After a local video store slapped him with a $40 late fee for Apollo 13 in 1997, Reed Hastings got to thinking about a DVD-by-mail rental service. The Netflix CEO later tossed aside the rental model in favour of a more customer-friendly subscription service and, in 2007, embraced online video streaming. Fast-forward to today, and Netflix is one of the hottest companies on the planet, leading the charge into a new era of TV that’s on-demand and available on everything from a smartphone to a flat screen. But the price of acquiring all that content is rising fast, raising questions about Netflix’s business model and soaring stock price, including a few from Hastings himself.
We’ve heard a lot about how the future of TV will be interactive, because the internet provides the opportunity for two-way communication. Why hasn’t that materialized in a big way?
Interactivity and a better experience aren’t always the same thing. Now, interactivity is a big part of video games, which have been a big part of entertainment for 20 years. That’s what we think of as a ‘lean-forward’ type of entertainment. It’s much more intense. But TV is more of a ‘lean-back’ entertainment—so the big improvement there is on-demand, because it conforms to your schedule. If you look at our shows, like House of Cards, that would have done very well on cable. It’s not a new form of entertainment.
Do you think that a revolution is still coming for TV? Will there be an iPhone moment?
Those sorts of things are very hard to predict. My favourite example is someone in 1850 taking care of horses as a farrier. They would have said, “Look, horses have been part of human existence for 5,000 years. We are horse people. It’s permanent.” But all of a sudden, the internal combustion engine comes along and, with it, oil fields and automobiles, which basically replace the horse completely. So we often have these long periods of stability and then a sudden inflection point. Maybe there will be some magic around something like Google Glass or a smart watch, but it won’t happen for the next few years.
So what does television look like to you, two or three years from now?
Screens will be very thin like an iPad, but very large. They will be 4K [ultra-high resolution] with 60 frames per second—such incredible video quality, compared to what we’re used to today. The user interfaces will be some mix of voice and touch—kind of like using an iPhone to control the TV. And there will be a lot of personalization. If you live in a multi-person household, it will say, “John or Susie is now watching,” or maybe it will just recognize you. Your mobile phone, tablet and TV screen will seem very similar in the way you interact with them.
This was a big year for Netflix, when it came to original programming. House of Cards won three Emmys, and you just announced another season. How did the decision to get into original programming come about?
If you look at cable networks, they almost always start licensing content wherever they can, so they can build a subscriber base. But then they start doing their own content; it’s a pretty well-trodden path. Of course, most of the time, it’s not very good at first, but our team in L.A. did an extraordinary job in being willing to pay up for David Fincher, Kevin Spacey and Robin Wright to make a great signature item. But the business evolution itself is well understood.
For those of us who aren’t in the TV industry, what’s the advantage of producing your own content? I can’t imagine it’s cheaper.
No, it’s actually quite expensive, but it gives you something unique. Without that, you’re merely licensing old shows from everyone else and it’s very substitutable. When you finally get big enough to afford to do shows, like Orange Is the New Black, which everyone wants to see, you’ve got something that people talk about and identify with Netflix. It’s a reason to join. It’s also a reason to stay for the next season. It’s a powerful tool if the shows are of high quality. What’s unique for Netflix is that we get to release these programs around the world at the same time. That’s a tremendous difference, because everywhere else, the entertainment landscape is Balkanized nation by nation. Cable networks all have weird agreements about how soon a show can be made available [after its original broadcast date]. We’re part of the next wave, where it’s all one world, one internet.
This is a risky business, though. A lot of shows don’t pan out—or maybe they’re critically acclaimed, but no one watches them. What’s to stop Netflix from falling into the same trap that some networks have, where it’s all about cheap-to-make reality programming?
The fundamental advantage we have is being over the internet. We can do different things for different people. We don’t only have to do high-brow House of Cards-like content that’s very elite and intellectual. We also do a great business on Hemlock Grove, which is more of a thriller, or horror. But it gets promoted to different people, based on their tastes. We can also do a Russell Peters special. In broadcast or cable, it’s the same show for everyone. That’s what forces them to the lowest common denominator. We don’t have to do that. If we had to show Russell Peters from 7 p.m. to 8 p.m., we would probably have to try and tone him down.
You don’t need a mass audience.
The company does, but any one show does not, so we can let each comedian and each director be out there and be passionate about what they do. Then it’s up to the algorithms to correctly promote the right things to the right people. Of course, anyone can search for anything, because they’re in control, but I’m talking about the suggestions we make. The diversity that the internet allows gives us a huge fundamental advantage, but you still have to produce good shows. We may have a strategic advantage, but we can still overwhelm it with bad execution. So as long as we do good shows, we have this creative freedom that will find the audiences.
Netflix is adding a lot of subscribers, but you’re spending a lot on content and you’re not charging that much. Won’t you have to raise prices?
We do need revenue growth, but that doesn’t mean we need to increase prices. You get great revenue growth from membership growth. Our membership two years ago was 22 million globally and now it’s 40 million. That’s what allows us to get more content. We should be able to grow like that for many years, because of the overall evolution to internet video.
What happens when you become a mature company? You’ve already tried to effectively raise prices once, which didn’t go over well. You were forced to apologize for it. Does that mean you’re forever locked into $7.99 a month?
We’ve been super-happy with the growth we’ve had at $7.99. So, instead of thinking about that, we’re thinking about getting more content, making the streaming better and making the user interface better. We have no plans to change. I think, if you look especially at free services like Google and Facebook, you see that the combination of low prices—or, in their case, free and ad-supported—and very high volumes has had the biggest impact. When you grow up, as I have, in the shadow of Steve Jobs, Bill Gates and others, success is defined as the total global transformation of a market. To achieve that, you need low prices and an attractive offering. It’s about trying to make a positive impact on a big scale.
Is the ambition to be a disruptive company, so that everyone will eventually be watching Netflix and no one will watch cable and satellite? What’s the long-term goal?
We can’t replace cable. They have sports and news and lots of other content and categories that we don’t have. We’re just not an effective replacement. But we can be a place where people choose to spend most of their time. When you sit down on the sofa, do you pick up your cable remote, or do you pick up your iPad?
In your most recent letter to shareholders, you took the unusual step of suggesting Netflix’s shares may be overvalued. You don’t see a lot of CEOs doing that. Why did you weigh in?
When you look at the market, with the S&P at a record high and Netflix, in particular, being the fastest riser this year in the whole S&P 500, that indicates to us that shareholders are piling into the stock, because they are momentum investors. They just buy the stock because it’s going up not because they follow the economics of the company. Our worry is that too many momentum shareholders will lead to a big run up and a correction down the road.
I’m not sure your words had much impact, judging by the stock price.
No, they didn’t seem to. On the other hand, when your stock is down and you say it’s undervalued, that doesn’t work well, either.