FOR THE NEXT few weeks, I batted ideas around with Christina and Te, argued about those ideas with Reed, and watched them slowly turn to ash on the floorboard of my Volvo, somewhere between Scotts Valley and Sunnyvale. I started to get discouraged.
I don’t remember how we first learned about DVDs. Christina might have uncovered the then-nascent technology during her market research. My co-founder at Integrity QA, Steve Kahn, was a home theater tech geek and might have mentioned them at the Pure Atria offices. I might have read about them in the newspaper—they were in test markets in San Francisco and six other cities in 1997.
But I suspect I learned about them from Reed. He actually read all the free tech journals that got mailed to Pure Atria—journals that, in my case, only accumulated in a dusty pile in the corner of my office. And sometime after the online video rental idea crashed and burned, he’d complained to me about another exorbitant late fee he’d incurred at a video store. Movies were on his mind—and movies by mail had been one of the few ideas I’d had that had caught his eye.
One thing’s for certain: I didn’t see a DVD on a shelf.
Prior to 1997, DVDs were only available in Japan. And even if you found one, there was no way to play it—no DVD players were for sale in the States. It was easier, far easier, to find a laser disc than a DVD.
Even on March 1, 1997, when the first DVD players went on sale in U.S. test markets, there were no DVDs available for purchase outside of Japan. It took until March 19 for any titles to be released in the United States, and the few that were available weren’t exactly hot new releases. The Tropical Rainforest. Animation Greats. Africa: The Serengeti. The first mass release of titles—thirty-two in total—came a week later from Warner Bros.
The history of the format is a fascinating one, and it’s too long for this book. But essentially, everyone—movie studios, the video player manufacturers, the big video chains, the computer companies—wanted to avoid a repeat of the VHS/Betamax wars, in which two competing technologies battled it out in the marketplace, confusing customers and setting back the adoption of the VCR for years. And nobody—aside from cinephiles and collectors—really liked the expensive, large laser discs that had come out a few years before, either. There were various competing technologies in development in the mid-nineties, and all of them were compact disc–sized.
Take note of that: compact disc–sized. That was what caught my eye. A CD was much smaller than a VHS tape. And much lighter. In fact, it occurred to me that it was probably small and light enough to fit into a standard business envelope, requiring nothing more than a 32-cent stamp to mail. Quite a difference from the heavy cardboard box—and expensive UPS shipping rates—a VHS would have required.
Christina did some digging and found out that the studios and manufacturers were planning on pricing the DVD as a collectible item—$15 to $25 per disc. That’s a far cry from what had happened in the eighties, when studios responded to the newly ubiquitous video store by raising the prices on tapes. Once the studios realized that the video rental stores were making all the money (by buying one VHS cassette and then renting it out hundreds of times—a right established by the Supreme Court as the “first sale” doctrine), they had decided that the only way to respond was to price the VHS high enough that they essentially captured their “fair share” of all that rental income. They knew that by raising the price like this they were saying good-bye to consumer purchases, but it was worth it because most people didn’t want to own a movie.
The studios had learned from that mistake, and they wanted DVDs to be like CDs: collectible consumer products. If DVDs were priced low enough, they reasoned, customers would forget about renting and instead buy movies, the same way they bought albums on CD. The studios envisioned customers with shelves of movies in their family rooms—avoiding the rental middleman altogether.
Cheaper inventory, cheaper shipping—it was looking like movies by mail could work, if (and this was a big if) DVD became a popular format. With other huge categories—books, music, pet food—slowly being taken online, the movie rental category (which brought in $8 billion a year!) was a tempting target. Betting on DVDs was a risk, but it might also be our way to finally crack that category. With the whole world consumed by VHS rental, we might be able to make DVD rental by mail work—and have the video rental by mail category to ourselves for a while.
VHS by mail was dead. But DVDs by mail could work.
Now if only I could find one.
I have a longtime fantasy of working as a postman. After a few years in California, it had become a running joke with Lorraine and me. Anytime I got fed up with office politics, or worried about the perpetual boom-bust cycle of startups, funding, and bubbles, the two of us would sit on our deck with a glass of wine and imagine our alternate life somewhere else. I’d work as a mail carrier in a tiny town in northwest Montana, she’d homeschool the kids, and we’d cook dinner together at 5:00 when I had finished my route. No more crises. No more all-nighters. No more weekends in the office. No more travel. No more getting up at three in the morning to write down all the thoughts that had woken me up from a sound sleep.
