It's the spring of 2011. Netflix (NFLX 0.10%) and its red DVD-by-mail envelopes drove video-rental giant Blockbuster to bankruptcy six months earlier. Digital streaming is just a free bonus that comes with Netflix's DVD-rental service, and the company just announced its first content production deal.
Nobody knew then that the company was about to launch headfirst into video streaming, effectively abandoning DVD mailing at the height of its popularity. The execution of the strategy shift was a fumble of epic proportions, but long-term investors can't complain about the end result. Ten years later, Netflix has created a global entertainment empire while its stock has returned a mind-boggling 1,620%.
Did anyone see this incredible future coming in 2011? Hindsight is 20/20, so let's take a clear-eyed look back at Netflix's game-changing strategy shift from the perspective of 2021.
Netflix was a very different company in March 2011. The DVD rental business generated trailing sales of $2.16 billion, and the company's market cap stood at a respectable $11.3 billion. We're looking at a fairly standard mid-cap stock here, still light-years away from challenging media giants Walt Disney (DIS 0.57%) or Time Warner in terms of business results.
Four months earlier, Time Warner CEO Jeff Bewkes brushed off the Netflix threat by comparing it to the Albanian army taking over the world. "I don't think so," Bewkes said. That notorious quip represented the typical attitude toward Netflix in the media industry of 2011. The company was nothing more than an interesting distribution channel.
And why not? Hollywood was armed to the teeth against the incoming Netflix threat. The newcomer simply replaced video stores like Blockbuster in the grand scheme of things. The throwaway addition of digital video streams could be countered with tools already available to the cable TV industry. Pay-per-view services and video on demand could intercept Netflix's newfangled media streams, which depended on web browsers far from the average living room or a rare breed of internet-connected set-top boxes. And nobody wanted to upset the apple cart in the delicate and time-honored relationship between film studios and movie theater operators.
I liked what Netflix was doing and expected the consumer-friendly streaming service to become a powerful business someday. Original shows like House of Cards didn't make sense to me at the time, though: The streaming service should surely rely on hit movies produced and promoted by the likes of Disney and Warner Bros., leaving Netflix to focus on the distribution end of the media pipeline.
The game-changing moment
The Qwikster episode was a difficult pill to swallow in the summer of 2011. To recap, Netflix separated its online streaming alternative from the DVD-by-mail program and started charging customers separately for each service. The original company name was reserved for the new streaming service, and the DVD offering was renamed Qwikster.
CEO Reed Hastings wanted to make a clean break from the old DVD business, but the sudden split came as a shock to subscribers and investors. Netflix shares fell from an all-time split-adjusted high of $43.54 per share to just $8.91 in four months, forcing Hastings to cancel the sharp split and the Qwikster name. To this day, Netflix still offers a DVD-mailing service under the well-known company name, but it's a forgettable afterthought. Global streaming services accounted for 99% of Netflix's total revenue in 2020.
Was Qwikster really a mistake?
As it turns out, Hastings had the right idea all along. Netflix's future was always going to be focused on video-streaming services. A DVD rental service by any other name would smell as sweet after all. Sticking with the original plan, Qwikster could have been spun off into a completely separate business under handpicked CEO Andy Rendich, possibly adding video game rentals and other new ideas along the way.
That's easy to say 10 years later, of course. In 2011, Hastings had no other choice than backing down from the harsh Qwikster detachment. The separation really called for more-delicate handling as many customers only saw their monthly subscription fees skyrocketing. The larger ambition of offering more content through a more user-friendly interface was unclear in 2011.
What about the original-content idea?
What struck me as a misguided marketing plan in 2011 now looks like a stroke of genius. Netflix moved on from a handful of high-budget shows under contract from third-party content creators, like House of Cards and Orange Is the New Black, to form its own award-winning studio with dozens of in-house productions around the world.
Early on, I was hoping that Netflix might turn into a central clearinghouse where consumers could find premium content from every studio under the sun. In reality, studios started inching away from their content-distribution deals as Netflix proved that there was a healthy market for digital streaming. So every content creator worth its salt has its own proprietary streaming platform these days, and Netflix has been forced to depend on a large and varied catalog of completely exclusive content.
The company invested $11.8 billion in streaming-content production and acquisition last year, up from $406 million in 2010. You have to spend money to make money. The billions and billions of dollars that Netflix has invested in original content has driven the subscriber count from 20 million to 204 million over the last 10 years.
Could investors see Netflix's massive future coming?
Netflix was a driving force behind some massive changes to the entertainment industry. Streaming services Disney+ and Hulu now represent Disney's long-term future. Time Warner is now a subsidiary of telecom giant AT&T (T -0.77%), burning billions of dollars in Time Warner's shareholder value as the supposed Albanian army took over the world. The COVID-19 pandemic gave Hollywood the final push to separate studio interests from the traditional movie theater distribution model. The willingness to abandon the industry-changing DVD business in order to focus on the new streaming idea was central to the whole revolution.
Did anybody expect Netflix to achieve all of this in less than 10 years? Not really. At the same time, the writing was on the wall in 2011. Streaming video was going to be big, and Netflix was an obvious leader from the start. So I doubled my Netflix holdings near the Qwikster-inspired market bottom in November of that year. That portion of my Netflix holdings has returned 4,210% so far, and I'm not selling anytime soon.
Don't forget that Reed Hastings is willing and ready to run away from the streaming business as soon as an even better model comes along. I don't know what that might be, but the internet-based streaming business surprised most of us, too. This growth story still has decades to go before the final credits roll. I can't wait to see what Netflix will do over the next decade or two.