JUMP CUT
A REVIEW OF CONTEMPORARY MEDIA

copyright 2013, Jump Cut: A Review of Contemporary Media
Jump Cut
, No. 55, fall 2013

Digital dreams in a material world: the rise of Netflix and its impact on changing distribution and exhibition patterns

by Kevin P. McDonald

This article examines the rise of Netflix, the Internet-based movie rental and subscription service founded in 1997, and its pivotal role in a rapidly transforming home entertainment market. Focusing on the period between 1998 and 2008, the article provides a history of the company and the strategic advantages that allowed it to outmaneuver various competitors. The article also considers the viability of Netflix’s business model and how the company has modified its focus throughout this period. By examining this history, the article shows that Netflix was the beneficiary of both its own fortuitous timing and glaring miscalculations by its competition. It also demonstrates the ways in which unlikely intermediaries are able to amass significant power and initiate industry-wide shifts in periods of rapid technological change.

The Internet killed the video store?

Netflix came and broke our heart
On-demand tore it apart
In my mind we lost the store
Be kind rewind forever more

In November 2010, the writing was on the wall or, to be more precise, on a dry erase board in the display window at Lost Weekend Video in San Francisco, CA.[1] [open endnotes in new window] The question of whether the Internet has killed the video store is accompanied by revised lyrics to a 1979 song by the British New Wave band The Buggles that seemingly answers in the affirmative. In this way, it’s not only a mournful lament about the declining state of video rental stores, but a contradictory and telling omen about our age of rapid technological change. The song, “Video Killed the Radio Star,” gained widespread attention as the first music video aired by MTV and has since served as melodic shorthand for the inexorability of media convergence.[2] Its lyrics bemoan the inevitable casualties of technological progress. The Lost Weekend Video Store’s parody, in contrast, evokes romanticized notions of the video store that had been displaced not necessarily by technology but by rapidly expanding corporate chains in the 1990s.

In this regard, the display obscures the immense impact video rental retailers had in inaugurating a new era of home entertainment and the upheaval they themselves had ignited within the media and entertainment industries. The tragedy for video stores was simply that they had been unable to leverage their pioneering role to ensure their survival in an era of new digital media. As this video store’s “clever-but-sad commentary” drew a few fleeting headlines, it was soon evident that these retailers were not alone in facing new and unlikely forms of competition.[3]

Approximately seventy miles south of Lost Weekend Video, the main culprit indicted in the store’s modified lyrics, Netflix, was obviously singing a very different tune. In the company’s 2010 fourth quarter letter to shareholders, CEO Reed Hastings announced that Netflix had completed one of its most successful years in what had been a largely successful first decade.[4] Launched in the midst of the late-90s dotcom boom, Netflix was among the legions of new start-ups hoping to parlay the Internet and associated digital technologies into a lucrative business endeavor. While most of these companies failed, Netflix succeeded by adapting the brick-and-mortar video store convenience into an online environment. The company was especially noteworthy in that it combined the power of a web-based interface with the existing United States postal system to deliver DVDs directly to customers. It was with this unique, and in some ways counter-intuitive, hybrid approach that Netflix supplanted not only neighborhood video stores like Lost Weekend, but leading corporate giants such as Blockbuster Video.

Though its initial success was closely tied to the blueprint provided by rental retailers, the company’s long-term ambitions revealed the limits of that model. By 2010, Netflix was shifting its attention away from DVD-by-mail operations to focus on its new streaming service—a form of digital delivery that seemingly brought to fruition the belabored dream of video-on-demand (VOD). With the success of this new service, Netflix amassed a subscriber base of more than twenty million, with seven million joining in 2010 alone.[5] This made it one of the largest subscriber services in the country, comparable to cable providers such as Comcast and premium cable networks such as Home Box Office (HBO). The company’s size provided it with leverage both as it prepared to expand internationally and as it worked with manufacturers to establish its streaming software as a standard feature on hundreds of consumer electronic devices.[6] The success of the new service also had its drawbacks as Netflix had to negotiate a new and very different set of distribution rights with content producers. The major media and entertainment conglomerates were eager to embrace the benefits of Netflix’s new streaming technology, but they were also extremely wary of the company’s instrumental position at the center of a rapidly changing and increasingly competitive home entertainment market. The resulting tensions contributed to a period of general volatility and vacillating strategies for the upstart company. Thus, even amidst apparent triumph, Netflix faced many of the same liabilities that eventually pushed video stores to the brink of extinction.

Although Netflix has ignited well-publicized debates among business executives and Wall Street prognosticators, the company and its practices remain a relatively unexplored object of scholarly study.[7] As the following study will show, Netflix provides a particularly illuminating case study because of how directly it intersects with many of the recent changes in home entertainment and because its impact underscores how new technologies and changing consumer preferences dramatically reshape the media and entertainment industry. To put it in slightly different terms, Netflix arrived at the time traditional content producers were shifting their focus to non-theatrical or secondary exhibition windows. This new approach to distribution and exhibition was accelerated by a succession of home media formats, from VHS to DVD and Blu-ray, and the different retail strategies they each involved.[8] During this same period the widespread introduction of the Internet and, more specifically, the increased availability of higher-speed broadband and wireless services made it possible to distribute, through streaming, a growing array of media in exclusively digital formats.[9] These changes coincided with a proliferating array of interactive consumer electronics that featured integrated Internet capabilities, including video game consoles, portable personal computers, smartphones, and high-definition television sets. While facilitating new opportunities for media convergence and exchange, these shifts also created a great deal of anxiety for traditional content producers like the major Hollywood studios, which have had to quickly adapt their core strategies in order to optimize the value of their assets and the rights they control.

At the dawn of this era, there was a great deal of excitement about the unlimited, even utopian, potential of new digital technologies. Even though movie and television producers foresaw the economic advantages of digital distribution and video-on-demand, they couldn’t or didn’t pursue those strategies in earnest or fully commit to the shifting priorities that such a transition would require. This lag allowed unlikely intermediaries like Netflix to take the lead and establish a critical ‘first-mover’ advantage in what still remains a tumultuous and perpetually changing market. The major media conglomerates, along with technology and telecommunications interests, now are attempting to regain their advantage by introducing competing services and by leveraging their access to premium content, popular Internet portals, and various distribution channels. Regardless of whether they could vanquish the likes of Netflix or not, clearly the dreams fostered by digital technologies still will remain closely tied to the material interests of the same oligopoly that has controlled media and entertainment for most of the past century.

The rise and fall of empire(s)

By the late 1990s, the Bay Area’s Silicon Valley was home to a growing number of technology-based firms. Amidst the burgeoning dotcom boom, countless entrepreneurs hoped to strike it rich by turning the still fledgling Internet and its associated digital technologies into modern day goldmines. While Netflix turned out to be one of the most successful and resilient of these early dotcom start-ups, it was not the first attempt to wed the video rental business with the new potential of the Internet. The idea in fact originated in 1984 thousands of miles away in Manchester Center, Vermont. There, Stuart Skorman purchased a small video rental store, Empire Video, which he would go on to expand into a six-store regional chain over the next decade.[10] Despite the success of Skorman’s store, he decided to sell Empire to Blockbuster Entertainment in 1994, just as the growing rental behemoth was completing its own empire. By acquiring a number of smaller, independent chains, the company boasted 2,100 franchises and a 12% share of the overall rental market.[11] Skorman believed that the Internet would fundamentally transform the rental industry and would even, in the not too distant future, make it possible to deliver all movies on-demand in a digital format. With the $3 million from the sale of Empire, he moved to San Francisco to build a new company that combined the power of the Internet with the principles that had made his earlier store a success. In 1996, working out of a warehouse space in the trendy South of Market area, Skorman launched Reel.com, a website that offered 80,000 titles for sale and made another 35,000 videos available for ‘rent-by-mail.’[12] As Netflix’s immediate precursor, Reel shared many of the same business principles and long-term ambitions. Reel also illustrated the ways in which the Internet initially flummoxed rental retailers, and it was precisely because of their inability to fully integrate the new technology that Netflix was able to subsequently trigger an industry-wide transformation.

The key feature of Empire had been its vast selection. It carried upwards of ten thousand titles when the average store in 1988 tended to offer three thousand or less.[13] Although the video rental business was shifting toward a hit-driven model, focusing more and more on new releases, Skorman recognized the value of guiding customers to older hits, sleepers, cult favorites, and foreign films. Though the store celebrated its cachet amongst sophisticated movie buffs, to take full advantage of this principle Skorman would also need to drive average customers to the far ends of Empire’s extensive catalogue. For this very reason, he pioneered the art of what he termed movie matchmaking. In short, this meant providing various forms of information that would lead customers to movies that matched their personal tastes. As he continued to develop this service, information ranged from personal recommendations and staff reviews to generating hundreds of novel movies categories (e.g., “So Bad It’s Good”) and, at one point, giving away three thousand copies of Leonard Maltin’s Movie Guide.[14] The Internet obviously promised to enhance these practices. And indeed, when Reel.com went live, it featured a software program called Reel Genius that offered recommendations based on customer preferences. While the site had additional information including original content generated by staff writers and user-generated ratings, the new software provided a more efficient means of customizing information on an exponentially broader scale.