Part of the fantasy was a wistful yearning for a slower, simpler life—for getting off the treadmill. There was something tempting about a job that you could leave behind at the end of the day. And for Lorraine, I’m sure the fantasy of the simple life was equally vivid. For years she had tolerated my tendency to drift off midsentence if a work thought pushed its way in. She had gotten used to waiting out the two- or three-second lag time between when she said something and I finally was able to drag my focus away from what I was working on to respond.
The simple life was tempting economically as well. Silicon Valley is not only one of the most expensive housing markets in the country—everything is pricey here. Even though we had saved a fair amount of money from some of my earlier ventures—and were earning a living wage—there was a feeling that we were running as fast as we could just to stay in place. On the porch, Lorraine and I would lapse into long fantasies and their attendant economic realities: With the money we had saved, and the money we would make selling our current house, we could afford a palace in Montana. I could almost be retired at forty. And with even a part-time postal job, we would be doing great…
But like all wistful yearning, our vision for a new life in the woods was probably best left unfulfilled. If I actually lived in, say, Condon, Montana, and only had my daily mail route to keep me busy, I’d probably quickly learn just why postal workers…go postal.
The truth is, I like headaches. I like a problem in front of me every day, something to chew on. Something to solve.
That summer, I was doing a lot of chewing at Lulu Carpenter’s, a cafe at the top of Pacific Avenue in downtown Santa Cruz. Reed and I would meet there for breakfast once or twice a week, before driving into work. From one of the sidewalk tables where Reed and I usually sat, with our backs to the cafe’s huge open windows, we would look directly across the street at the Santa Cruz post office, looming over Pacific Avenue like a church.
The Santa Cruz post office is a grand, many-columned building. It’s an appealing, distinctly old-fashioned place—granite and sandstone exterior, glossy tiled floors, a hallway of post office boxes, their brass handles somewhat tarnished. I wasn’t sending many letters by 1997—I was in tech, and email was king—but watching the stream of people parading in and out the doors of the post office made me want to start a correspondence with someone. It made me think back to my first jobs as a junk mail king, when I used to mail thousands—no, hundreds of thousands—of letters a week.
It made me want to mail things again.
“Look,” I said, eyeing the delicate leaf etched in foam on the surface of my cappuccino. I was thirty minutes into the “DVDs by mail” pitch that Christina and Te had helped me formulate. “Let’s just try it. Mail a CD to your place. If it breaks, it breaks, and we know that this idea could never work. If it gets there, you got something to listen to on Tuesday night.”
Reed’s eyes bored into me. It was eight o’clock on a Monday morning, and not only had he probably already been awake since four, he’d also already had a double shot of espresso. Now he was halfway down a cup of regular coffee. He’d already reminded me several times that neither of us had ever actually seen a DVD.
Me? I was excited as a bird. I’d been up early as well, surfing at the Lane as the sun came up. But even hours later, sipping coffee on dry land, I could see this latest idea ahead of me, just starting to differentiate itself from the horizon, rising in the distance as an indistinct swell. It was still too early to see if it was going to be rideable or not—but regardless, it was best to maneuver into position anyway.
Reed sensed that I was fidgety. “Alright, alright,” he said. “Finish your scone.”
We walked down the street to Logos, the used record store on Pacific, and waited out front until they opened for business. They didn’t carry DVDs yet, of course. But we thought a CD would be close enough. I bought a used Patsy Cline Greatest Hits compilation—if this didn’t work out, at least it was a disc someone might want to listen to. Within minutes, Reed was cracking the CD out of its clamshell while I ducked into Paper Vision, an office supply store, to look for an envelope. It seemed stupid to buy a whole box of envelopes just to mail one thing, so I bought a greeting card—two puppies in a wicker basket, barking HAPPY BIRTHDAY. It came with its own pink envelope. Reed printed his address on it in the post office, while I fed coins into the vending machine to buy a 32-cent stamp.
In went the CD. On went the stamp. I licked the seal of the envelope, kissed it for luck, and dropped it in the slot under the worn brass sign saying LOCAL MAIL ONLY.
