How a $40 Overdue Fine Created Netflix

Some people face hardships, concede that they are inevitable, and deal with them. Others can see the same difficulties and be pummeled into defeat or paralyzed into inaction. Then we have the very few who take the third path and use those setbacks as opportunities to change the world.

Most of us have encountered a late fee at one time or another. Whether it was an overdue library book, a bill that didn’t get paid on time, or taxes that were sent in a little past the deadline, it is just a fact of life that we are supposed to be punished when we don’t do things according to someone else’s schedule.

Reed Hastings was unwilling to accept this aspect of life. When he was slapped with a $40 late fee, it made him so mad that it motivated him to create an innovative, supremely-successful business. It was so successful that it changed the paradigm for an entire industry. It probably changed your life, as well.

The year was 1997. Hastings had other things on his mind and totally forgot about the movie he had rented. He may have forgotten about the VHS tape of Apollo 13, but the store from which he rented it did not. By the time Hastings returned the movie, he had incurred late fees totaling $40.

Hastings paid the penalty, but he wasn’t happy about it. He and co-worker Marc Randolf started talking about it and wondered if there was a way to build a movie-rental business without late fees. They put their heads together and created a start-up company called Netflix.

Inside a Blockbuster video rental store

One year after the unforgivable $40 late fee, Netflix opened for business as a DVD-by-mail rental. The whole notion of renting movies through the mail was innovative enough. Limiting the rental to DVDs seemed inconceivable. Most homes had VCRs, but DVD players were new and expensive. Blockbuster was the dominant movie rental company, with rental stores in every major population center. The VHS rental industry was a $16 billion per year industry. Why wouldn’t Netflix try to tap into that?

As Hastings and Randolf contemplated their business model, they concluded that VHS tapes were too delicate to survive repeat trips through the mail. DVDs were not only sturdier but easier and less expensive to ship. They also expected the DVD market share to increase and eventually supplant the VHS medium.

With their minds made up, they launched their business, offering 925 DVD titles — almost the entirety of that which was available on DVD at the time. They also used the newfangled thingamawoogit called the internet and drove customers to the company website for more information and to place orders.

Perhaps the novelty of the whole thing — internet included — was a big part of the secret to the company’s success. Its website soon generated a lot of traffic. The company aggressively sought partnerships with Sony, HP, and Toshiba, offering free DVD rentals to customers who purchased new DVD players.

Even with all the odds against it, Netflix started to grow in name recognition and popularity. The company caught a big break in 1998 when it received a $30 million investment from French-based company Groupe Arnault. With this investment, Netflix launched a subscription service. Instead of being charged on a per-rental basis, customers had the option of paying a monthly fee and renting as many titles as they wished (limited to having a maximum of four checked out at a time). In keeping with the motivation for starting the company, there would never be a late fee for not returning a DVD within a given time.

In 2000, Netflix was making a name for itself and bringing in $5 million in income, but its expenses were far greater. It would lose $58 million that year. In contrast, its biggest competitor, Blockbuster, would pull in $4.5 billion.

Despite their grand plans to become the leader in the industry, the company’s founders were discouraged by the bottom line. Hat in hand, they approached Blockbuster and offered to sell their business for $50 million and become an online affiliate for Blockbuster.

Not only was their offer rejected, but Hastings and Randolf were also laughed out of Blockbuster’s offices. The corporate behemoth didn’t have time for such a small-time operation — one that was clearly a flash-in-the-pan novelty that would soon disappear. The Netflix founders returned home, wondering whether the next year would be the last for their company.

It turned out that 2001 was the year when DVDs really caught their stride as a medium. The price of DVD players dropped significantly, and the superior viewing experience made customers eager to forego VHS tapes and seek out the DVD alternative. With the brick-and-mortar stores still focusing primarily on VHS rentals, Netflix saw a big uptick in customers.

In 2003 — just three years after being dismissed as a flash-in-the-pan, Netflix turned a profit for the first time. It was also the year the company enrolled its one-millionth subscriber. Despite all the challenges and disappointments, Netflix had emerged as a force to be reckoned with.

The next year, 2004, Blockbuster acknowledged that Netflix wasn’t completely insane. It started an online DVD rental-by-mail service that looked suspiciously like the one they had dismissed so insultingly a short time ago. The number one video rental company in the world put itself in direct competition with Netflix and its business model.

In 2005, the movie rental landscape looked completely different than in 1998. The internet had grown in popularity, speed, and accessibility. Increasingly, customers preferred to do their shopping online, rather than drive to a physical outlet.

Netflix, which had been established on a model of renting through the mail, was sending 1 million DVDs per day. In contrast, Blockbuster was struggling to adjust to its new mail-order model. On top of that, Blockbuster continued to hold on to its brick-and-mortar stores, even as their popularity declined. The overhead to maintain the facilities was eating away at the corporate giant’s bottom line. While Netflix’s profits continued to grow, Blockbuster’s popularity and profitability started to decline.

The ten-year anniversary of Reed Hasting’s $40 fine was a big year for Netflix. In 2007, it mailed its 1 billionth DVD. It also stuck its toe in the water to try a new use of the internet: streaming video.

High-speed internet was steadily gaining ground and market share. Would it be possible to rent movies for online viewing?

The trial run did not offer any of the popular movies of the day. Copyright laws had not contemplated such a method of distribution, so film distributors were reluctant to give permission. The movies that were available, although generic and lackluster, seemed to be well received. This certainly seemed to be worth developing further.M

Meanwhile, Blockbuster’s profits continued to decline.

With the success of the online streaming service, Netflix aggressively sought the rights to offer additional titles. In 2008, it partnered with Starz to add thousands of movies in this way. Now, customers didn’t have to wait for a DVD to be shipped. In a matter of moments, you could have your movie of choice showing in your home.

By now, the entertainment industry was waking up to the reality of the Netflix world. Disney, Lionsgate, Paramount, MGM, and Sony all signed deals with Netflix to offer their movies through internet streaming. By 2010, 20% of those who were watching movies during the peak prime time hour were doing so through Netflix.

2010 was also a significant year for Blockbuster. Its revenue, which had been $4.5 billion at the start of the decade, was a mere $161 million in 2010. Recognizing that its business model was unsustainable, the company that laughingly dismissed Netflix filed for bankruptcy.

At its peak in 2004, the Blockbuster giant consisted of 9,094 stores and employed approximately 84,300 people, 25,800 of whom were outside the United States. Today, there is only one Blockbuster location in the world. It is in Bend, Oregon. In August 2020, the location was listed as an Airbnb rental for a 1990s-themed sleepover.

Netflix, in contrast, has continued to grow in popularity and profitability. In 2021, its revenue for the year was $29.7 billion — an increase of 18.81% from the year before.

All of this happened because one person was unwilling to let a $40 late fee get the best of him.

What do you think you could make out of your most recent disappointment?

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