Despite all of its early promise, the precocious start-up was riddled with serious problems. Like many dotcoms at the time, Reel struggled to generate cash flow. After investing millions to get the site up and running, it only generated $745,000 in revenues during its first year of business.[15] And while revenues increased in its second year, Reel could not project making a profit for the foreseeable future. One problem was that although the website was successful in drawing traffic, the information provided by Reel did not necessarily translate into sales or rentals. Perhaps due to the unfamiliarity of the web, “only 2.5 percent of Reel.com visitors [would go on to] complete a transaction, compared to 75 to 80 percent of video store shoppers.”[16] More serious problems loomed on the technical side of things. Despite Skorman’s wholesale belief in the power of technology, he was actually quite incompetent when it came to implementing it within his various business endeavors.[17] Throughout its early existence, Reel.com lacked the basic e-commerce features necessary to complete online transactions. The system was not set up to store customers’ information automatically, it was prone to crashing, and, at one point, it lost thousands of orders.[18] With all of these problems, Skorman decided to hedge his bets by going against the grain of the dotcom boom. In June 1997, he opened an eight thousand square foot video store in Berkeley, CA, that would serve as a brick-and-mortar counterpart to Reel’s virtual storefront. Based on his earlier experience, he knew that a large video store “catering to sophisticated movie buffs could be a cash cow” and that, even if anachronistic, this might temporarily provide the solvency needed to continue his otherwise failing Internet business.[19]

The problems afflicting Reel were not, however, entirely Skorman’s doing. These problems were tied both to the immaturity of Internet-based business operations and to the changing focus of the video rental industry. As the two issues came into contact, the potential for failure was most certainly amplified. It was likely for this reason that nearly all of the major rental chains had been extremely cautious in setting up any kind of online operation. Blockbuster, for example, launched its website in 1996, but it was used strictly as a tool for promotions and brand publicity.[20] In 1998, the chain began selling select new videos through the web, but its overall ambitions remained quite limited. Smaller and more specialized retailers also used the web to post a searchable catalog of titles, which, like Reel, might draw online traffic without necessarily adding to their bottom line.[21] In any case, these various concerns seemed to evaporate instantly in 1998 when Hollywood Video, the second largest rental chain, announced its plans to purchase Reel.com for the staggering sum of $100 million.[22] The promise of its business model together with the leverage that came with being an early adopter of Internet technologies made Reel a lucrative asset despite its financial woes. What’s more, Hollywood Video saw the purchase as an opportunity to leapfrog its competitors, establishing a leading online presence of its own while also incorporating Reel’s “smart” software and a rapport with serious movie connoisseurs.

Unfortunately, the alluring promise of synergy never fully materialized. One significant factor was that shortly after the deal between Hollywood and Reel was completed, Amazon.com announced that it would be entering the home video market. Founded in 1994, Amazon was one of the earliest and most aggressive online retailers, and, like Reel, it attracted endless media hype with the promise of unlimited potential even as it continually failed to turn a profit. Unlike Reel, however, Amazon had the technical proficiency and e-commerce experience to support its expanding enterprise. After failing in its own efforts to acquire Reel, Amazon purchased the Internet Movie Database (IMDB.com) to supply customers with the same kinds of information that Reel’s matchmaking services provided. Soon after its arrival, Amazon became the top video retailer on the web.[23] Its success encouraged the arrival of additional online retailers such as Buy.com, as well as more specialized sites such as DVD Express—all of which, following an industry-wide trend, were devoted exclusively to a sell-through model rather than rentals.[24] With Amazon discounting its VHS and DVD titles up to 30%, these competing sites focused primarily on price.[25] Rather than provide original content or personalized recommendations, these sites offered price-comparison technologies so as to guarantee the best value. Inundated by new competition and threatened by a wholesale reorganization of the home entertainment market in which a sell-through approach that primarily benefitted the major studios took precedence, Reel terminated its online rental service less than six months after its deal with Hollywood Video. The service had accounted for only 5% of the company’s business in the previous year.[26] Moreover, it required additional overhead costs while the increased cost and hassle of shipping rentals were a deterrent to consumers. Renting online was proving to be cumbersome, and Reel had determined that it was simply “not an ideal business model for the Internet.”[27]

With mounting losses and little market traction, Hollywood Video shut down Reel’s entire e-commerce operation in June 2000.[28] For Blockbuster, Reel’s failure seemed to be a clear indication that the online video rental business was not a viable threat. With this reassurance, Blockbuster remained conspicuously slow in its own attempts to develop online strategies and, instead, the company viewed the emerging sell-through approach as its main competition.

It was the combination of Reel’s spectacular demise and Blockbuster’s disinterest that led directly to Netflix’s emergence. Founded in 1997, Netflix opened for business only a year after Reel, yet its slightly later arrival made a world of difference. Netflix likely learned from some of Reel’s mistakes, but more generally it benefitted because the Internet’s overall infrastructure was then better established and the basic standards of e-commerce better understood. Whereas Reel betrayed its new business model by eventually returning to its ‘brick-and-mortar’ foundations, Netflix, conceived entirely as part of this new era, was more fully committed to developing an exclusively Internet-based service. While Netflix missed out on the on the dotcom boom’s early windfalls—it had rented a mere 2,700 DVDs by mail as Reel was on the verge of its $100 million payday—it benefitted enormously by avoiding the burden of hyperbolic expectations and over-inflated stock values. Finally, and perhaps most important, Netflix was able to grow incrementally, building a loyal customer base on the strength of its reputation as a tech-savvy trailblazer. At the same time, Blockbuster failed to recognize the fledgling service as a serious competitor until it was too late. Unlike its precursor, Netflix made the most of this good fortune and shrewdly went on to supplant what had been one of the most dominant forces in home entertainment.

As Netflix began operations, it shared several key similarities with Reel. It offered a basic rental service whereby customers used an online interface to select the movies they wanted to see. The films were then delivered through the mail and sent back with a pre-addressed, pre-paid mailer. Also like Reel, Netflix emphasized the breadth of its selection and used proprietary software—a program called CineMatch—to direct customers toward more eclectic fare, effectively downplaying new releases while appealing to more discriminating movie connoisseurs.[29] While both companies emphasized convenience and the ability to accommodate discerning video aficionados, there were also some fairly significant differences. First, Netflix rented only DVDs. At the time VHS still dominated the market and Netflix took a risk to focus exclusively on an unproven format. The wager paid off, however, as the new technology penetrated the market faster than either television or the VCR.[30] In another example of its good timing, Netflix avoided having to decide whether it had to duplicate an existing inventory in order to carry both formats. This problem was even more pronounced for retailers like Reel since it also carried the laserdisc format as part of its larger efforts to court more discerning movie buffs.[31]

When Netflix first opened its catalog was limited to a paltry 900 titles.[32] The reason for this was that the studios were hesitant to embrace the new format and had only released a limited number of titles. This small scale, however, turned out to be another blessing in disguise. While early adopters were spending $400 to $500 for new DVD players, traditional rental stores were offering only 100 to 150 titles in the new format. This provided Netflix with a relatively small, but highly dedicated segment of consumers willing to try a new service in order to access additional DVD titles. At the same time, while the smaller library was easier to manage at the outset, Netflix was in an ideal position to scale up its selection both as DVDs became more popular and as the company expanded its customer base. Finally, because DVDs were lightweight and durable, the company was able to streamline shipping and handling, maximizing both the efficiency of its distribution system and the overall convenience of its service.[33] This convenience in shipping marked another critical departure from Reel, which, in trying to ship and receive VHS cassettes as part of its rent-by-mail service, was unable to fully align its delivery method with various changes concurrently adopted within the U.S. postal system.[34]

A second, more important departure from Reel was that in September 1999 Netflix abandoned the pay-per-unit model and introduced a subscription plan.[35] For a monthly fee, customers had access to unlimited rentals. The critical selling point of this approach was that customers could hold onto each rental as long as they liked without incurring late-fees. Inspired by his own $40 late fee from Blockbuster, Netflix CEO Reed Hastings recognized how much these penalties were widely abhorred.[36] The new plan not only struck a chord with consumers but helped to address several practical issues as well. The subscription model had the advantage of guaranteeing a constant stream of revenues prior to individual transactions. Second, it allowed Netflix to tie its recommendation engine to its revenue source in a way that Reel was never able to devise. Customers used CineMatch to build a queue or list of films they wanted to rent. The next film on the queue would automatically be sent as soon as the previous rental was received. This further let Netflix maximize its back catalog and guide customers away from new releases. For customers, the service seemed a better value. People always had something to see for their monthly fee even if wasn’t the exact film they wanted or if it sat unwatched for weeks at a time. The subscription fee was ultimately a voluntary commitment, with a very different valence than punitive late-fees. While these were all key advantages as Netflix began a period of dramatic growth, the most significant impact of the subscription model may have been that it exposed the extent to which brick-and-mortar rental services relied on late-fees as a vital source of revenues.

