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Private Screening

Reed Hastings, founder and CEO of Netflix -- and Fast Company's Customers First Award winner -- talked recently with Fast Company Associate Editor Jena McGregor about customer experience, the Amazon and Blockbuster threats, and what's in store for the online DVD rental service company. Here, we offer WEB EXCLUSIVE bonus material from that interview.

FAST COMPANY: You've talked in the past about how much you admire Howard Schultz and Starbucks. Is it that because of the customer experience they provide?

Reed Hastings: Starbucks was not customer-driven, it was vision-driven. Howard went to Italy, saw the experience of what a coffee bar could be, then re-created that in America, despite many, many skeptics.

Now, did he listen to customer feedback about the necessity of low-fat and non-fat milk? Sure. Has he adapted in various ways after listening to customers? Sure. But he fundamentally had a vision that he could create this wonderful third place for people to gather, and that he could start the coffee culture throughout America.

When people asked how big the market was for espresso and cappuccino, there was no way for him to prove it was a multibillion dollar market. He could say, "I think it will be x, but it's up to us to create it."

Similarly, people ask us, "What are you trying to do? How big are you going to make it?" But nobody's ever done it. We continue to prove that it’s relevant and compelling to many people. We're creating a new paradigm but at this point the Starbucks and Netflix parallel diverges because we're not doing retail stores. But in both cases, there was no existing market. In both cases, many people thought it was a little niche and it's turned out to be a very large and wonderful market for consumers, employees, and shareholders.

FC: They're also known for customer service, no? Do you see that as a comparison?

RH: Because we're Web-based, our warehouse employees never interact with the customer. So what we focus instead on is to have the Web site be the most personalized in the world. If the Starbucks secret is you get a smile with your latte, ours is that the Web site adapts to an individual's taste, so that of the 50,000 movies available, we can figure out which 50 we ought to put on the screen that would be relevant to the individual.

FC: What happened when Wal-Mart entered the market -- did you shift your focus more toward customer service, knowing you can't beat them on price?

RH: November 2002 was when they entered, and we'd been doing it for three years already. We knew it to be pretty challenging to do well, and we knew there would be large barriers -- that this was not going to be a cakewalk for other companies. Our idea was also that it's a big market. There's 65 million homes in America that subscribe to cable and 25 million that subscribe to satellite TV. That's 90 million homes that pay for subscription entertainment, so that's the addressable market -- people who have the money and interest to have our service. So having another company come in and validate the market could be very helpful.

We had opened 10 distribution centers, and we opened 10 more. The key is we didn't let it rattle our confidence or game plan, and we stayed on course. That next year we opened our distribution centers and continued to grow. Our stock price was all over the map, but if you look at the graph of our numbers of subscribers, it's a straight curve up. It's incredibly smooth. People tell their friends about Netflix, the word spreads, and we make the service better. In many ways, it's about staying on game and focusing.

Most companies over-diversify and very few companies are too focused. Look at Starbucks: They're basically doing the same thing as when they were founded in 1985, but they're doing it on a much grander and more important scale. Businesses that are simple that way, that have a straightforward model and relentlessly focus on the execution, can be very large and very successful because they don't have to invent whole new products and go through the technology transitions. It's one model -- improve it, improve it, improve it, get it bigger, improve it, get it bigger, improve it, over and over and over again. That's very exciting because you can make a very big cultural consumer impact.

FC: What are some specific things you've been doing to continually improve customer service over the last few years?

RH: The key insight in customer support is when there's a problem, you've already hurt the experience. So 95% of our work is to avoid the problem in the first place. We work really hard to eliminate everything customers might complain about -- like that they got a scratched disc or that their disc hasn't shown up. We have an active integration with the post office on theft and loss, so as soon as loss starts showing in a zip code higher than it should, we and the post office work together closely to get that resolved the way it should be. We think about it mostly in terms of problem avoidance.

We have a great customer support group. The miraculous thing about it is it's smaller now than in 2000 when we had only 100,000 customers instead of today's 3.2 million. It's not because people are on hold longer -- we still have great response times. It's because we've learned how to avoid so many problems. That's the big leverage. You read a lot about outsourcing of customer support -- send it to India, save $3, all this stuff. That's totally uninteresting to us. We're focused on much higher leverage and avoiding issues and fixing them at their root cause.

