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How Did Netflix Start?

When Marc Randolph and Reed Hastings founded Netflix in 1997, the company appeared to be an upstart DVD rental business whose only real value proposition was the mail-order element of its operation.

Fast forward two decades and Netflix has become one of the biggest TV and movie studios globally, with more subscribers than all the cable TV channels in America combined. So how did Netflix start and end up moving from movie rentals to making the movies themselves in just 20 years? By being consistent and ambitious.

Netflix innovations

Netflix has innovated in several entertainment key areas. First, they started with a DVD rental business bolstered by the internet, then developed a streaming business from scratch, and finally invested in creating original content.

But many of the most pivotal business decisions Netflix has made in the past twenty years have not been all surprising. As we will see, it makes perfect sense that Netflix became a movie studio — it just did not look that way to most people in the beginning.

The History of Netflix

Netflix always seems to capitalize on the latest consumer trend. The company has enjoyed a fair share of these kinds of opportunities, but the company’s early wins had very little to do with good fortune. Netflix’s secret weapon was a keen understanding of its market. Randolph and Hastings may have built their initial business around DVDs, but they knew that they would not be in the DVD business forever.

In 1997, Blockbuster was the undisputed king of the home movie and video game rental services. So when Netflix launched in ’97 with its mail-order DVD rental business model, most people saw Netflix as a more convenient way to rent movies.

Although this was an essential element of Netflix’s early business, Randolph and Hastings never intended to be the best entertainment distribution company. They saw a great opportunity to use the internet to decentralize entertainment and unbundle premium TV from the monopolistic grip of Big Cable players.

DVD rental was not Netflix’s endgame, it was just a way for the new company to gain a tentative foothold in an extremely competitive market. Netflix had over 6.5M subscribers by the end of 2006 —a 7-year annual compound growth rate of over 79%—and the business had finally become profitable, generating over $80M in profits.

“Movies watched” metric

The company was able to achieve an impressive growth by challenging incumbent players with a genuinely innovative business model and by focusing on its single North Star metric: movies watched.

Cable TV channels usually calculate their audiences based on how many viewers a TV show has. Netflix handles this from the opposite direction by focusing on how many movies a viewer has watched. Netflix leverages its vast media catalog to optimize for movies watched per individual user instead of optimizing individual shows to maximize the number of viewers.

This little yet crucial factor has allowed Netflix to focus more on how to better engage viewers and iterate on its core “movies watched” metric through key product initiatives such as its CineMatch recommendation algorithm.

In 1999, many analysts doubted the viability of Netflix’s subscription-based model, but this was key to the company’s success because it helped position Netflix as a leader in its field with a service where you could watch as many movies as you want rather than paying per rental. This was the real innovation that contributed to much of Netflix’s early growth.

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