Speaking of luck: Many months later, well into the Netflix experiment, I went on a tour of the Santa Cruz post office. By then, the company was a go. We hadn’t launched yet, but we were far beyond the early days of just throwing ideas out the window of a Toyota Avalon on Highway 17. We were close enough to actually launching that I decided I needed to see exactly how our DVDs would move through a post office, so we could tweak the design of our mailers.
I felt like a little kid as I passed the stained baskets on the back side of the mail slots, the loading docks, the delivery office. The Santa Cruz postmaster himself traced the path that, he explained, was exactly the same one our pink envelope had taken nine months earlier: from stamp to slot to sort to bag to the delivery truck that would ultimately take it to Reed’s mailbox. I was expecting a highly automated system running at high speed under great pressure, something capable of destroying even the sturdiest of our prototypes. Or if it wasn’t happening here, I thought that the letters would be sent to a larger facility in nearby San Jose, to be sorted and mangled there, before coming back to Santa Cruz for delivery. But what I found was something more human, more analog. Hand-sorted for immediate dispersal, local mail was given directly to the drivers. It was a surprisingly fast and gentle process.
“Is this how it’s done everywhere?” I asked.
The postmaster laughed in my face. “Definitely not,” he said. “This is local mail. All the other mail for out-of-town gets trucked over to San Jose and they sort it there.”
“So, what you’re telling me is that if I mailed a naked CD inside an envelope and addressed it to anywhere else, it would have gotten scratched, cracked, or broken?”
“Most likely,” he said.
Lucky us, I thought.
It’s called a false positive—also known as being lucky. If we’d used any other post office—or if Reed had lived in Los Gatos or Saratoga—our CD might have been destroyed. Hell, if we had mailed it to my house in Scotts Valley instead of his place in Santa Cruz, the thing wouldn’t have made it. And I wouldn’t be writing this book. Or maybe I would be, but it would be about shampoo.
Instead, the very next morning, less than twenty-four hours after our pink envelope vanished into the slot, I met Reed in a parking lot in Scotts Valley and he pulled out our envelope. Inside it was an undamaged CD.
“It came,” he said.
“Thank God,” I said.
So long, customizable surfboards. Good-bye, personalized baseball bats.
When that CD arrived safely, I think Reed and I both knew we’d found our idea. All of Christina’s and Te’s objections—the turnaround time, the convenience factor—were still valid. But if it only cost 32 cents to mail a DVD, and we could buy them for twenty bucks apiece, we both knew we had a shot.
One of the real factors separating DVDs and VHS, Christina and Te and I found out, was the size of the library. Even in places where DVDs were available in the United States, there weren’t that many titles. By mid-1997, there were still only about 125 titles to choose from. There were tens of thousands of movies on VHS.
“So the thinking is,” Christina said when I showed her the CD, “we get in early? Beat the video stores to the punch, and then have more inventory?”
I nodded. “It’s more like ‘have any inventory.’ Nobody has a DVD player yet, so it’s going to be a while before the video stores even start carrying DVDs. We’ve probably got a long window of being the only game in town.”
“Might make up for lag time,” Te said. “If people can’t find a DVD in a store anyway, they won’t mind waiting as much.”
Christina’s brow was furrowed, but I could see that she was starting to agree.
“Okay,” she said. “Has anyone actually watched one of these?”
We had our idea. Now we just had to figure out how to pay for it.
When you start a company, what you’re really doing is getting other people to latch on to an idea. You have to convince your future employees, investors, business partners, and board members that your idea is worth spending money, reputation, and time on. Nowadays, you do that by validating your product ahead of time. You build a website or a prototype, you create the product, you measure traffic or early sales—all so that when you go to potential investors, palm outstretched, you have numbers to prove that what you’re trying to do isn’t just a good idea, but already exists and works.
For instance: A few years ago, when my son graduated from college, he moved out to San Francisco with a buddy of his, intent on starting a new company. In less time than it took to drive from our place in Scotts Valley to San Francisco, he had built a website on Squarespace, set up a credit account on Stripe, bought some banner ads using AdSense, and set up some cloud-based analytics on Optimizely to measure the results. All within a single weekend.