A year after introducing their new plan, Netflix had amassed more than 250,000 subscribers. By 2002 it had more than doubled that number, and in 2003 its customer base was well over a million.[37] In May 2002 Netflix was one of the few Internet start-ups to enjoy a successful IPO, raising $82 million—used to pay off debt, acquire additional inventory, and construct ten new distribution centers to ensure next-day delivery across the country.[38] Netflix continued to grow during this time and effectively established itself as a recognizable brand without having to spend extensively on marketing or advertising. Wal-Mart acknowledged as much when they announced plans to start a competing rent-by-mail service in late 2002.[39] Blockbuster, however, remained reluctant to enter the rent-by-mail business. The reigning rental empire still controlled 40% of the storefront market, and its main concern continued to be the fact that rentals had begun to flatten, as the new DVD format seemed to favor a sell-through approach.[40] By the time Blockbuster finally rolled out its mail-order service in May 2004, it announced that it expected to gain 30% of the rent-by-mail market in the next year.[41] It instead encountered several stumbling blocks and, despite its confidence, made at least one devastating miscalculation.

Blockbuster quickly learned that garnering a share of the online market would not be as simple as expanding its retail outlets. Setting up an e-commerce website for a national brand was an immense endeavor, requiring not only vast technical provisions but also additional business operations such as distribution centers that were completely outside of its current business model. There were additional obstacles as Netflix had received a broadly worded patent for its online subscription service in 2003.[42] And whereas Netflix was focused exclusively on its Internet-based service, Blockbuster was wavering between different, and to some extent opposing, business principles.[43] In 2006, Blockbuster announced a revised service, Total Access, in an attempt to take advantage of its expansive physical presence. Many thought that this new “bricks-and-clicks” approach, integrating a rent-by-mail subscription with an in-store option, would indeed give Blockbuster the leverage it needed to pose a more serious threat to Netflix. While the new plan gained some initial traction, it eventually resulted in the same uneven dynamic that undercut the match between Hollywood Video and Reel.com. One Netflix official coyly noted such an incongruity by suggesting that Blockbuster’s in-store promotion for the new online plan was akin to seeing an advertisement for bus travel inside an airport terminal.[44]

As Blockbuster scrambled to build its rent-by-mail service, it made something of a fatal decision in December 2004 as it announced a plan to eliminate all late fees.[45] At this point, Netflix was up to 2.5 million subscribers and growing steadily. In a first sign of panic, Blockbuster claimed that it needed to improve customer relations. The move was a complete disaster on several fronts. As the rental giant continued to focus on new releases, the absence of a late fee policy made it even more difficult to manage its inventory, which in turn further aggravated customers. More important, late fees, as a general rule, accounted for 15% of video store revenues.[46] For a franchise the size of Blockbuster to lose late fees was a devastating blow. In 2005 it forfeited approximately $400 million in late fees.[47] The subsequent cash crunch forced the company to cancel its third quarter dividend. Although Blockbuster maintained its 40% share of the rental market, it had descended into free fall.

The turmoil continued as “activist” investor Carl Icahnn tried to orchestrate a hostile take-over of Hollywood Video (which eventually merged with the third largest video chain, Movie Gallery).[48] Blockbuster tried to cut costs by closing hundreds of outlets but saw its stock plummet despite its efforts. By 2010 the company would be forced to file for bankruptcy, having lost ground on multiple fronts. While Netflix had established a clear advantage in terms of rent-by-mail and subscription services, discount retailers like Wal-Mart and Target had assumed a lead position in the sell-through approach that studios favored. At the same time, cable providers appeared to be best suited to offer various video-on-demand options, and technology firms like Apple with its iTunes platform seemed to have the upper hand in terms of developing the digital download market. In addition to these challenges, Blockbuster faced a new competitor in Redbox, the most prominent purveyor of automated self-service kiosks or vending machines that were located outside of supermarkets, gas stations, convenience stores, and fast food restaurants. Adopting a strategy that had once been Blockbuster’s bread-and-butter, these kiosks largely specialized in new releases and popular titles and in doing so, effectively provided a more convenient and efficient version of the video store experience.[49] These challenges emerged in rapid succession, and all of them laid claim to some kind of leverage as home entertainment began an immense transition.

Although Blockbuster continued to control up to one third of a multi-billion dollar industry, as early as 2006 it had begun to be viewed as a relic. Traditional video retailers lost the leverage they once held and their value deteriorated sharply as Wall Street pronounced the brick-and-mortar video business a dead end. Netflix’s apparent triumph meanwhile rested on several factors. It succeeded where Reel had failed in three ways:

It was largely by virtue of this last feature that Netflix was ultimately able to out-maneuver Blockbuster. The subscription model allowed the Internet-based rental service to take advantage of changing consumer preferences, building a zealous membership at same time Blockbuster was increasingly alienating its own customers. Moreover, even as industry analysts repeatedly predicted that Blockbuster’s overall size and superior position would allow it to prevail, the rental giant was simply too late in recognizing the significance of its new competitors and too cumbersome to succeed in a new digital environment.[50] Netflix may not have been the first tech firm to wed Internet technologies to the video rental business. It was, however, the first to prioritize technological innovation in formulating its business model and to do so in a way that gave it leverage over the existing rental retailers. Netflix had realized a major accomplishment in holding off Blockbuster, as well as Wal-Mart and the others that had tried to duplicate its service.

Nevertheless, a new wave of battles loomed on the horizon as the Web 2.0 generation began to take shape. Netflix would not only have to modify its rental service continually but also rethink its place within the overall film industry and, more specifically, re-evaluate how its impact on changing distribution and exhibition practices would affect its long-term viability.

The short end of the Long Tail

In October 2004 Wired editor Chris Anderson published an article on what he termed the “Long Tail,” a new economic model inextricably tied to the Internet and the digital technologies that it helped to shape.[51] According to this new model, it was possible to build a profitable business on the low but steady demand for a wider range of inventory as opposed to the fleeting but large-scale demand for the most popular goods. In addition to this main principle, Anderson identified three key tenets that made Long Tail economics possible.

For instance, “more than a quarter of Amazon’s book sales come from outside its top 100,000 titles.”[52] That means that when taken as a whole, content that appeals to a highly specialized or limited audience constitutes a market that begins to rival the revenue generated by hits. In Anderson’s book-length account of the shift toward the Long Tail, he observes that the trend is most obvious in entertainment and media. To emphasize this point, he consistently cites Amazon, Netflix, and RealNetworks’ music service—Rhapsody, as primary examples of the phenomenon.[53] In the abstract, Anderson’s term had explanatory power. It seemed to pinpoint the underlying logic of the most successful Internet endeavors and it quickly became a mainstay in the lexicon of business gurus and aspiring entrepreneurs. For Netflix, however, the Long Tail only played a tangential role in its overall ascent. While the company often extolled the virtues of this approach, it would ultimately abandon the Long Tail strategy as it transitioned from novel start-up to a major force in the home entertainment industry.

Lost in Anderson’s fervor for new technology is the fact that the video rental industry as a whole spearheaded the Long Tail model long before the term was invented. That is to say, the entire industry turned on drawing in revenues without devoting additional expenditures to inventory. Even as rental stores had to purchase content at a higher wholesale price, each tape only “need[ed] to be rented 20 times at $3/rental to break even.”[54] Everything after that point was pure profit. As retailers like Stuart Skorman realized early on, it was possible to optimize this principle by building an extensive selection of older and more marginal films and then finding innovative ways to direct customers to these titles instead of new releases. As profitable as this approach may have been, the rental industry by the end of the 1980s, led by rental chains like Blockbuster, was increasingly devoted to “stocking and promoting hit movies” at the expense of precisely the kinds of titles that were capable of generating higher profit margins.[55] With its hit-driven approach, the rental industry ended up with the exact inverse of Anderson’s formula for the Long Tail: 80% of its revenues stemmed from 20% of its inventory.[56] This reliance on hits underscored several additional problems. First, as the rental chains increased the number of new releases they carried, this approach helped studios reduce the overall manufacturing costs of producing home videos. So studios and wholesalers could lower sell-through pricing that, in turn, ate into the rental market. Second, the larger rental chains, again in conjunction with the shift toward popular new releases, attempted to leverage their growing scale by negotiating revenue-sharing deals with their suppliers. These deals typically lowered their up-front costs, allowing rental retailers to purchase VHS cassettes at cost in exchange for a percentage of the profits generated by specific titles.[57] As a result, a larger percentage of the stores’ revenue was tethered to an inventory that they did not fully control. In undermining their own profit margins, rental stores began to focus on ancillary revenues such as video sales, video game rentals, merchandise sales (ranging from toys, posters, and apparel to concessions), as well as initiation and late fees to make up the difference.

With the shift to a hit-driven business model, the rental industry seemed to forfeit its innate affinity for Long Tail economics. While this might have resulted from a poor long-term strategy (tied in part to the rise of national chains that privileged all out growth and short-term profits over long term sustainability), the rental industry was also dependent on Hollywood studios and other content producers who were increasingly looking to maximize their own Long Tail interests. The major studios, ever since they were forced to relinquish their ties to theatrical exhibition, have looked to secondary markets as an important source of revenue.[58] As vital as they have been, these secondary markets have also caused a certain degree of antagonism and ambiguity. The studios, for instance, have been extremely cautious when it comes to new technologies. In the most glaring example of kind of backward-thinking, the studios took legal action against the manufacturers of the VCR in the 1980s, not realizing that home video would soon be their most lucrative secondary market (far surpassing the money generated by licensing film rights to television and pay TV and even box office totals by the end of the 1980s).[59] The studios were similarly leery of the new video rental business. Their apprehensions subsided only after rental retailers proved that they could provide studios a substantial source of additional revenues. Hollywood eventually both embraced these new opportunities but bemoaned the need to partner with third parties.

