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Ted Sarandos on How Netflix Predicted the Future of TV

When Ted Sarandos first met with Netflix founder Reed Hastings about working for his start-up online video-rental service in 1999, Hastings laid out his vision for the new recruit.

Hastings saw his company’s future as providing streaming video delivered to subscribers via the internet, even though Netflix at the time made its money by mailing DVDs to subscribers across the country.

Sarandos, who has been Netflix’s head of content since early 2000, was impressed by the clarity of Hastings’ plans. This was right around the time that music file-sharing service Napster was starting to make headlines and provoke copyright infringement lawsuits. Sarandos took the job with the understanding that Netflix wasn’t going to be strictly a mail-order DVD service for long. But what he couldn’t have known was how profoundly the company’s pioneering efforts would upend the traditional entertainment industry.

“We never spent one minute trying to save the DVD business,” Sarandos says. And yet even as it scales unprecedented heights, the company does still send DVDs via its trademark red envelopes to about 3 million subscribers.

The strategy for expansion came down to a question of timing for the streaming launch. Broadband speeds and streaming technology built into consumer devices had to hit a critical mass before Netflix would strike. The company was mindful of the bad reception consumers gave to earlier online movie-distribution ventures that could take hours to download a two-hour film. Apple’s iTunes service offered a better system, but it still wasn’t instant for users.

“Back then, [Hastings] said that postage rates were going to keep going up and the internet was going to get twice as fast at half the price every 18 months,” Sarandos recalls. “At some point those lines would cross, and it would become more cost-efficient to stream a movie rather than to mail a video. And that’s when we get in.”

The lines crossed in early 2007. Netflix began offering subscribers the option of streaming licensed movies and a few TV series. As streaming took off, Sarandos and his team began to gain insights into how the company’s subscribers watched TV. They began to recognize the demand for viewers to binge-watch one series at a time and the potential for algorithm-driven recommendations to keep customers engaged with Netflix’s service for hours on end. The Netflix team couldn’t help but see signs that many users opted to watch back-to-back episodes of a series in bursts, and that many would stick to episodes of one or two shows at a time. They had also recognized, even from the DVD days, the potential value of being able to make taste-based recommendations to subscribers.

“House of Cards” debuted in 2013, starting Netflix’s foray into original programming.
Courtesy of Netflix

The company stirred the ire of subscribers when it officially split its DVD and streaming subscriptions into two plans in 2011, at which point it was still sending out discs to 14 million customers.

Since then, Netflix has slowly been shedding DVD subscribers every quarter while adding new streaming subs by the millions. The company ended its last quarter with nearly 3 million DVD subscribers, all of whom are in the United States, and 130 million streaming subscribers from all around the world.

So why doesn’t Netflix close down its DVD business to fully focus on streaming? Because the profit margins for each DVD subscriber are still very good. Those 3 million subscribers contributed close to $53 million to the company’s profits during its most recent quarter.

And while Netflix has been increasingly profitable, the company has had plenty of quarters in the past where the DVD service made all the difference. In fact, it built its entire streaming business with profits derived from the DVD side. And the company hasn’t completely given up on investing in its DVD.com unit.

In early 2017, DVD.com even launched a mobile app to help its members organize their rentals from their phones. Some of these optimizations are starting to pay off, with relative profit margins increasing over time. In the second quarter of 2016, DVD.com subscribers contributed an average of $15.65 to Netflix’s profits. Two years later, that number has climbed to $17.66 per member per quarter.

However, those DVD profits won’t last forever. Netflix has lost approximately 190,000 DVD subscribers every quarter for the past two years. At this rate, the company will say good-bye to its last DVD members by 2022. The flip side is that the costs for operating DVD.com are also declining. Netflix spent $77 million on buying DVDs in 2016; last year that expense fell to less than $54 million.

“Pay television didn’t have a distribution problem — it had a packaging problem and a content problem.”
Ted Sarandos

Netflix’s original-content push took off in earnest on Feb. 1, 2013, with the debut of “House of Cards.” Five years later, the streaming service has grown to the point where it is projected this year to deliver more than 80 new feature films (original and acquired) and an astounding 700 new TV series.

In essence, Netflix has reinvented the cable bundle for the on-demand era. Rather than focusing on a collection of channels that inevitably carry a lot of chaff between the wheat, Netflix opted to put the emphasis on distinctive programs spanning all manner of genres. It studied what did and didn’t work about the cable business and set about improving it from the company’s Silicon Valley confines in Los Gatos, Calif.

Today, Sarandos sees more competitors, including Disney, entering Netflix’s arena, but says he views that as a positive for the overall industry. Netflix is spending an astounding amount on content — an estimated $13 billion this year — and is still a young enough business to be focused on market share rather than profits. Those are advantages its older rivals don’t have. But Hastings, in Sarandos’ view, came into the marketplace with the coveted asset that money can’t buy: vision.

“Pay television didn’t have a distribution problem — it had a packaging problem and a content problem,” says Sarandos. “We saw that a lot of [cable customers] were paying for sports they didn’t want and channels they didn’t watch. There’s got to be much more equilibrium between consumer demand and pricing. Through the growth of all these direct-to-consumer services, television will become better and better.”

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