Latest / The Pivot Podcast with Fexingo: How Businesses Change Direction and Survive Disruption / How Netflix's DVD Business Model Almost Killed It
Transcript
- Lucas: So here's a number I've been thinking about: in 2007, Netflix had about seven and a half million subscribers, and they were almost entirely a dvd by mail company. Their market cap was roughly one point four billion dollars. Luna: Right — the red envelopes. I remember those. And streaming was barely a thing. Lucas: Exactly. They had launched streaming that same year, but it was a side project. Maybe nine hundred titles, mostly older content. The DVD business was the engine. It had incredible margins — they'd figured out the logistics better than anyone. Luna: So what broke? If the model was working, why pivot? Lucas: Well, Reed Hastings saw what was coming. Bandwidth was getting cheaper. YouTube had shown people would watch video online. And the DVD business — profitable as it was — had a natural ceiling. It was physical. You can't scale physical faster than the post office can move. Hastings later said he realized that by 2013, streaming would be the primary way people watched movies. Luna: So he decided to bet the company on something that wasn't yet the main business. That's a gutsy call. Lucas: It was. But the way they executed it — that's the cautionary tale. In 2011, Netflix announced they were splitting the DVD business into a separate company called Qwikster. The idea was to let streaming run independently without being dragged down by the declining DVD operation. But the announcement was a mess. Luna: I remember the backlash. People were furious. They didn't want two queues, two websites, two bills. Lucas: Within four months, Netflix lost about six hundred thousand subscribers in the U.S. alone. The stock dropped from around three hundred dollars to under sixty. That's a sixty percent decline. Hastings had to publicly apologize and scrap the Qwikster plan. Luna: But they didn't scrap the streaming pivot. They just stopped calling it Qwikster. Lucas: Right. They kept investing in streaming content. They started producing House of Cards in 2013. That was the real turning point — spending one hundred million dollars on an original series based on data they had about what subscribers watched. No one in Hollywood was doing that. Luna: It's interesting — the pivot itself was correct, but the branding of the pivot almost killed them. It's like the strategy was sound, but the communication was toxic. Lucas: Exactly. And there's a deeper lesson there. When you're pivoting away from your core business, you have to manage the transition in a way that doesn't alienate the customers who are still funding that core business. Netflix's DVD customers felt abandoned. Lucas: Let me throw another number at you. By the end of 2013, Netflix had about forty-four million streaming subscribers worldwide. Today, that number is over two hundred and sixty million. The market cap is around two hundred billion dollars. Luna: So from one point four billion in 2007 to two hundred billion today. That's a compound annual growth rate of — I'd have to do the math — but it's enormous. Lucas: Roughly thirty percent per year over fifteen years. Very few companies sustain that. Luna: But wasn't there also a moment when they almost pivoted too late? I mean, Blockbuster had a chance to buy Netflix in 2000 for fifty million dollars. They passed. Lucas: Right, that's the famous missed opportunity. John Antioco, Blockbuster's CEO, later said he regretted not taking the deal. But even if Blockbuster had bought Netflix, they probably would have killed the streaming side. Their whole model was built on late fees and physical stores. Luna: So the lesson might be that the pivot requires not just a new product, but a completely different mindset about how you make money. Lucas: Precisely. Netflix's DVD business had high variable costs — postage, distribution centers, packaging. Streaming has high fixed costs — content licensing and production — but near-zero marginal cost per subscriber. That changes everything about how you price, how you market, how you grow. Luna: And that's probably why they were able to eventually recover from the Qwikster fiasco. The underlying economics were so much better. Lucas: Yeah. But they almost blew it by moving too abruptly. If you look at the timeline, streaming didn't become Netflix's primary revenue source until around 2015. They needed those four years of DVD profits to fund the content library. Luna: So it was a gradual pivot disguised as a sudden one. Lucas: Exactly. And that's the nuance a lot of coverage misses. The pivot wasn't just 'we're going to be a streaming company.' It was 'we're going to run two businesses side by side for a few years, and we need to manage the decline of the old one without killing the cash cow.' Luna: That's really hard to get right. Most companies either starve the new thing or cling to the