Netflix Looks Back on Its Near-Death Spiral

By JAMES B. STEWART

For Reed Hastings, the chief executive of Netflix, the worst part of the company’s 2011 self-inflicted Qwikster debacle, in which Netflix tried to both raise prices and spin off its DVD-by-mail business, wasn’t the parody by “Saturday Night Live,” the scathing media criticism or even the dizzying plunge in the company’s stock price from almost $299 in July 2011 to about $53 last September.

It was the thousands of e-mails that poured in from angry and disappointed customers.

“I realized, if our business is about making people happy, which it is, then I had made a mistake,” Mr. Hastings told me this week, in a rare public comment on an episode that could have destroyed the company. “The hardest part was my own sense of guilt. I love the company. I worked really hard to make it successful, and I screwed up. The public shame didn’t bother me. It was the private shame of having made a big mistake and hurt people’s real love for Netflix that felt awful.”

This week, Netflix announced that it gained three million subscribers globally in the first quarter and that revenue for the quarter exceeded $1 billion, a record for the company. On Tuesday, the stock jumped 22 percent, the first time it has traded over $200 since the Qwikster episode, and it is up 135 percent so far this year, making Netflix the best-performing company in the Standard & Poor’s 500-stock index. The company is basking in the critical glow of its original series, “House of Cards,” and this month narrowly surpassed HBO in total subscribers.

In the annals of corporate missteps, there are few parallels to such a rebound from what once looked like a death spiral, especially in the momentum-driven world of technology. Zynga, the online game maker, and Groupon, the Internet coupon company, are struggling with brutal competition. In an old-economy industry like retail, J. C. Penney was in the midst of a similarly bold attempt to reposition the company when it fired its chief executive, and is now fighting to survive.

How did Netflix simultaneously manage both a fundamental transformation of the company and a public relations disaster?

Mr. Hastings said he realized that the company’s attempt to both raise prices and separate into two companies, one the legacy DVD-by-mail business and the other the up-and-coming broadband streaming business, was trying to do too much too fast. Angry subscribers abandoned the company in droves (800,000 in the fourth quarter of 2011 alone), revenue missed estimates and the stock plunged.

“I messed up,” Mr. Hastings wrote in an unusually forthright September 2011 blog post. Citing the precedents of AOL and Borders Books, which struggled or failed to make the digital transition, “my greatest fear at Netflix has been that we wouldn’t make the leap from success in DVDs to success in streaming.” But in the rush to accelerate the transition, he wrote, “In hindsight, I slid into arrogance based upon past success.” He also made a video apology.

Mr. Hastings said he didn’t expect the apology alone to “turn it around,” adding, “I wasn’t naïve enough to think most customers care if the C.E.O. apologizes, but I thought it was honest and appropriate.”

The mea culpa resonated, though, with some important constituencies, including some Wall Street analysts, who were punishing the company’s stock. Richard Greenfield, an influential media analyst at BTIG, said that he was impressed that Mr. Hastings “realized his mistakes and openly admitted them.”

“He dusted himself off, stood back up and started running,” Mr. Greenfield said. “Very few people can do that.”

Still, Mr. Hastings said, “The situation made me nervous and very focused.

“I couldn’t say with confidence that we’d recover. We were in a place that was quite risky. We didn’t have the reserves to make a second stumble.”

On the other hand, he didn’t panic, and he didn’t lose confidence. Although he made some big changes, like scrapping Qwikster, he never questioned his original vision for the company, which he helped found in 1997. Nor did he lunge at supposedly transformative opportunities that were pressed upon him — a lesson he learned from a four-year war with Blockbuster that began in 2004, when Blockbuster, then the dominant and much larger DVD distributor, tried and failed to crush its upstart competitor.

“There were elements of panic in my reaction back then,” Mr. Hastings said. “We got desperate and we did some dumb things.” (He cited online advertising on the Web site; starting Red Envelope, an independent film producer and distributor, since shut down; and buying DVDs out of the Sundance Film Festival.) “After we eventually won the Blockbuster battle, I looked back and realized all those things distracted us. They didn’t help, and they marginally hurt. The reason we won is because we improved our everyday service of shipping and delivering. That experience grounded us. Executing better on the core mission is the way to win.”

Plenty of people were urging him to take drastic steps to show the company was regaining momentum, like buying sports programming, offering a pay-per-view service or buying a hardware maker like Roku, which makes streaming players for televisions. “There was amazing pressure to come up with the shiny object that would make everything better,” he said. “But the phrase I used was, ‘There are no shortcuts.’ We weren’t going to find an idea or gesture that would make people love us again overnight. We had to earn their trust by being very steady and disciplined. And we had to be careful because we were on probation. We had to stick to what we do well and not lose confidence. I couldn’t say for sure we’d recover. But I was confident that our best odds were to be very steady and focus on improving the service.”

Mr. Hastings, now 52 years old, stayed out of the public eye, the better to focus on day-to-day management. By the end of the first quarter of 2012, the subscriber exodus had subsided and began to show slow but steady improvement. Still, Wall Street was unimpressed as international expansion and content costs soared. In September, a year after Mr. Hastings’s apology, Netflix shares dropped to $53.80. Mr. Hastings said he found the stock plunge “a little unnerving, but we don’t manage for the stock price.” He went on: “Wall Street people may be friendly, but then they’ll turn around and short you. It’s not personal. They’re trying to make money. And if I was in their shoes, I might have felt the same way. Once the wheels come off a company, it’s hard to recover.”

Then, in January, the company announced it had added two million streaming subscribers during the fourth quarter of 2012, beating estimates, as consumers embraced tablet computers and Internet televisions during the holiday season. The activist investor Carl Icahn disclosed he’d acquired a 10 percent stake in the company, calling the shares undervalued. The stock began to climb.

“House of Cards,” Netflix’s venture into original programming, starring Kevin Spacey and directed by David Fincher, made its debut to critical acclaim in February and attracted millions of new subscribers. “Netflix is following along the path of the cable networks,” BTIG’s Mr. Greenfield said. “HBO did it; AMC did it; FX did it. Eventually Netflix will own and control its own content. It’s a natural evolution.” Mr. Greenfield issued a buy recommendation on Netflix on April 15, just ahead of this week’s rally.

Netflix may also have benefited from more fundamental factors. “One reason they bounced back is that Netflix has the same dual competitive advantages that characterize all of the great media franchises, which are scale and customer captivity,” said Jonathan A. Knee, senior managing director at Evercore Partners and director of the media program at Columbia Business School. “The unfortunate events of 2011 notwithstanding, those structural advantages are complemented by a real culture of operational excellence, which isn’t often the case in media or digital companies.”

With this week’s developments and the stock over $200, “in one sense I can say this is behind us,” Mr. Hastings said. “But it’s like a partially healed bone. It’s still quite fragile. Were we to make a similar mistake, we’d be right back in the penalty box. So we’re not really out of the woods. We’re growing and we’re making good progress, but we’re still not fully back to where we were.”

What advice does he offer? “Don’t get distracted by the shiny object,” he said. And if a crisis comes, “execute on the fundamentals.”