With the success of DVDs and the sell-through approach, Hollywood studios sought to expand their stake within secondary markets. More specifically, they tried to expand their control over the entire lifecycle of a given title and to maximize the profitability of their assets across different windows. With new digital formats and video-on-demand platforms looming on the horizon, Hollywood considered itself in an ideal position to realize these goals. There were, however, numerous unanswered questions regarding the future landscape of home entertainment. First, as the importance of downstream revenues increased, exhibition windows—the period of time in which a film is available in the theater, on pay-per-view, etc.—began to shrink. The accelerated availability of films, along with the interchangeability facilitated by new digital formats, paradoxically increased the pressure on studios to fabricate and then police periods of exclusivity. Second, while some assumed that new high-definition and digital formats would simply replicate the DVD’s success, the growing array of new and convergent forms of media along with changing consumer preferences suggested that this might not be the case. Such technological issues were further compounded as studios pursued their own proprietary digital platforms or negotiated strategic alliances with preferred partners. To some extent, it was the lack of industry-wide standards that allowed newcomers like Netflix to quickly carve out a commanding position. Despite all the excitement about new technology, then, the instability of the overarching industry necessitated a wait-and-see approach in which the status quo persisted for much longer than anyone expected. Also, while the studios and other content producers were more conscientious of the need to maximize the Long Tail value of their assets, they simply were not always in a position to do so.

Though the larger rental companies had abandoned the Long Tail in favor of a hit-driven approach, there were some efforts to counterbalance their dependence on new releases by moving up the supply chain and participating in the production process. Blockbuster, for example, launched DEJ Productions in 1998 to acquire or co-finance independent films for exclusive release in its retail outlets.[60] Blockbuster publicized this new endeavor as part of its commitment to independent films and other niche genres. In several cases, DEJ proved that films such as Boondock Saints (1999), which performed poorly in a minimal theatrical release, could be extremely successful in terms of home video sales and rentals.[61] DEJ soon began distributing to all retailers and quickly established itself as one of the biggest buyers at festivals like Sundance. Netflix, likewise hedging against its reliance on studio-controlled content, followed Blockbuster by establishing Red Envelope Entertainment in 2006.[62] Like DEJ, Red Envelope aimed to participate in financing, producing, and distributing films in exchange for either exclusive DVD rights or some manner of revenue sharing. Even prior to the launch of Red Envelope Netflix had begun to seek out independent films as well as older, cult films such as Eraserhead that were languishing without home video distribution deals.[63] Once Red Envelope was formalized as a subsidiary, it again followed DEJ’s lead and established itself as an aggressive presence at Sundance and Toronto. It also showed that it was willing to expand its involvement across the production process. In a co-distribution deal with Roadside Attractions for Puffy Chair (2005)—one of the founding films of the genre known as “mumblecore”– Red Envelope agreed to share marketing costs in exchange for a portion of the film’s overall profits.[64]

In both cases, the move into production and financing focused almost exclusively on specialty content, namely independent films and documentaries. DEJ eventually shifted its focus to bigger independent productions such as the award-winning hits Crash (2004) and Monster (2003).[65] Following its deal for Puffy Chair, Red Envelope purchased Hal Hartley’s The Girl from Monday (2005) and partnered with Samuel Goldwyn on Julie Delpy’s romantic comedy 2 Days in Paris (2007). It also worked with the Independent Film Channel (IFC) on Sherrybaby (2006) and Cannes winner 4 Months, 3 Weeks, 2 days (2007) as part of a ten-picture output deal.[65] Red Envelope was even more aggressive in acquiring non-fiction films, essentially finding documentaries both inexpensive and highly marketable, with potential for additional revenues through theatrical and DVD release. Furthermore, documentaries meshed nicely with the programming interests of cable networks such as the Discovery Channel. At the same time that documentaries were enjoying an unprecedented box-office run with Fahrenheit 9/11 (2004), March of the Penguins (2005), and An Inconvenient Truth (2006), Red Envelope fully funded The Comedians of Comedy (2005) and acquired the rights to various biographies documenting well-known public figures such as Ralph Nader in An Unreasonable Man (2006) and Tony Bennett: The Music Never Ends (2007). Some of Red Envelope’s biggest hits included higher-profile documentaries such as This Film is Not Yet Rated (2006), No End in Sight (2007), and Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders (2006).

In addition to expanding its control over select inventory, the move into production allowed Netflix to bolster one of its most marketable features. As the rental service made its initial foray into the market, it built its brand around an extensive catalogue (which quickly expanded to include more than eighty thousand titles) and the ability to cater to its customers’ discerning tastes. Various commentators heralded Netflix’s allegiance to niche content in general and noted their broad selection of documentaries and foreign films in particular.[67] The company further indicated that a majority of its catalog came from suppliers smaller than Lionsgate, and that it was able to significantly expand viewership for small-scale films and documentaries like Memento (2000), Capturing the Friedmans (2003), and Born into Brothels (2004).[68] CEO Reed Hastings, additionally, highlighted the fact that Netflix customers rented Whale Rider—a 2002 New Zealand and German co-production made for approximately $4 million—as often as heavily publicized Hollywood blockbusters The Hulk and Charlie’s Angles II, which had been released at the same time.[69] In short, Netflix was able to drive traffic to films that didn’t have the resources to compete in a media saturated, blockbuster driven entertainment market. According to chief content officer, Todd Sarandos, it was possible to put an actual dollar amount on this feature claiming,

"We can get a film to perform as if it did $1 million at the box office without spending the marketing dollars to get that.”[70]

While this approach allowed Netflix to effectively utilize the Long Tail potential of its inventory, it also enhanced its overall cultural cachet. By the company’s own account, it had, with its ability to ‘recommend’ specific films and encourage customers to sample a much broader spectrum of titles, effectively “taken the place of what college film societies did in the '60s and '70s, when they turned audiences on to new European films and old masters.”[71]

The financing and acquisition that Netflix pursued under the guise of Red Envelope dovetailed with this marketing strategy. It allowed Netflix to further diversify its already extensive catalogue and to enhance its ability to target more discerning tastes. At a more practical level, Red Envelope allowed Netflix to foster better relations with independent producers and distributors, and it provided the possibility of generating supplementary revenue streams. In both regards, Netflix seemed to personify the Long Tail approach. On the one hand, the company was devoted to expanding its overall catalogue, providing a wider range of choices and using various customization and recommendation tools to match customers with this material. On the other hand, the business was taking advantage of its ability to optimize undervalued content. This premise underscored the entire video rental industry but was even more pronounced as DEJ and Red Envelope became involved in the production of specialty fare such as low-budget independent films and documentaries. These projects offered low-cost, low profile initial investments that promised modest but highly profitable long-term returns. Despite the apparent success of these endeavors and the Long Tail model more generally, both Blockbuster and Netflix decided to abandon their subsidiary production arms. Blockbuster sold DEJ to another studio for $25 million in November 2005 largely because of the financial pressures they were experiencing.[72] And Netflix shut down Red Envelope a few years later in July 2008. The reason for Netflix’s decision was less immediately clear; however, it coincided with several larger shifts in the company’s overall approach.

At the time Netflix launched Red Envelope in 2006, it had approximately three million subscribers. These numbers represented a significant growth rate and were considered particularly impressive in the eyes of Wall Street analysts. However, in terms of the overall home entertainment market, the company’s subscriber base represented only a tiny fraction. It was precisely because Netflix was such a specialized service that it made sense to boast about the discerning tastes of its clientele and the extensive catalogue that it offered. Two and a half years later, Netflix ended 2008 with nearly ten million subscribers and was maintaining its projection to double in size again over the next three to four years.[73] As the company began to change in overall size and customer profile, it recognized that it was no longer feasible to rely entirely on its affinity for specialty content or niche audiences. This meant not only appealing to more mainstream tastes but also maintaining access to the premium content controlled by the major Hollywood studios. The importance of this relation was evident as early as 2000, when Netflix agreed to the same revenue sharing deals with studios that had been a standard at Blockbuster.[74] According to one report, Netflix in fact shut down Red Envelope because it did not want to compete with the studios or jeopardize these types of partnerships.[75] In 2009, Netflix again capitulated to the studios’ more explicit and much publicized demands for a twenty-eight day waiting period between the release of DVDs and their availability for rental.[76] The mounting tension evident in such disputes was tied not only to the steady decline of home video sales but also to the general instability triggered by economic recession and ongoing technological innovation.[77] As the major studios looked to better secure their own Long Tail interests, they wanted exclusive control in dictating the terms of subsequent exhibition windows, and were willing to cut out, or at least pressure, unnecessary middlemen in order to do so.

