THE BLOG
08/06/2013 06:11 pm ET Updated Oct 06, 2013

Netflix, the Sequel: From Customer Revolt to Emmy Breakthrough

Netflix is the toast of the town, and they rightly deserve to be congratulated not only for bringing joy to their nearly 30 million subscribers, but for impressing stalwarts from both the Street and the Valley.

When they first launched in 1997 -- pre-Google! -- the company innovated a video-rental business model based on "no late fees." While Amazon had been practicing e-commerce since 1994, Netflix set itself up as a competitor to thousands of mom-and-pop video stores, as well as big box chains like Blockbuster. The company also faced a heavy lift in their efforts to shift consumer behavior away from in-store rental to DVD by mail, and then again to online streaming.

Yet in recent years, Netflix first failed to grasp -- and only later learned to love -- the implications of its networked reality. In a world that had rapidly gone from connected, to interconnected, to interdependent, the company missed its opportunity to engage with the very forces from which it had so handsomely profited. Its near death experience -- and the how of its recovery -- make the Netflix tale profoundly relevant not just to media junkies, but to any engaged individual, organization, or government.

Over time, Netflix came to realize that what makes them unique is neither their distribution platform, nor -- contrary to conventional wisdom -- their product offerings. While House of Cards is exclusive content, albeit Emmy-nominated, we are swimming in an ocean of original programming. What's key to Netflix's performance is their relationship to their customers.

And, as is so often the case, Netflix had to stumble before it could walk.

When Netflix decided to raise its prices and announced it would split its company in two, 800,000 subscribers voted with their feet and left the service practically overnight. I had never seen such a mass exodus of consumers in such a short period of time. For me, it was a turning point revealing the increased the power of the individual.

I found myself sharing that experience and similar examples -- Bank of America and Verizon had also lost droves of customers due to taking customers for granted -- in conversations with friends, colleagues, and eventually with global audiences, onstage and in print (including in Forbes here and here).

Something about the Netflix example resonated strongest among readers and audiences. People leaned forward in their seats when they heard me reference the price increase. They started talking about "Netflix moments" to describe this power shift to the individual, using it to assay everything from the Russian people contesting Putin's claim to absolute power to consumers who took to social media to lambast corporate decisions on pricing or supply-chain sourcing or executive compensation.

Ironically, before Netflix unilaterally announced that it was cleaving its company in two and expecting its loyal customers to buck up under the price hike, it had circulated a PowerPoint deck that proclaimed the importance of a culture that encourages employees to "listen well, instead of reacting fast." What this kerfuffle highlighted was that such a declaration was necessary but not sufficient. The company still had to do the work of building authentic relationships with its customers.

After all, the breach certainly wasn't due to the "what's" of the decision. The price increase wasn't outrageous. And the reasoning underpinning the decision-Netflix came to the decision as part of a brilliant strategy to move into the streaming video business -- a move that was extremely, even presciently, sound. The company was way ahead of its competitors in seeing that the future of video resided in streaming. What drove those customers away had everything to do with how it behaved -- specifically, how abruptly the company made a business decision that profoundly affected its subscribers and how they perceived that "one-way conversation" as the true offense.

The company's hit extended far beyond subscriber loss: The day after Netflix made its subscriber loss public, the stock cratered, dropping 37 percent -- the single biggest intraday stock decline since 2004. Netflix had dug itself a deep hole.

The company started clawing its way back with a video in which CEO Reed Hastings acknowledged the tone-deaf nature of the decision in an abject apology to customers: "I messed up," Hastings wrote. "I owe everyone an explanation. It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming, and the price changes... In hindsight, I slid into arrogance based upon past success."

This nuanced mea culpa reflected how power has shifted in the 21st Century. Customers, just like citizens, expect "two-way conversations." Just think of the revolts that autocratic leaders have incited in Egypt or that a bus price increase triggered in Brazil. When leaders do not honor the emergent expectation of interactive discourse -- to exert power through their stakeholders, rather than wielding it over them -- customers and citizens today have power, at their fingertips, to unite. That's one reason why business audiences respond strongly when I hold up Netflix's price change as an example: so many of them had the exact same experience -- or realized their exposure. That's why shedding "only" 800,000 customers as the result of a one-way conversation almost seems quaint today: I recently wrote about Zynga -- the online gaming company -- and how they lost nearly 38 million users by not getting its own HOWs right.

Netflix stayed on my radar. It became my go-to example of how businesses cannot afford to operate in our newly transparent, interconnected and interdependent world. And, as I continued to speak about the company, I recognized that with each invocation, I was obligated to track its progress. Otherwise, I would myself be guilty of using the company simply to make a point.