(One of the ideas they tested? Shampoo by mail. What can I say, the apple doesn’t fall far from the tree.)
But back in 1997, you could raise $2 million with a PowerPoint. In fact, you had to. There are a lot of reasons for that, but the most fundamental had to do with time. In 1997 there was no Squarespace. No Stripe, no AdSense. No Optimizely. No cloud. If you wanted to build a website, you had to have engineers and programmers build it for you. You had to have servers to serve the pages. You had to figure out a way to accept credit cards. You had to do your own analytics. Forget a weekend. Try six months.
And you needed money for that. Money to hire people, to rent space, to buy equipment…money to survive until you could prove your idea had merit, and until you could raise your first serious funding.
It was kind of a catch-22: You couldn’t prove to your investors that your idea would work unless they gave you money to prove that your idea could work.
You had to sell them on your idea.
But before you could accept that first dollar and sell your very first share of stock, you had to put a dollar sign on it. This is called valuation. You come up with a number: What your idea is worth.
In common parlance, it’s typically a good thing when someone says, Hey, there’s a million-dollar idea!
But in Silicon Valley, that’s not very much.
To wit: Netflix is currently worth around $150 billion. Back in 1997, though, Reed and I decided that the intellectual property—the idea for DVD by mail, plus the fact that he and I were the ones working on it—was worth $3 million. That wasn’t a ton—but it seemed like enough. Enough to take seriously, but not so much that no one would want to risk money on it.
We figured that it would take $2 million to get the company off the ground: $1 million to get the site launched, and another $1 million to run it while raising our next round of funding. We’d need an angel investor. Luckily, both of us knew one: Reed.
Reed wanted to be our angel investor because, even though he was leaving Silicon Valley for the education world, he wanted a way to stay connected to it. Funding us was his way of keeping his toe in the water. It would allow him to remain a part of the startup culture that he loved so much. Starting and running small companies had given his life order, meaning, and joy, and I think he may have been scared of losing that as he transitioned into the education field. As an angel investor in our company, he’d have a kind of safety net, a tether back to a world he understood and knew how to navigate. It was fear of missing out, pure and simple.
I decided not to put any money in. For one thing, I’d just had my third child—my son Hunter. And, unlike Reed, I’d be donating a lot of time to the project.
My risk was my time. His was his money.
But by not putting any money in at the outset, I’d effectively changed my ownership percentage. To understand why, you need to know a little bit about how startup companies raise money. There’s math involved, but bear with me.
As I mentioned earlier, Reed and I had assumed that the value of Netflix (which at that point was just two guys and an idea) was $3 million. So to keep the math easy, I decided that to start, there would be six million shares of Netflix stock, each worth fifty cents, and each representing a small fraction of ownership in the company. On day one, there were only two owners of the company—Reed and I—and we split it down the middle. Each of us received three million shares—or 50 percent of Netflix. Now, if nothing had happened since then, and I still owned 50 percent of Netflix, my world would be a little different. As I mentioned, Netflix is now worth about $150 billion. Owning half of that would be a nice piece of change.
But then comes something called “dilution.”
Remember, at this point it’s just two guys and an idea. We need to build a website. Hire people. Rent an office. Buy whiteboard markers. (I really like whiteboard markers). So we need money. Reed was willing to give it to us, but he had to receive something of value in return. So what happens is that we sell him stock. We don’t sell him shares that we already have, we create new shares and sell him those. And since we’ve already said that each share is worth fifty cents, in exchange for Reed’s $2 million, we sell him four million shares.
So now everyone’s happy. We now have a company that is worth $5 million, and its assets include the idea (which we valued at $3 million) and the $2 million of cash. But now the ownership has shifted. I still own my three million shares, but now there are ten million total shares, so my percentage of ownership has changed from 50 percent to 30 percent. At the same time, Reed’s ownership has increased. He now owns seven million shares: the three million of his original shares for the idea, plus the four million shares he received in exchange for his investment.
So he’s gone from owning 50 percent of the company to 70 percent. We’re now 70/30 partners.
This didn’t bother me at all. Dilution is a normal part of the startup world. True, my share had decreased from 50 percent to 30 percent—but I’d much rather own 30 percent of a company that has money to pursue its goals than 50 percent of a company with no cash on hand.
