Netflix and the Benefit of Flip Flopping

Reed Hastings, CEO of Netflix, gave subscribers some good news yesterday:

We are going to keep Netflix as one place to go for streaming and DVDs. This means no change: one website, one account, one password … in other words, no Qwikster.

As a long time subscriber, I can only say Hallelujah.

But I am not surprised. Hastings has changed course sharply before. Most famously, he killed off a set-up box–the Netflix Player–just weeks before its scheduled launch. I take that as a sign of great leadership. As I wrote two years ago:

Reed Hastings is not a man who gets locked in by sunk costs: he’s willing to kill projects … even if he’s got years invested in them.

That’s a real strength. I am sure he regrets the decision to move toward Qwikster, but kudos to him for reversing course.

P.S. Netflix’s corporate culture was the subject of one of my most popular posts. Favorite line: “Adequate performance gets a generous severance package.”

Netflix Avoids the Sunk Cost Fallacy

The highlight of this month’s Wired magazine is a profile of Netflix and its CEO, Reed Hastings. The theme is Netflix’s strategy to thrive even as their business model changes (e.g., as on-line streaming replaces DVDs by mail).

The opening paragraphs document an impressive willingness to change course:

It had taken the better part of a decade, but Reed Hastings was finally ready to unveil the device he thought would upend the entertainment industry. The gadget looked as unassuming as the original iPod—a sleek black box, about the size of a paperback novel, with a few jacks in back—and Hastings, CEO of Netflix, believed its impact would be just as massive. Called the Netflix Player, it would allow most of his company’s regular DVD-by-mail subscribers to stream unlimited movies and TV shows from Netflix’s library directly to their television—at no extra charge.

The potential was enormous: Although Netflix initially could offer only about 10,000 titles, Hastings planned to one day deliver the entire recorded output of Hollywood, instantly and in high definition, to any screen, anywhere. Like many tech romantics, he had harbored visions of using the Internet to route around cable companies and network programmers for years. Even back when he formed Netflix in 1997, Hastings predicted a day when he would deliver video over the Net rather than through the mail. (There was a reason he called the company Netflix and not, say, DVDs by Mail.) Now, in mid-December 2007, the launch of the player was just weeks away. Promotional ads were being shot, and internal beta testers were thrilled.

But Hastings wasn’t celebrating. Instead, he felt queasy. For weeks, he had tried to ignore the nagging doubts he had about the Netflix Player. Consumers’ living rooms were already full of gadgets—from DVD players to set-top boxes. Was a dedicated Netflix device really the best way to bring about his video-on-demand revolution? So on a Friday morning, he asked the six members of his senior management team to meet him in the amphitheater in Netflix’s Los Gatos offices, near San Jose. He leaned up against the stage and asked the unthinkable: Should he kill the player?

Three days later, at an all-company meeting in the same amphitheater, Hastings announced that there would be no Netflix Player.

In short, Reed Hastings is not a man who gets locked in by sunk costs: he’s willing to kill projects (or, in this case, spin them off) even if he’s got years invested in them. A good example for my students when we discusses costs in a few weeks. And just another example of the strengths of Netflix’s culture.

Netflix Boosts Prize Economics

By at least one metric – the number of people who have mentioned it to me – my brief post about Netflix appears to be my most popular one so far.

The post linked to a remarkable slide deck about the corporate culture that Netflix has embraced in its quest for excellence. Most memorable line: “adequate performance gets a generous severance package.” If you haven’t seen it, I encourage you to click on over. It’s worth your time.

Yesterday’s award of the first Netflix prize highlights another strength of Netflix’s culture: it clearly does not suffer from “not-invented-here” syndrome. Indeed, quite the reverse. A few years ago, Netflix realized that it had reached its limit in trying to improve the accuracy of its movie recommendation system. Even though users may rate dozens (or more) movies, it turns out to be difficult to predict what other movies they will like.

So Netflix decided to outsource this problem in an ingenious way: it offered a $1 million prize to any person or team that could improve the recommendation algorithm by at least 10%. Stated that way, the problem seems deceptively easy. But it took nearly three years before the winner – a team led by AT&T Research engineers – took home the prize.

As recounted in Netflix’s press release, this marathon ended in a race to the wire:

“We had a bona fide race right to the very end,” said [CEO Reed] Hastings. “Teams that had previously battled it out independently joined forces to surpass the 10 percent barrier. New submissions arrived fast and furious in the closing hours and the competition had more twists and turns than ‘The Crying Game,’ ‘The Usual Suspects’ and all the ‘Bourne’ movies wrapped into one.”

Netflix said “BellKor’s Pragmatic Chaos” edged out a team called “The Ensemble,” another collaboration of former competitors, with the winning submission coming just 24 minutes before the conclusion of the nearly three-year-long contest. The competition was so close and the submissions so sophisticated that it took a team of external and internal judges several weeks to validate the winner after the contest closed on July 26.

Happily, the resulting algorithm won’t be exclusive to Netflix:

The contest’s rules require the winning team to publish its methods so that businesses in many fields can benefit from the work done. The winning submission and the previously hidden ratings used to score the contest will be published at the University of California Irvine Machine Learning Repository. The team licensed its work to Netflix and is free to license it to other companies.

On the first day of my microeconomics class, I told my students that economics is all about incentives. As an example, I used the famous prize for a way to measure longitude, which inspired the invention of the chronometer (i.e., a clock of sufficient precision to measure longitude). Next time around, I will mention the Netflix prize as well.

P.S. Not one to rest on its successes, Netflix has already announced plans for a second Netflix prize. This one aims to find a better way to recommend movies to people based on demographic data (e.g., where they live) rather than movie ratings.

Big Salaries at Netflix

The slide deck describing the culture at Netflix has some real gems (ht kottke.org).

For example, here are three elements of the company’s compensation practices:

Unlike many companies, we practice “adequate performance gets a generous severance package.” (slide 26)

Netflix vacation policy and tracking: “there is no policy or tracking” (“There is also no clothing policy at Netflix, but no one has come to work naked lately.”) (slide 68)

Big salary is the most efficient form of compensation. (No bonuses, no free stock options, etc.) (slide 106)

Well worth a read.