The threat by major studios to withhold access to premium content seemed to reveal a decisive vulnerability in the rental business. This in turn called into question the entire Long Tail premise and, more specifically, its role in the future of Netflix. Maximizing long-term value and exploiting new methods of efficiency were increasingly important principles, but media and entertainment in particular involved a complicated array of stakeholders many of whom had the power to limit or undermine the interests of unnecessary intermediaries like Netflix. With Red Envelope, Netflix had an opportunity to pursue its own form of vertical integration. However, the plan was not viable because the content it was best suited to produce did not match its increasingly mainstream subscriber base. Additionally, the Long Tail benefits of this material did not justify the risk of losing access to premium content from other major stakeholders. As eager as the Hollywood studios were to embrace the Long Tail for their own purposes, they also found the approach flawed. The studios were ultimately reluctant to entirely abandon the additional revenues generated by the rental market yet still had no proven business model for delivering their premium content to consumers in a more direct or efficient manner.

At this juncture Netflix again demonstrated its propensity for fortuitous timing. In 2008, Netflix was not only adopting a more mainstream sensibility but also sought to introduce a new form of digital delivery. After several studios had failed in their efforts to launch various video-on-demand platforms, Netflix turned its attention to ‘streaming’—a system whereby data is made available as it is delivered.[78] In another instance of improbable serendipity, Netflix announced in October 2008 that it had reached a deal with the premium cable channel Starz for the rights to stream about a thousand movies.[79] The deal served as a major catalyst in propelling subscribers to try Netflix’s new streaming service and, in the process, significantly transform both the company and the future of home entertainment. Though Netflix had once again struck it rich with content that others had been unable or unwilling to optimize, its days as an improbable, and somewhat overlooked, intermediary were in short supply. In pursuing this new direction, Netflix was unlikely to simply settle for the short end of the Long Tail. But it was also not clear what exactly this new direction would entail.

Precursor or postscript?

As Netflix released its 2010 fourth quarter report, it seemed that the rental service had secured a place within the media and entertainment industry. It had established an impressive record by Wall Street’s standards—raising its stock from just under $10 per share in 2002 to a peak of nearly $300 in 2011[80]—and it had distinguished itself as a market leader by successfully integrating new Internet technologies into the video rental business. At the same time, Netflix now would face its most difficult and tumultuous period, with some of the adversity arising specifically because of its remarkable ascent. First, Netflix built its initial business model by improving what had been an exclusively brick-and-mortar retail enterprise. It enjoyed early success because of its rapid growth and because the various metrics used by financial analysts tended to favor it over existing rental retailers. Unlike its predecessor Reel.com, Netflix could actually back up these favorable assessments and indeed offered a more convenient and efficient service to a growing number of subscribers. In this regard, Netflix’s success fundamentally transformed the entire rental industry.

In moving forward, however, the company’s initial business model was something of a drawback. For example, as Netflix looked to focus more on its new streaming service, its inventory of DVDs and distribution centers were suddenly a source of extraneous overhead. Even its sterling track record with Wall Street added the burden of exorbitant expectations and kneejerk reactions, at times instigating undue concerns and public relations gaffes. The success of the new streaming service, on the other hand, caused the value of digital rights to immediately skyrocket, in turn jeopardizing the company’s ability to secure additional content. Their success also created an uneasy dynamic with content providers leery of repeating Starz’s miscalculation but desperately needing additional revenues to make up for declining DVD sales.

Many of the underlining practical questions facing the video rental industry were further exacerbated as digital rights negotiations, contracting, overlapping exhibition windows, and changing consumer habits all became increasingly intertwined. As with traditional rental retailers before it, Netflix initially had been preoccupied with the dilemma between new release hits and specialty niche content. But as the new media landscape evolved, it quickly began to adjust its overall approach and discovered the advantages of embracing a more diverse mix of content. Also during this time television programming was one of the fastest growing areas within home entertainment.[81] This programming was valuable for several reasons. There was a broader overall spectrum of content, including many shows that had never been released on VHS or DVD. There were also a wider variety of release strategies, ranging from packaging entire earlier seasons to making the most recent episodes available for limited periods of time. These attributes of television’s ‘afterlife,’ along with the serial nature of many programs seemed to be more conducive to emerging online viewing preferences.[82] As Netflix began to increase its emphasis on television programming, the company began to be discussed less as a rental outlet and more as a particular type of media channel. Thus Netflix began to draw specific comparisons with HBO, the premium cable network that also started out with a distinctly hybrid business model and that had successfully navigated several significant transformations within the media industries.[83]

Like Netflix, HBO’s launch was tied to a technological breakthrough in that it was the first to use satellite transmission for the purpose commercial broadcasting.[84] Just as Netflix adopted DVD ahead of the curve, HBO carved out a dominant place within the fledgling secondary market of pay-TV. And like Netflix, HBO started as a subscription-based service that depended on its ability to access premium Hollywood content. The studios responded to the rise of HBO with a mixture of ambivalence and resistance. On the one hand, they welcomed the arrival of another secondary market and the possibility of generating additional downstream revenues. On the other hand, they were wary of another middleman, particularly one that had established a dominant position within this new market. As part of this escalating rivalry, several studios sought to introduce their own pay television channel, Premiere. The channel would not only allow the studios to showcase their films, but more importantly it would allow them to institute a nine-month window of exclusivity (not entirely unlike the twenty-eight day window currently imposed on Netflix). However, the endeavor was eventually struck down on legal grounds, and the studios remained handcuffed in their efforts to embrace new forms of distribution and exhibition. As Jennifer Holt has shown, the legal clashes between Hollywood studios and burgeoning cable interests nonetheless also marked the beginning of a gradual shift to a “more tolerant attitude” with regard to vertical and horizontal integration within the media industries.[85] This shift was somewhat obscured in the sense that HBO rather than the studios was in the best position to take advantage of this change in attitude.

As HBO continued to expand its subscription base, enjoying tremendous growth between 1976 and 1983, the cable channel like its subsequent variants in the rental industry had both the necessary resources and incentive to move into financing and production.[86] HBO pioneered the practice of financing theatrical films in exchange for guaranteed rights to the pay-TV window. Because these “pre-buy” arrangements shut the studios out of a critical secondary market, HBO’s financing tended to favor independent projects that the studios had rejected wholesale.[87] While HBO maintained its affiliation with independent and specialty content (especially documentary), it began to shift its attention in the 1990s to high-profile original series such as Sex and the City and The Sopranos.[88] These shows became incredibly lucrative in their own right as they generated additional revenues through DVD sales and syndication after their initial runs. Beyond that, the strategy demonstrated the strength of HBO’s vertically integrated position and, perhaps more importantly, how this position would be vital in distinguishing a clear brand identity.

By the time Netflix was giving up on its own short-lived flirtation with vertical integration, HBO’s strategy was becoming increasingly commonplace among cable networks. The specialty channel IFC, for example, moved into production and distribution in 1999 to ensure the flow of apt and economical content. At the other end of the spectrum, ESPN, one of the largest and most successful cable channels, began producing a series of documentaries precisely as a way to hedge against the skyrocketing costs of live sporting events. Interestingly, in almost all of these cases independent projects and specialty content have played an important role. Such projects, however, have had little to do with pursuing the promise of greater media diversity or consumer choice but have merely provided a cost-effective pretext for reaching desirable niche demographics and building brand value. More broadly, it has become clear that while cable channels have been in an ideal position to utilize vertical integration and build distinctive brand identities, their success simultaneously depends on the fact that they exist as part of much larger media conglomerates.

Despite the many parallels between the two, Netflix’s lack of a conglomerate affiliate marks a significant and telling difference. Following the early clashes between premium cable channels and traditional content producers, the two sides recognized the importance of negotiating a mutually beneficial coexistence. This understanding eventually culminated with the merger of Time Inc. (HBO’s parent company) and Warner Communications in 1989, one of the first major deals in a decade of epic restructuring. For HBO, the deal assured several key benefits. First, it guaranteed access to the premium content of at least one major Hollywood studio. Second, the new conglomerate included an expanded number of multi-system cable operators and thus ensured that HBO would maintain access to distribution and exhibition channels.[89] In effect, the merger illustrates the importance of strategic alliances and interlocking interests within the media and entertainment industry. Individual channels like HBO can best utilize the advantages of vertical integration and develop content that enhances a distinct and highly marketable brand identity. However, they need the leverage, security, and access to infrastructure provided by an overarching conglomerate in order to remain viable. It is in this regard, as Janet Wasko notes, that even amidst dramatic changes throughout the entire industry,

“Hollywood studios, as part of well-heeled transnational conglomerate organisations, will continue to be the dominant forces in guiding whatever models prevail.”[89]

Many commentators viewed Netflix’s lack of a conglomerate partner as a certain death knell. While the company has indeed encountered certain setbacks and some additional challenges because of its position, predictions that Netflix would be supplanted by HBO or other extensions of major media conglomerates have simply not been borne out. There are several possible reasons for the company’s ongoing resilience and perseverance. First, Netflix has the advantage of a substantial subscriber base. With over twenty million subscribers, it has secured a significant share of the overall market and, more important, has a steady source of income to support its operations. Even as acquiring the rights to premium content has become more expensive and in some cases openly vitriolic, Netflix’s cash flow provides it with the financial resources to continue doing so. As some competitors have refused to negotiate the rights to certain content, Netflix has also used its financial wherewithal to return to financing and producing original material. Its success with a number of originally produced serial dramas allowed the company to quickly rebound from several much-publicized setbacks and a precipitous stock downgrade in 2011.[91] With the success of this programming, Netflix began to focus more deliberately on exclusive content as a key “differentiator.”[92] However, the company also realized that even if select titles were necessary to drive interest, it was simultaneously important to balance premium content with a diverse range of specialty fare. By aggregating content in this way, Netflix can offer a distinct, yet relatively economical, service that individual studios cannot match.