Could I have tried to split the investment with Reed, in order to have stayed 50/50 partners? Sure. That’s called “going pro rata” and it happens all the time. But my pockets weren’t as deep as Reed’s, I had more familial responsibilities, and, unlike him, I’d be spending almost every waking hour of the next few years on our idea. Plus, I thought that putting significant amounts of my own money into the project would limit my capacity for other types of risk-taking. If I stood to lose a million dollars—and not just my job—I’m not sure I ever would have been able to take some of the imaginative leaps that were so crucial in the early going.
In Silicon Valley, tech talent is the scarcest resource, and an unknown fledgling company can have a hard time attracting top employees. But Reed—thanks to the Pure Atria deal—had clout. Within a few days he’d put us in touch with one of the key players in what would become early Netflix’s eccentric, largely foreign-national ops team: Eric Meyer, a muppetlike Frenchman with a frenetic manner who would eventually become our chief technology officer. Eric had worked with Reed earlier in his career but now held a senior position at KPMG. I knew it would take some convincing to get a talented (and highly paid) software developer like Eric to join our ragtag bunch. So I started as soon as I got his number.
In the meantime, I needed to come up with something approaching a business plan. Notice that I used the word “approaching.” I never intended to get there. Most business plans—with their exhaustive go-to-market strategies, detailed projections of revenue and expenses, and optimistic forecasts of market share—are a complete waste of time. They become obsolete the minute the business starts and you realize how wildly off the mark you were with all your expectations.
The truth is that no business plan survives a collision with a real customer. So the trick is to take your idea and set it on a collision course with reality as soon as possible.
But we still had to figure out where to start, and for that I leaned on Christina. We spent hours at the whiteboard in my office, trying to visualize what an online video store would actually look like. Christina drew every page of the proposed website by hand, sketching out meticulously how every piece of content—the DVD title images, the synopses, the ordering information—would fit. I started looking for office space—or at least for conference rooms where we could meet, once I had a team together. The Best Western down the street from my house in Scotts Valley was my top contender. You could rent the conference room there for $250 a week.
All of this might seem like it happened fast. And it did—in a matter of weeks, we’d gone from a list of nebulous ideas to a semicoherent plan for moving forward. But here’s the thing about Silicon Valley in the late nineties: everything was fast.
It hadn’t been slow in the eighties—not exactly. But progress had occurred on a more incremental scale. It was an engineering driven culture, so it all moved at the speed with which things could be built. At Borland International, where I worked in the eighties, the very architecture of the corporate campus—engineers on the top floor, in the window offices, and everyone else on the floors below them—enforced a sense of hierarchy: engineers were on top, and everyone else worked for them. Along with that hierarchy was a certain staidness. Change happened logically, according to plan.
By the mid-nineties, things had changed. Jeff Bezos’s success at Amazon had shown us that it wasn’t just more powerful hardware or more innovative software that would lead to future progress—it was the internet itself. You could leverage it to sell things. It was the future.
The internet was not predictable. Its innovations were not centralized on a corporate campus. It was a whole new world.
Here’s how tangibly—and quickly—things had changed. In 1995, when I was wrapping up my time at Borland, you could actually buy a published book that listed every website in existence. Since there were only about 25,000 sites, that book was less than one hundred pages long. But by March of 1997, when Reed and I were making our brainstorming commutes over the Santa Cruz Mountains, there were about 300,000 websites. By the end of that year, there were a million—and the number of users had grown to a hundred times that number. We weren’t the only ones trying to figure out new ways to monetize the internet. There were thousands of people like us looking for the right angle, the right product, the right way to take advantage of a brand-new medium.
I’ve heard people call the mid- to late-nineties in Silicon Valley “the era of irrational exuberance.” And I agree about the exuberance part. Who wouldn’t be exuberant about the advent of one of the most revolutionary, game-changing technologies in the history of our species?
But irrational? Not quite. The excitement we felt at the dawn of the internet era was completely rational. We were on the edge of an open green field—unplowed, unplanted. Talk to enough entrepreneurs and engineers about the mid-to-late nineties, and what they’ll describe to you sounds like something straight out of the journals of Lewis and Clark. We all felt like pioneers on the eve of a great expedition. There was enough land for everyone.