Key Lessons learned by Netflix in Early years

The early years were very defining for Netflix as they tried different business models and strategies. Their fail fast approach helped them to try out various strategies and quickly figure out which ones were working and which ones weren’t.

One of the key lessons they learnt in the beginning was that it was not necessary for there to be retail locations to reach subscribers. They used the US postal service to deliver the DVDs to customers. This lowered their costs significantly as they were not required to pay location rent or salesperson salaries.

Further, without concentrating on VHS tapes that most rental stores kept, they focused on DVDs. More and more people were buying DVD players and they benefitted from cross-promotional programs between makers and sellers of DVDs. DVDs were also very light and thus inexpensive to ship. This gave them increased competitive advantage over traditional stores.

Their initial pricing model was similar to rental stores – a fixed price for the rental and delivery, and a late fee for late returns. Netflix was receptive to realize the frustration this pricing model resulted in for the customers. They had to pay similar prices for slower deliveries. Plus, the high late fees associated with rentals discouraged most people.

The inflection point for Netflix came when they switched to a prepaid subscription model. Customers were only required to pay a monthly subscription fee to hold 4 movies in a month. They could exchange them with 4 other movies the next month. This enabled them to turn their disadvantage of slower delivery times into the customers having a movie every night.

Netflix continued to learn further and their model underwent one more iteration. They recognized that allowing customers to exchange movies as frequently as they liked enabled them to explain their value proposition better and market with an ‘unlimited’ tag. This attracted the frequent watchers and Netflix quickly became their go-to source for movies. They have continued to use this strategy to this day.

After changing their business model, Netflix encountered the problem of recent releases being over-shipped and running out-of-stock. They started an editorial blog to recommend 5 movies everyday to counter this problem but these movies would also run out-of-stock everyday. Netflix then developed a proprietary recommendation system based on user’s preferences and tastes. This enabled them to have a uniform distribution of demand across different genres. Netflix then stopped recommending movies that were out-of-stock and this finally solved their problem. New release rentals dropped to 30% from 70% in 2006. They have used the same lessons in their later strategies and these have contributed to the enormous success they had with VOD.