took off, but Randolph quickly realized that their much larger competitors—Best Buy, Walmart and Amazon—would slowly squeeze Netflix’s profit margin to nothing.


“By trying to run a business that did two things well, we inevitably were forced to make an endless series of compromises that resulted in us doing neither of them well,” he says. In response, Hastings handed the DVD-sales business over to Amazon in exchange for the chance to advertise Netflix’s fast-growing rental business to the online giant’s customer base. Amazon has been trying to catch up with Netflix’s rental business ever since.


Rule Three: Technology + Marketing = An Unstoppable Duo

Much of the company’s early success was fueled by the shared wisdom of Hastings, a tech whiz, and Randolph, a marketing guru. Hastings and his engineers turned Randolph’s marketing data into features that would both appeal to customers and create efficiencies for the business. They created a movie-matching algorithm to show each subscriber a custom-tailored roster of films and to control inventory costs by promoting in-stock films. The marketing department developed a program that tracked consumer responses to Netflix ads, and algorithms decided where to locate distribution centers. 


And in 1999, shortly after Hastings took the helm as chief executive, he used data from customers to again scrap a part of the business, ditching à la carte rentals to bet the company on subscriptions. This balance between technology and marketing proved critical to nurturing Netflix’s culture, focusing its business, and ultimately driving archrival Blockbuster into bankruptcy. 


Rule Four: Don’t forget rules 1–3.

A string of successes built on forward-thinking strategies doesn’t mean a company can ever turn deaf to its customers. Netflix was riding high in 2011, and Hastings graced Fortune’s cover as the Businessperson of the Year. Its subscriber base topped 25 million—larger than cable giant Comcast—and instant streaming looked likely to steal customers from the $98 billion cable industry that dwarfed the $8 billion market Netflix had stolen from Blockbuster. To do this, Netflix needed hundreds of millions of dollars to secure the rights to stream premium movies. 


To fund the expansion, Hastings returned to his playbook: Scrape off the barnacles and use technology to innovate. But he forgot to incorporate the consumer viewpoint that Randolph had instilled in the company. The DVD-by-mail service had reached its peak and was slowly withering—that was clear. Years earlier, Hastings had predicted it’d take a decade or more for the streaming catalog to match the DVD-by-mail service’s breadth and that he would let the DVD operation dwindle on its own schedule. So it took many by surprise when, in July of 2011, Netflix announced that it would raise prices on some of its customers by as much as 60 percent and spin off its DVD service as a separate business called Qwikster. 


Those who wanted to keep both streaming and DVD delivery had to maintain two separate queues and pay two different bills. But everything about Qwikster, from its silly name to its inconvenient interface, was missing the consumer-friendly magic that had consistently landed Netflix on the top of consumer satisfaction polls. Worse, the move seemed calculated to kill off DVD–by-mail before consumers were ready to let it go. 


More than 1 million subscribers quit in protest, and the company’s stock plunged from $300 to $60. Hastings took a lashing in the media as America’s worst CEO, and the ridicule from angry customers and TV pundits was withering. 


Marc Randolph, who has advised several tech startups since leaving Netflix in 2002, said the Qwikster launch was “ham-handed, tone-deaf, and unquestionably damaged the brand.” But Hastings was right to stay focused on the company’s future, which was instant streaming and not “mailing plastic around the world.” 


“What is truly mind-blowing is that when I was CEO, trying to build up my nerve to walk away from selling DVDs, I risked alienating tens of thousands of customers,” says Randolph. “Reed is showing that he has the courage and conviction to do the right thing despite having tens of millions of them. This is why he’s the best entrepreneur on the planet.”


Gina Keating’s new book, Netflixed: The Epic Battle for America’s Eyeballs, is available this month.  


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