old thing too long. Lucas: And Netflix almost did both — they clung to the DVD model for too long in terms of corporate structure, but then they tried to rip the bandage off too fast. It's a classic tension. Luna: If today's episode was useful to you and you appreciate that it's ad-free, buy me a coffee dot com slash fexingo helps. That's literally what keeps the podcast going. Lucas: Yeah, it's a small gesture that makes a big difference for us. So if you feel inclined, that's the link. Lucas: Anyway, back to Netflix. One thing I find remarkable is that the streaming pivot also changed the kinds of data they collect. With DVDs, they knew what you rented. With streaming, they know when you pause, rewind, abandon, binge. Luna: Right, that's the data that drove House of Cards. They knew that users who watched the original British version also liked David Fincher and Kevin Spacey. So they greenlit a series that had a statistically proven audience. Lucas: That was unprecedented. Traditional Hollywood greenlights a pilot based on a script and a producer's track record. Netflix greenlit a two-season, one-hundred-million-dollar commitment based on user behavior. That's the pivot's real payoff — not just a new delivery channel, but a new way of deciding what to produce. Luna: And now every streaming service does that. But Netflix was first. Lucas: First, and willing to take the risk. But let's be clear: the risk only paid off because the pivot was executed over years, not months. They started streaming in 2007, introduced originals in 2013, and didn't fully separate the DVD business until 2016 when they finally spun it off as a separate entity. Luna: So it was a ten-year pivot, not a one-year pivot. Lucas: Exactly. And that's the template. When your core business is still profitable, you don't abandon it overnight. You use its cash flow to fund the new model, and you give yourself time to learn. Luna: Are there other companies that have done this well? I'm thinking of Adobe, which moved from selling software in boxes to a subscription model. Lucas: Great example. Adobe announced in 2013 that they would stop selling Creative Suite as a perpetual license and move to Creative Cloud subscriptions. Their stock dropped about thirty percent initially. But they stuck with it. By 2015, subscription revenue was the majority. Now it's over ninety percent, and the stock has multiplied many times over. Luna: So the pattern is similar: a multi-year transition, some initial pain, but a much better long-term business model. Lucas: Right. And both Netflix and Adobe had to manage the expectations of investors who were used to the old model. That's the other layer — you're not just pivoting your product, you're pivoting your investor base. Luna: What about companies that tried and failed? I'm thinking of J.C. Penney's attempt to reinvent itself in 2012 under Ron Johnson. Lucas: That's a textbook failure. Johnson came from Apple and tried to remake J.C. Penney into a hip, no-coupon, everyday-low-price retailer. He eliminated sales and promotions. The core customers — middle America — hated it. Within a year, revenue had dropped twenty-five percent, and Johnson was fired. Luna: So what was different? Why did it fail while Netflix's pivot succeeded? Lucas: Three things. One, Johnson changed the pricing model too abruptly — no gradual transition. Two, he didn't understand that J.C. Penney's customers loved the game of hunting for coupons. Three, he didn't have a new profit engine ready to replace the old one. Netflix had streaming ready. Adobe had Creative Cloud ready. J.C. Penney had nothing but a new logo and some Michael Graves teapots. Luna: So the pivot has to be from a position of strength, not from desperation. Lucas: Ideally, yes. But sometimes desperation forces the pivot. Look at how Nintendo pivoted from playing cards to video games, or how IBM went from hardware to services. Those were survival moves. But even then, they took time. Luna: I think the Netflix story is the best modern case because it's so well-documented. We can see the numbers, the missteps, the recovery. Lucas: And it's ongoing. Netflix is now pivoting again — into advertising and gaming. They launched an ad-supported tier in 2022, and they're building a gaming division. The question is whether those will be as successful as the streaming pivot. Luna: That might be a future episode. Lucas: It might be. For now, the takeaway is: a pivot is not a single event. It's a multi-year process of managing two business models at once, using the old one to fund the new one, and communicating the change in a way that doesn't scare away the customers who pay the bills today. Luna: And if you're a business leader listening, maybe the first question to ask is: what is your version of the DVD business? What's the thing that's profitable today but has a ceiling? Lucas: That's exactly the right question. Thanks, Luna. Luna: Thanks, Lucas. See you next time.