The second reason for Netflix’s survival is that it has always been a technology-based company. It has more experience and expertise both in terms of software development and day-to-day logistics. Netflix, moreover, established industry standards with its user interface and its various “personalization” engines. This, again, sets the company apart from both individual studios and cable operators, which have been largely unable to replicate these services. As part of its success, Netflix has established one of the most popular destinations on the Internet.  Their website ranks among the top twenty-five in the U.S. and likely constitutes an even larger web presence considering its overall usage.[93] Though Netflix was the beneficiary of several fortuitous developments completely outside of its control, its longstanding commitment to technology cemented its reputation as a savvy trailblazer and the market leader in developing new forms of delivering digital entertainment. These associations were further fortified as the company appeared to single-handedly introduce streaming technologies into the mainstream and, then again, as Netflix programming was literally embedded within the next generation of consumer electronics.

In both regards, Netflix has maintained some of the flexibility and versatility that enabled it to outmaneuver an earlier era of competition. Despite the company’s remarkable navigation of one of the most turbulent periods in media and entertainment, it appears that Netflix will likely remain in a precarious position. Certainly both its move into production and its reliance on technology entail formidable risks. As many studios know all too well, a string of failures can quickly and irreparably undermine the success of an individual production.  Meanwhile, technology is moving so quickly that it is highly unlikely Netflix will be able to sustain its ‘first mover’ advantage. Even more problematic is that Netflix’s basic operation relies on infrastructure it does not control. Just as its rent-by-mail service was inextricably tied to the U.S. Postal Service, its streaming service relies on Internet providers and cable operators, some of which are directly affiliated with various competitors. Whereas external circumstances worked to Netflix’s benefit throughout much of its first decade, it seems highly likely that at some point its luck will take a very different turn.

The rise of Netflix ultimately reveals the instability of the current situation and just how drastically home entertainment has changed in a matter of ten years. Its success involved an improbable combination of factors and demonstrates how in a period of radical transformation an unlikely intermediary can play a disproportionate role in reshaping a multi-billion dollar industry. What is also interesting about this period is that even if the major conglomerates are in a better position to eventually regain control of the home entertainment market, their efforts to institute new forms of exclusivity and to more carefully exploit premium content across multiple windows and formats have produced decidedly mixed results. In many ways, these efforts have done more to create confusion and instability than to generate additional revenues or points of strategic convergence. The zeal for secondary markets, and video-on-demand in particular, now appears somewhat misguided, as new technologies and changing consumer preferences have made for an increasingly fragmented and competitive market in which the demand for media artifacts appears to have disintegrated into the ether. The industry’s lack of a clear or unified long-term strategy essentially extended the life and value of a rental market that was supposedly doomed long ago, allowing the likes of Netflix to persevere in the process. It is for some of these same reasons that Hollywood’s digital dreams have not turned out the way many had hoped or expected. These dreams have not only failed to duplicate the material profits delivered by earlier home entertainment formats such as DVDs but have unexpectedly required an extensive material infrastructure of their own. Despite the tendency to overlook the realities of this new era, it seems likely that digital dreams will continue to harbor their fair share of disconcerting twists and occasionally nightmarish turns.

Notes

1. “Internet Killed the Video Store: A Sing-Along Lament from a Struggling Local Institution” Telstar Logistics. 11 November 2010.  Web. 23 September 2012. Links to the story were featured on the website Boing Boing and Laughingsquid.com. [return to text]

2. Marks, Craig and Rob Tannenbaum. I Want My MTV: The Uncensored Story of the Music Video Revolution. New York: Dutton, 2011: 40—41.

3.   “Internet Killed the Video Store.” See also: Vascellaro, Jessica E. and Sam Schechner. “Slow Fade-Out for Video Stores.” WJS.com. The Wall Street Journal. 30 September 2010. Web. 23 September 2012.

4. Hastings, Reed and David Wells. “Q4 10 Letter to Shareholders.” Ir.netflix.com. Netflix, Inc. 26 January 2011. Web. 23 September 2012.

5. ibid.

6. In 2010, Netflix launched a streaming-only service in Canada. The following year it expanded into Latin America and, then, into the United Kingdom and Ireland. In 2008, Microsoft announced a deal with Netflix in which the Xbox 360 would be pre-installed with software that allowed users to access Watch Instantly streaming service through the console. Following the success of this partnership, Netflix pursued similar agreements to ensure that its streaming service would be available through a number of consumer electronic devices including Blu-ray players, set-top boxes (e.g. Roku), and HDTVs. See: Ward, David. “Xbox Pacts with Netflix.” Variety 14 July 2008. LexisNexis. Web. 5 July 2013. 

7. There are several book-length studies that focus either exclusively or partially on the home video industry. These include Paul McDonald’s Video and DVD Industries (London: British Film Institute, 2007), Joshua M. Greenberg’s From BetaMax to Blockbuster: Video Stores and the Invention of Movies on Video (Cambridge, Mass.: MIT Press, 2008), Jeff Ulin’s The Business of Media Distribution: Monetizing Film, TV, and Video Content (Burlington, MA: Focal Press, 2010), and Chuck Tryon’s Reinventing Cinema: Movies in the Age of Media Convergence (New Brunswick, NJ: Rutgers University Press, 2009). Netflix receives little mention in these works, which might be explained by the fact that the company’s impact was not fully apparent until 2008-2009. This neglect has been partially rectified with Gina Keating’s Netflixed: The Epic Battle for America’s Eyeballs (New York: Penguin, 2012). Two earlier accounts of the video industry will serve as equally important points of reference throughout the following study. These are Janet Wasko’s Hollywood in the Information Age: Beyond the Silver Screen (Austin, TX: University of Texas Press, 1995) and Frederick Wasser’s Veni, Vidi, Video: The Hollywood Empire and the VCR (Austin, TX: University of Texas Press, 2001).

8. Home video technology began to gain traction in the mid-1970s with the introduction of the Videocassette Recorder or VCR. VHS refers to the format initially developed by JVC and that prevailed over Sony’s competing Betamax system. By 1990, approximately two-thirds of American homes included a VCR and $8.4 billion was spent on video rentals, “nearly twice as much as the total box-office gross” (Maltby, Richard. Hollywood Cinema. 2nd ed. Malden, MA: Blackwell, 2003. 193). Whereas the VCR fostered a burgeoning rental system, the Digital Video Disc or DVD, introduced in the late-1990s, was better suited to a sell-through approach whereby distributors retailed the disc at a lower price in order to sell directly to consumers. In 2002, DVD sales surpassed those of VHS and by 2006 approximately 80% of Americans owned a DVD player. Blu-ray discs and other high-definition formats provided additional storage and became available around 2006, but have failed to duplicate the success of either VHS or DVD. See McDonald: 150—161. See also: Brookey, Robert Alan. “The Format Wars: Drawing the Lines for the Next DVD” Convergence: The International Journal of Research into New Media Technologies, Vol. 12, no. 2 (2007): 199-211.

9. Smith, Aaron. “Home Broadband 2010.” Pew Research Center’s Internet & American Life Project. 11 August 2010. Web. 26 June 2013.

10. Skorman, Stuart and Catherine S Guthrie. Confessions of a Serial Entrepreneur: Why I Can’t Stop Starting Over. San Francisco: Jossey-Bass/Wiley, 2007. 75-81.

11. Wasko (1995): 152-153.

12. Skorman: 123. See also: Fitzpatrick, Eileen. “Video Retailer Reel.com Expands Online Options.” Billboard 17 May 1997. LexisNexis. Web. 29 September 2012.

13. Wasko (1995): 150.

14. Skorman: 84-86.

15. Said, Carolyn. “Reel Bummer: Movie Web Business Collapses After a Run-In with Dot-com Reality.” San Francisco Chronicle 23 June 2000. LexisNexis. Web. 29 September 2012.

16. Emert. Carol. “Virtual Video Venture Gets ‘Reel’: Online Rental Site Opens Walk-In Berkeley Store.” San Francisco Chronicle 12 July 1997. LexisNexis. Web. 29 September 2012.

17. Skorman. 88-89, 131-133.

18. Said, “Reel Bummer.” Also discussed in Skorman: 131-133.

19. Skorman: 124. See also: Emert, “Virtual Video.”

20. Graser, Marc. “Vid Chains Eyeing Online.” Variety 15 February 1999. LexisNexis. Web. 29 September 2012. Also: Miller Rosenblum, Trudi. “Vid Catalog Cos. Untangle the Web, Craft Effective Sites.” Billboard 31 May 1997. LexisNexis. Web. 29 September 2012.

