Reed Hastings: Innovator of the Year

The Netflix chief is out to conquer the realm of movie rentals

Q&A: Reed Hastings
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On a Wednesday afternoon in early March, about 300 staffers gathered around the earth-tone courtyard of Netflix's 165,000-square-foot, Tuscan-style complex in Los Gatos, Calif., right on the edge of Silicon Valley, as a casually dressed executive with an easygoing manner and a great smile told them the best news they'd heard all year: Netflix had just signed its 10 millionth subscriber.

The significance of that number wasn't lost on Reed Hastings, the 48-year-old founder, CEO, president and chairman of Netflix: After a decade in business, the company was surging -- an amazing accomplishment in the midst of an economic crisis.

But his way of presenting it was as revealing of his style as his success -- success that has come from some of the most original thinking in today's entertainment environment and that has led The Hollywood Reporter to name him its 2009 Innovator of the Year.

Hastings had champagne for everyone and his company's distinct red-and-white log was painted on his face along with -- in gold glitter -- the number 10 million. He carried his ever-present BlackBerry, with its photos of his two young kids, and his laptop computer was somewhere nearby -- the closest thing he has to a personal office, which he's resisted for years in favor of easy mobility.

"I'm just around," he quipped later. "I have no place to hibernate."

Hastings, in fact, has no plans to hibernate -- nor will he have time, given his ambitious plans for his company.

While Netflix's core business -- renting a vast selection of DVDs to its subscribers by mail -- is racking up record profits (operating income was more than $910 million last year and net income $121 million), Netflix is investing in streaming media, bundled together for consumers at one price.

Hastings believes you have to invest for long-range goals, even if that hurts the short-term earnings.

"We're losing a fortune," he says. "I mean, we're paying the studios a fortune for content, and paying the cost for distributing and we have no revenue." But, he says, "you have to be willing to financially support the innovation. If it has to be profitable in the first quarter, you get very narrow-gauge innovation, not the broad approach."

It's the broad approach that has defined Hastings' thinking his entire life. How many other business pioneers have made a fortune from their first company, then gone back to college to improve their education? How many have spent some of their most productive years as a Peace Corps volunteer in Swaziland, one of the poorest countries on Earth? How many have devoted vast financial and personal resources in a protracted battle to improve education for everyone, as Hastings has done?

Most business tycoons remain purely that. But Hastings is one of the pioneers in a new wave of executives who are as socially minded as they are money-minded, who want to change the planet even more than their bank accounts.

"The compelling thing about Reed," says Dan Schnur, Director of USC's Jesse Unruh Institute of Politics, "is that he was willing to work in politics for a long time, as much as he disliked it, in order to accomplish a set of policy objectives that had absolutely nothing to do with his own professional success."

Wilmot Reed Hastings Jr. was born Oct. 8, 1960, in Boston, where his father was a corporate lawyer who also worked in government, which required the family to relocate to Washington. There, his mother worked with first-time offenders in the criminal justice system.

In his late teens, Hastings enrolled in a small liberal arts school, Bowdoin College in Maine, where he proved a math whiz and won the mathematics department's top prize. After graduating in 1983, he enrolled in a Marine ROTC program, which led him to spend a summer in boot camp in Virginia.

It was Hastings' belief in service that led him to join the Marines. But what he learned that summer was that he didn't want to be a Marine at all: Being told to make his bed a certain way and having all his questions and suggestions slammed down wasn't for him. So after graduation, he joined the Peace Corps.

Hastings was assigned to Swaziland in Africa, where he taught math classes for two years and where his lifelong interest in education began.

"These kids all saw it as a privilege to be in school, as opposed to working the fields," he recalls. "I learned a lot of respect for the effort they put in."

Upon his return to the U.S., Hastings enrolled in graduate school at Stanford University, where he earned a master's degree in computer science. "I was very hungry for intellectual stimulation," he says.

In his first subsequent job, at Adaptive Technology, he invented tools to debug software and learned about the importance of focusing on one great product. He took that knowledge to his own firm, Pure Software, which made products to troubleshoot software.

Pure was an immediate hit and doubled in size each year. But Hastings wasn't happy.

"The company was growing beyond my ability to manage it well," he acknowledges. "We were growing 100% a year, but it wasn't that enjoyable. I always felt like we weren't doing a great job."

After the company was acquired in August 1997 by Rational Software for $750 million, Hastings chose to leave. Anyone else might have sat on his laurels. But here's where Hastings was different.

First, he and his closest colleagues "spent a whole bunch of time talking about the mistakes we made before," in the words of Patty McCord, who worked at Pure and now heads human resources at Netflix.

Then, even more surprising, Hastings went back to Stanford to pursue a degree in education.

Hastings never completed that degree, but it fueled his concern for education and his belief that English should be the primary language taught in schools.

He also wanted more charter schools, as an alternative to problem-plagued public schools. That issue troubled him so much, in fact, that he invested millions in a ballot initiative and would have served as president of the California State Board of Education had fellow Democrats not blocked him.

But Hastings was blocked, and with that public service avenue stymied, he returned to his first interest: business.

"I realized I should do business," he says. "Business I love."

During the time Hastings was pursuing his educational passions, he simultaneously funded two startups. One provided tools to test the load capacity of Web sites; the other was based on an idea he had when a personal movie rental went awry.