FC: Who's your ideal Netflix customer?

RH: A customer who's traveling and forgets to rent a movie and watches no movies in a month [might be], because they haven’t cost us anything and they've paid us $9.99 or $17.99. On the other hand, a customer who's a very light user is not going to stay with us very long. It's not that there's something wrong, that they don't like you, it's just that they aren't watching any movies. That's the number one reason for customer churn. On the other extreme we've got users that are total movie hounds -- they're watching 15 movies a month -- and in some narrow sense, it would be better to get rid of them because you're losing money on them. But then, they stay with us a long time. So there is no best customer. We try to make the experience work for all of them and we try to balance that.

An interesting exercise is when we run short of titles. We try to always be in stock, but sometimes we're not. Say we've got 1,000 copies and there's 5,000 people who want a movie. So maybe somebody's already gotten a lot of value for their $20 or $18 or $9 because they've watched a lot of movies while other people have hardly watched that many movies this month, so they haven't gotten enough value yet. Our sense of fairness is that if we run short, it goes first to the people who haven't gotten the most value yet in order to create a fair and balanced experience for our customers.

FC: What have you learned about trying to delight your customers?

RH: Back in the dot-com days, we didn't have that much money, but we spent a half million dollars to get this nice molded DVD rack, this really nice thing to hold your Netflix movies. We thought boy, this is going to be great for new customers, and they're going to love us, and churn is going to drop significantly.

But of course we were smart enough to test it, and every other customer got one. We looked at 10,000 customers who got one and 10,000 who didn't and the satisfaction and the churn were still the same in the two groups. The a-ha! for us is that consumers don't want doo-dad extras, they want the core service to work well -- getting their movies on time, making the Web site fast. They thought, "I can figure out where to store my own movies."

Then, for a while we started doing bonus shipments. When we had excess inventory of something, and it's in your queue, but not in the first position, wouldn't it be cool if we sent it to you a week in advance? It's not going to cost us more. But it overwhelmed customer support. As soon as customers got their bonus DVD, no one understood it. They were afraid it was going to cost them. It confused them. It was a catastrophe. Our consumers as a whole want simple and reliable things they understand and not fancy extras.

FC: What do you think of the threat of Amazon entering the DVD rental business?

RH: Amazon's a great company with a lot of skills. A year ago, we thought they were going to enter into the U.S. or the U.K. They entered the U.K. but have not entered the U.S. It seems less likely and less formidable that they will at this point -- less likely because if they were going to they would have by now and less formidable because of our price cuts. We're priced at a level where you can only break even on very high volumes.

FC: And what about Blockbuster? What are their competitive advantages? They don't seem to have the software recommendation competency that Netflix has.

RH: Blockbuster's single biggest advantage? Instant gratification, very simple. If you have $4, there's zero complexity, zero uncertainty. There's the movie, you pay your $4, you walk out. Online, they're integrating with the retail side, and the two free coupons [that Blockbuster gives away to its online customers for in-store rentals] is a good way to recognize that. The other thing is branding. On the coasts and among the elite, they say, "Oh, Blockbuster" -- everyone's been burned -- but in the rest of the country, it's a brand customers know and trust. They may not love them -- it's like Kmart and Sears -- but it's straightforward. The brand is a big advantage for them, because it's known.

As for the software, that's our core technological advantage, but I would say the Netflix brand and customer base are even more important. If I had to recreate something, I could recreate the technology faster than I could the brand. Netflix represents online rentals to the public -- that's why being first is forever an advantage. Let’s put it this way: The technology is a $200 million barrier; the brand and customer base is probably twice that.

FC: So there's a lot of talk about downloading movies on Netflix, which you plan to begin testing before the end of the year. What do the next few months have in store?

RH: The next big wave in studio and Netflix profits is not downloading. It's high-definition DVD. The hardware industry wants it to succeed because they want to sell another 100 million high definition DVD players. The studio wants it to succeed because they want customers to buy another copy of The Godfather. Yes, there's a high-def DVD format war coming. Yes, it will get resolved. So the big economic story in the next five years is not downloading, it's high-definition DVD. What we see in downloading is that it will be a long, slow evolution that at some point, five to 10 years from now, will get really big. We'll be glad then that we've been doing it for five years.

See the full 2005 Customers First Awards.