21. Miller Rosenblum, Trudi. “Vid Catalog Cos. Untangle The Web, Craft Effective Sites.” Billboard. May 31, 1997.

22. Emert, Carol. “Hollywood Makes a Deal for Reel.com: Video Giant is Paying $100 million for Net Firm.” San Francisco Chronicle 31 July 1998. LexisNexis. Web. 29 September 2012.

23. Said. “Reel Bummer.”

24. Wasko (1995): 148. Wasser: 134-135. Ulin: 169-174.

25. Fitzpatrick, Eileen. “Amazon.com Starts Selling VHS and DVD Titles on Internet.” Billboard. November 28, 1998.

26. Graser. “Vid Chains Eyeing Online.”

27. ibid.

28. Wilson, Wendy. “Reel.com Shut; Entire Staff Fired.” Variety 13 June 2000. LexisNexis. Web. 29 September 2012.

29. Thompson, Clive. “If You Liked This, Sure to Love That.” New York Times 23 November 2008. LexisNexis. Web. September 2012. And: Bloom, David. “Pix Find Their Niche via Mail/Net Blitzes.” Variety 14 October 2002. LexisNexis. Web. 25 September 2012.

30. Ulin: 188. McDonald: 143, 150-152.

31. Laserdisc was another early optical disc format that gained some popularity in the 1980s by appealing to a devoted segment of consumers. As Stephen Prince explains, “laserdiscs typically carried special features such as a film’s theatrical trailer, outtakes, and commentary by filmmakers and film scholars.” The format, as a result, “became the medium of choice for videophiles and for serious film fans who cared about things like proper aspect ratio and good image quality” (Prince, Stephen. A New Pot of Gold: Hollywood Under the Electronic Rainbow, 1980-1989. Berkeley: University of California Press, 2000. 110). See also McDonald: 63-64.

32. Swartz, Jon. “New Web Site Sells, Rents DVD Movies” San Francisco Chronicle 18 April 1998. LexisNexis. Web. 29 September 2012.

33. Netflix understood from the outset that it needed to build an efficient distribution infrastructure and that this involved collaborating closely with the postal system. For a general discussion of the system, see Keating: 54-58. Additional details have been posted on Hacking Netflix, an unaffiliated though predominantly favorable blog operated by Mike Kaltschnee. See, in particular, links to testimony by various Postal Service employees in the complaint submitted by GameFly, an online video game rental service, that Netflix and others received preferential treatment (“US Postal Service Testimony Released in Gamefly Case; DVD Shipping Process Detailed.” Hacking Netflix.com. Briki Media. 4 August 2010. Web. 2 October 2012). See also Kaltschnee’s tour of Netflix’s Hartford shipping center: “Hacking a Netflix Shipping Center.” Hacking Netflix.com. Briki Media. 23 July 2009. Web. 24 June 2013.

34. Throughout the 1990s, the US Postal Service was under a mandate to integrate new technologies, and automation equipment in particular, to improve efficiency and lower costs of its operations. See: DeLancey, Toni G. The Challenges of the United States Postal Service in Adapting in the Information Age. Ann Arbor, MI: UMI, 2010. 47-67.

35. Evangelista, Benny. “Movies by Mail; Netflix.com Makes Renting DVDs Easy.” San Francisco Chronicle 26 January 2002. LexisNexis. Web. 29 September 2012.

36. Though Hastings recounted this story regularly to explain the genesis of Netflix, it is, according to Keating’s account, entirely apocryphal (Netflixed 6-7).

37. Graser, Marc. “Diamond in the Rough.” Variety 20 November 2000. LexisNexis. Web. 29 September 2012. Bloom, “Pix Find Their Niche.” Sweeting, Paul. “Flixing Its Muscle.” Variety 22 January 2004. LexisNexis. Web. 29 September 2012.

38. Bloom, “Pix Find Their Niche.”

39. Netherby, Jennifer. “Wal-Mart Mails in DVD Rental Service.” Variety 17 October 2002. LexisNexis. Web. 29 September 2012.

40. Sweeting, Paul and Meredith Amdur. “Join the Video Club.” Variety 22 September 2003. LexisNexis. Web. 29 September 2012.

41. Sweeting, Paul and Ben Fritz. “Online Rental Wars Shine Light on Demand.” Variety 29 April 2004. LexisNexis. Web. 29 September 2012.

42. In June 2003, Netflix received a broadly worded patent for its online subscription service. It triggered a series of lawsuits and counter-suits between Netflix and Blockbuster. The settlement allegedly favored Netflix. See, “Blockbuster Settles Fight With Netflix.” New York Times 28 June 2007. LexisNexis. Web. 29 September 2012.

43. Keating notes that the team charged with building Blockbuster’s online operations was set up in a separate space which though within walking distance of the company’s corporate headquarters but was, in effect, “a world away” (Netflixed 92). This underscores the fundamental discrepancy between Blockbuster’s core business model and the new online approach. 

44. Zeitchik, Steven. “Rivals and Churn Burn Netflix Stock.” Variety 25 July 2006. LexisNexis. Web. 29 September 2012. Goldsmith, Jill. “Blockbuster Gets Its Second Wind.” Variety 7 March 2008. LexisNexis. Web. 29 September 2012. Szalai, Georg. “Netflix Rocked by New Plans from Blockbuster.” Hollywood Reporter 13 June 2007. LexisNexis. Web. 29 September 2012. Helft, Miguel. “The Shifting Business of Renting Movies, By the Disc or the Click.” New York Times 16 January 2007. LexisNexis. Web. 29 September 2012.

45. Goldsmith, Jill and Paul Sweeting. “Vid Fast-Forward.” Variety 15 December 2004. LexisNexis. Web. 29 September 2012. Munoz, Lorenza. “Blockbuster to Halt Late Fees, but There’s a Catch.” Los Angeles Times 15 December 2004. ProQuest Newsstand. Web. 2 October 2012.

46. Sweeting, Paul. “Rental Decline Hits Blockbuster Hard.” Variety 10 August 2005. LexisNexis. Web. 29 September 2012. Goldsmith, Jill. “Blockbusted!” Variety 10 October 2005. LexisNexis. Web. 29 September 2012.

47. Hettrick, Scott and Paul Sweeting. “Studios Stew Over Blockbuster Woes.” Variety 6 September 2005. LexisNexis. Web. 29 September 2012. Zeitchik, Steven. “B’Buster KO’d By Nice Guy Policy.” Variety 9 November 2005. LexisNexis. Web. 29 September 2012.

48. Netherby, Jennifer. “Big Blue Heavy on Challenges, Light on Green.” Variety 14 October 2005. LexisNexis. Web. 29 September 2012. Goldsmith, Jill. “Blockbuster Bets Bullying Will Seal Deal.” Variety 29 December 2004. LexisNexis. Web. 29 September 2012. McClintock, Pamela. “Vidtailer Stocks Take Their Lumps.” Variety 29 March 2005. LexisNexis. Web. 29 September 2012.

49. Graser, Marc. “DVD Rentals Re-energized.” Variety 16 March 2009. LexisNexis. Web. 29 September 2012. Graser, Marc and Susanne Ault. “Biz Seeks Cure for Slipped Discs.” Variety 6 April 2009. LexisNexis. Web. 29 September 2012. Graser, Marc and Marcy Magiera. “H’W’D Red Alert.” Variety 26 August 2009. LexisNexis. Web. 29 September 2012. Graser, Marc. “Vid Stores Fading Out.” Variety 18 March 2010. LexisNexis. Web. 29 September 2012. “Blockbuster Nears Chapter 11 Filing.” Variety 27 August 2010. LexisNexis. Web. 29 September 2012. For a more in-depth, scholarly account of Redbox, see: Tryon, Chuck. “Redbox vs. Red Envelope, or What Happens When the Infinite Aisle Swings Through the Grocery Store.” Canadian Journal of Film Studies, Vol. 20, No. 2 (Fall 2011): 38-54.

50. There were several extenuating circumstances that contributed to Blockbuster’s unfavorable position. Viacom purchased Blockbuster as part of its concurrent plans to acquire Paramount Communications in 1994. Though the deal seemed to provide both sides with a strategic advantage, Viacom decided to sell Blockbuster in late 2003 as the rental retailer’s profits had begun to flatten. As part of this process, both companies posted a loss of over $1 billion for that year. The addition of this immense debt load at the same Blockbuster was dealing with new competitors and a fluctuating market certainly made matters more difficult. See: Goldsmith, Jill. “Red Tidings for Viacom.” Daily Variety. 11 February 2004. LexisNexis. Web. 29 September 2012.

51. Anderson, Chris. “The Long Tail.” Wired 12.10 (October 2004): 170-177.

52. Anderson, Chris. The Long Tail: Why the Future of Business is Selling Less of More. New York: Hyperion, 2006. 23.

53. ibid. 15-18.