In the mid-1990s, Hastings had rented a VHS tape of "Apollo 13" from a video store, then lost it. The result was a $40 fee and a lot of aggravation.

He never forgot it, and talked to a number of venture capitalists about the possibility of renting videos by mail. The problem was, a VHS was too expensive to send through the postal service.

But when he learned of a new invention called DVD, everything changed.

"You couldn't buy a DVD then," Hastings notes, "but I knew they were a lot like CDs. So I ran out to Tower Records and got a bunch of CDs. I put them in envelopes and mailed them to myself. I had to wait for a day to see: Would they arrive? The next day, they all came -- and none were broken. I said, 'Hallelujah!' "

That hallelujah moment was the genesis of Netflix.

Then, remembering a time when he had lived in England and seen that local residents would leave out their empty milk bottles to be replaced by the milkman with full ones, Hastings conceived of a similar strategy for DVDs.

"I realized you could run our service that way," he says. "When you return one, you get another."

His idea to offer all-you-can-watch for a single subscription price was an immediate hit. Launched in 1999, Netflix had 270,000 subscribers by the end of 2000. The addition of distribution centers all over the U.S., ensuring overnight delivery, sparked even more subscriptions.

Now Netflix sought to adopt a variation on a strategy that had worked for Blockbuster, its chief rival.

In 1997, Blockbuster had developed a revenue-sharing model with the major Hollywood studios, which allowed it to buy more DVDs for less money. Hastings hired Ted Sarandos to knock on the doors of Hollywood's studio leaders in 2000 as they adapted the Blockbuster model to serve their own DVD-by-mail purposes.

The timing was favorable: Sony and Warner Bros., two big early proponents of DVD, wanted to widen distribution.

"They saw us as a champion of the format," Sarandos says. "They were tough deals to make, but once we had the model, all the others followed."

By 2002, Netflix was ready to go public. A year later, despite all the costs of initial investment, it had turned a profit.

"Now," Hastings says, "the question is: Will we live for 10 years or 100 years?"

Wall Street clearly believes in the latter. As a result, Netflix's shares have doubled since November alone, because investors believe that Hastings will steer his $1.4 billion (2008 revenue) company to a bright future, continuing a pace that saw a 23% growth in subscribers last year and 32% growth in 2007.

But Netflix's success isn't just based on Hastings' central, innovative idea; it's also based on an exceptionally imaginative management style.

Spend a day at the company and you learn what makes it tick so well. It's not just the almost idol-like adoration of Hastings himself; it's his conviction that there should be a minimum of rules and a maximum of employee interplay with fellow employees, customers, suppliers and investors.

"Bureaucracy creeps into an organization because managers want to control their people for optimum efficiency," he argues. "There's a natural urge to serve the company, to set procedures for everything. That drives out the creativity and the flexibility in an organization.

"You have to make it part of the value system that people are thinking about new ideas," he adds.

"People innovate or die."

Netflix has a published list of nine values that guide every aspect of the company.

Employees are allowed to take as much vacation time as they want; they're free to choose how much of their compensation comes in the form of salary or stock options; and those who are let go are given hefty severance packages so that their bosses don't feel guilty, and they can continue to the search for stars for every position.

In return, Netflix expects every employee to provide "ultra-high performance" and fit in with a culture that encourages "talent density."

For staffers, the company is rich with team-building activities like quarterly musical skits put on by the newest employees. "Our managers are managing human beings, not machines," Hastings argues. Given this, "you tap into feelings of creating a strong team dynamic."

That will be needed if Netflix is to chart the rough waters ahead.

Hastings, of course, has invested massively in streaming technology, which might eventually do away with the red Netflix envelopes that have become ubiquitous throughout the country.

"It was obvious that plastic discs would go away within 100 years, but we thought it would be sooner," he admits. "We thought by 2008, our business would be half streaming -- and by 2008 it was almost zero. So we again predict: By 2013 it will be half our business."

Right or wrong, he says, "We're always questioning: 'Are we doing the DVDs the right way? Are we doing the Web site the right way?' We think of it all as a bunch of experiments."

The experimenting has yet to go beyond domestic confines, but Netflix also has expanded its brand by incorporating it into the Xbox 360, TiVo and HD flatscreen TV from LG, Samsung and others.

Applications also are available for the Roku digital video player; and Netflix can now be streamed on a Mac.

But right now, Hastings says his biggest concern is something else: the rapid rise of Redbox, a company which places DVD kiosks in supermarkets and malls, offering rentals for $1 a day.

"It's a significantly bigger problem than Blockbuster, competitively," he says. "It's terrible for us (and) I don't think it's good for the industry either, because it so cheapens the movie rental. But it's very popular with consumers."

How this will impact Netflix remains to be seen. But the company has taken on competition before and won: Hastings remembers 2005, when Blockbuster and Walmart entered the DVD rental market with Amazon also threatening to join the fray.

"I was skiing with my family," he says, "and I pulled out my BlackBerry and remember getting a message from someone at Amazon: 'Do you want to do some kind of partnership?' I instantly knew they had decided not to enter the U.S. market. I was so happy."

Within a year, Walmart had dropped out of the rental business, while Blockbuster's future remains unclear.

Yes, there's a growing legion of players online and other competitors to threaten Netflix's dominance. But Hastings is confident he'll survive and even flourish.

"It's like being a player in the Super Bowl," he says. "You're not scared of the competition; you're challenged by them. You just want to play your best game."