54. Wasser: 143. See also, Ulin: 169-170.

55. Wasko (1995): 159.

56. Anderson (2006): 7.

57. Graser, Marc. Netflix Inks with Studios.” Variety 7 December 2000. LexisNexis. Web. 29 September 2012.

58. See, for example, Wasko (1994), Maltby (2003), and Prince (2000).

59. Among others, see McDonald: 125-126.

60. Sweeting, Paul. “The Backend.” Variety 20 July 2001. LexisNexis. Web. 29 September 2012. Frankel, Daniel. “DVDs Open Revenue Menu.” Variety 29 July 2002. LexisNexis. Web. 29 September 2012.

61. Hettrick, Scott and Daniel Frankel. “A Chip Off Old Block.” Variety 22 April 2002. LexisNexis. Web. 29 September 2012.

62. Zeitchik, Steven. “Netflix Adds its Own Pix to Mix.” Variety 27 February 2006. LexisNexis. Web. 29 September 2012. Zeitchik, Steven. “Netflix Taps Naraghi Veep.” Variety 18 April 2006. LexisNexis. Web. 29 September 2012.

63. Kotler, Steven. “Netflix Eager to Grow Indie Pic ‘Eco-System’.” Variety 2 March 2006. LexisNexis. Web. 29 September 2012.

64. Kotler, Steven. “Netflix Eager to Grow Indie Pic ‘Eco-System’.” Variety 2 March 2006. LexisNexis. Web. 29 September 2012. Morfoot, Addie. “Casting Wide Net for Niche Pix.” Variety 28 September 2007. LexisNexis. Web. 29 September 2012. Thompson, Anne. “Indies Caught in Web Dilemma.” Variety 18 February 2008. LexisNexis. Web. 29 September 2012. Mumblecore refers to an early-2000s subgenre of American independent film. It was initially associated with several films screened at the 2005 South by Southwest Film Festival in Austin, Texas.

65. As part of Blockbuster’s larger financial woes, DEJ was sold shortly thereafter. See: Hettrick, Scott. “DEJ Dealt to First Look.” Variety 8 November 2005. LexisNexis. Web. 29 September 2012.

66. Thompson, Anne. “Docs Get A Sporting Chance on the Net.” Variety 31 March 2008. LexisNexis. Web. 29 September 2012. Mohr, Ian. “H’wood Gets Real with Doc Flock.” Variety 12 June 2006. LexisNexis. Web. 29 September 2012.

67. Zeitchik, “Netflix Adds its Own Pix to Mix.” Bloom, “Pix Find Their Niche.” Grimes, Willliam. “Living Room Film Club, A Click Away.” New York Times 19 March 2004. LexisNexis. Web. 29 September 2012. Chmielewski, Dawn. “Calm Amid the Storm: Netflix Will Emerge from Battle with Blockbuster As a Powerful Mass-Market Force.” San Jose Mercury 27 February 2005. LexisNexis. Web. 29 September 2012.

68. Thompson, Anne. “Risky Business.” Hollywood Reporter 2 June 2006. LexisNexis. Web. 29 September 2012. Zeitchik, “Netflix Adds its Own Pix to Mix.” Bloom, “Pix Find Their Niche.”

69. Sweeting and Fritz, “Online Rental Wars Shine Light on Demand.” Healey, Jon. “Q & A; On a Mission to Change the Economics of Hollywood…” Los Angeles Times 10 April 2004. ProQuest Newsstand. Web. 2 October 2012.

70. Thompson, Anne. “Indies Caught in Web Dilemma.”

71. Tobias, Scott. “Mailboxes, Etc.—Independent Producers & Distributors.” Hollywood Reporter 1 August 2006. LexisNexis. Web. 29 September 2012. For a slightly different view, see: Kehr, David. “It’s the Delivery, Stupid: Goodbye, DVD. Hello, Future.” New York Times 6 March 2011. LexisNexis. Web. 29 September 2012.

72. Hettrick, Scott. “DEJ Dealt to First Look.” Daily Variety 8 November 2005. LexisNexis. Web. 29 September 2012.

73. “Netflix Corporate Fact Sheet.” Ir.netflix.com. 22 October 2007. Web. 8 August 2012.

74. Graser, Marc. Netflix Inks with Studios.” Variety 7 December 2000. LexisNexis. Web. 29 September 2012. Swanson, Tim. “Netflix Clicks Pix with New Studio Mix.” Variety 13 June 2001. LexisNexis. Web. 29 September 2012.

75. Goldstein, Gregg. “Netflix Closing Red Envelope.” Hollywood Reporter 22 July 2008. LexisNexis. Web. 29 September 2012. See also, Garrett, Diane. “Torn Envelope.” Variety 28 July 2008. LexisNexis. Web. 29 September 2012.

76. Graser, Marc and Dave McNary. “Deal Delays DVD Rentals.” Variety 7 January 2010. LexisNexis. Web. 29 September 2012.

77. Graser, Marc. “Vid Stores Fading Out.” Daily Variety 18 March 2010. LexisNexis. Web. 27 September 2012.

78. Early VOD platforms included CinemaNow, Movielink, and MovieBeam. Amdur, Meredith. “What’s the Holdup with VOD?” Variety 10 February 2003. LexisNexis. Web. 27 September 2012. Marlowe, Chris. “Fox Loads Pics on CinemaNow: First Online VOD Deal for Studio.” The Hollywood Reporter 3 April 2003. LexisNexis. Web. 27 September 2012. Amdur, Meredith. “Uploading Partner.” Daily Variety 12 August 2003. LexisNexis. Web. 28 September 2012. Fritz, Ben and Gabriel Snyder. “H’wood Seeking the Missing Link.” Variety 10 April 2006. LexisNexis. Web. 27 September 2012. See also: Perren, Alisa. “Business as Unusual: Conglomerate-Sized Challenges for Film and Television in the Digital Arena.” Journal of Popular Film and Television. Vol. 38, no. 2 (June 2010): 72-78.

79. Starz had been aggressive in developing its own subscription-based VOD service, introducing Starz Ticket in 2004. It revamped the service in 2006, rebranding it Vongo. In both cases, however, the service produced a tepid response and, as a result, Starz sold the rights the rights for a mere $30 million. See: Dempsey, John. “Netflix, Starz Strike Pic-Streaming Pact.” Daily Variety 1 October 2008. LexisNexis. Web. 29 September 2012.

80. “Stock Quote and Chart.” Ir.netflix.com. Netflix, Inc. Web. 23 September 2012.

81. Fritz, Ben. “More Net, Less Flix: Forget Movies By Mail. TV Streaming is the New Star for Netflix.” Los Angeles Times 5 February 2012. Proquest Newsstand. Web. 29 September 2012. Stelter, Brian. “Once Film-Focused, Netflix Transitions to TV Shows.” New York Times 28 February 2012. LexisNexis. Web. 29 September 2012.

82. Chmielewski, Dawn. “Binge-Viewing Transforms TV; Services Like Netflix are Letting Fans Watch Multiple Episodes or Even Entire Seasons of Shows All at Once.” Los Angeles Times 1 February 2013. Proquest Newsstand. Web. 16 June 2013.

83. Hastings made this comparison as early as 2005. See: Chmielewski, “Calm Amid the Storm.” For the nature of more recent comparison, see: Litteton, Cynthia. “Netflix Originals Vision Catches Biz’s Eye.” Variety 20 March 2012. LexisNexis. Web. 29 September 2012.

84. For the two most extensive accounts of HBO, see Michele Hilmes’ “Breaking the Broadcast Bottleneck: Pay Television and the Film Industry Since 1975” (Hollywood in the Age of Television. Ed. Tino Balio. Boston: Unwin Hyman, 1990, pp. 297-318.) and Jennifer Holt’s Empires of Entertainment: Media Industries and the Politics of Deregulation, 1980-1996 (New Brunswick, NJ: Rutgers University Press, 2011).

85. Holt: 43.

86. Edgerton, Gary R. “A Brief History of HBO.” The Essential HBO Reader. Eds. Gary R. Edgerton and Jeffrey P. Jones. Lexington: University of Kentucky, 2008. P. 4.

87. Hilmes: 302.

88. Anderson, Christopher. “Producing an Aristocracy of Culture in American Television.” P. 32. See also Thomas A. Mascaro’s overview of documentary at HBO. Both are included in The Essential HBO Reader.

89. Prince: 68.

90. Wasko, Janet. “The Future of Film Distribution and Exhibition.” The New Media Book. Ed. Dan Harries. London: BFI, 2002. P. 204.

91. Stelter, Brian. “A Resurgent Netflix Beats Projections, Even Its Own.” New York Times 24 January 2013. LexisNexis. Web. 16 June 2013. Stewart, James B. “Netflix Chief Recalls Its Near-Death Spiral.” New York Times 27 April 2013. LexisNexis. Web. 16 June 2013.

92. Hastings, Reed and David Wells. “Q4 12 Letter to Shareholders.” Ir.netflix.com. Netflix, Inc. 24 July 2012. Web. 23 September 2012.

93. “Top Sites in United States.” Alexa.com. Alexa Internet, Inc. Web. 6 October 2012. As Keating notes, Netflix reportedly accounts for upwards of 35% of all Internet traffic (Netflixed: 255).


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