Netflix began to rebound, and journalists and analysts both began to write about it as a success story. From my perspective, however, what is important is that the success is an outgrowth of its work on culture. Like more than 4.7 million others, I've clicked through Netflix's culture slides. The deck, created nearly four years ago, lays out nine behaviors and skills -- judgment, communication, impact, curiosity, innovation, courage, passion, honesty and selflessness -- that are valued at the company. The 128-page slide presentation said many of the right things, but that didn't mean it would translate to behavior. I wanted to keep track of the company's actions.

And I don't just mean standard measures of success. Yes, I'm impressed that Netflix has added more than 3 million video-streaming members in the first quarter of this year alone. It has eclipsed HBO, with a total streaming subscriber base of roughly 28 million. Others have pointed out that the company has posted the best performance among Standard & Poor's 500 companies so far this year, and its second quarter revenue topped $1 billion for only the second time in company history. But as I watch the company, I'm much more interested in the deeper drivers of these business outcomes, the ones that enable Netflix to thrive in a connected, interdependent world.

If Netflix had once lost sight of its mission, it has since returned to its origins. Hastings launched the company in 1997, not long after returning an overdue copy of "Apollo 13" to the local video store and was socked with a $40 late fee. He decided to create a company that freed customers from late fees, and in the pursuit of that mission, pioneered new forms of distribution -- from DVDs by mail to, more recently, streaming video. It is a business model that appeals to customers annoyed by rising postal rates and those who wish to cut their cable cord.

What Netflix clearly learned is that while customers appreciate cutting-edge projects and services, it's imperative that we attend to HOW companies and leaders behave. Even as Netflix focuses on innovation, it has reasserted that at the outset its business proposition -- its mission -- was about freedom. Freedom from frustration -- they are proud of their no-hassle online cancellation policy -- and freedom to watch on-demand, on any screen, and at any time. Rather than clamp down on households that watch its streaming service on more than one device (a common practice in connected homes, although one that some competitors would categorize as "piracy"), the company created a sharing platform that enables families to use more of its service.

The company's leadership continues to place a premium on values. Remember, in his apology, Hastings publicly declared that he needed to replace arrogance with humility. The company appears to have embraced an approach related to what I've described as a "moral audit" - the application of rigorous process improvement and change management techniques, if you will, to the values that truly animate every behavior and decision within an organization.

In its culture deck, Hastings stresses that Netflix does not tolerate "brilliant jerks"; despite the huge premium the company places on innovating and smarts, it does not want you around if you cannot collaborate with other employees, and stakeholders, in a meaningful and humble way.

As Netflix has entered the world of original programming, I've observed it tapping into a larger ecosystem to innovate. In a recent Forbes interview with MRC, the production company behind "House of Cards," the extent to which Netflix has extended trust became evident. While granting "final cut" to a director is uncommon in film, it is almost unheard of in television productions, yet for this show, the largest independent drama production of the last decade, the company was give precisely that kind of working relationship with Netflix. At the time of their contract negotiations, they were not even sure if the show would be eligible for Emmy consideration. Modi Wiczyk, MRC's co-chair, inspired his team, "let's just go do good work and karma will deliver." In the end, they were vindicated with 9 Emmy nominations.

I frequently write that all businesses are on journeys, whether they acknowledge it or not. These business journeys, like those in life, necessarily come with ups and downs, success, and failure. In our hyper-transparent age, companies can no longer present rosy, and impossible, narratives of never-ending upward linear progression. Resilient companies learn from their stumbles and commit fully to the reality of their journeys.

In that spirit, Netflix has done something more impressive than merely surviving a storm: it has thrived. It has done so by straddling two worlds, the start-up ethos of innovation and the durability of older-school companies that have prospered over the long term. Hastings' mention of his company's honor code in his culture slides echoes the thinking of another pledge: A company's first responsibility is to the people who use its products and services; the second responsibility is to its employees; the third is to the community and environment; and the fourth is to the stockholders, who will be well-served only if the first three responsibilities are met. The statement isn't from the Internet age. It was written in 1943 by Robert Wood Johnson, the son of the founder of Johnson & Johnson, and is called simply, "The Credo." This Credo remains a cornerstone of Johnson & Johnson's culture. (It was their credo helped J&J recover from the tainted Tylenol scandal of the 1980s.)

While Netflix's culture slides embed some of the thinking in J&J's Credo, it's in their most recent Investor Relations document that they explicitly detail a long-term position. Netflix describes itself as a "focused passion brand. Starbucks not 7-Eleven. Southwest not United."

When it comes to Netflix, I've also been on a journey. I can no longer simply refer to their price increase as an illustration of how our new interconnected reality affected the company, because their full story has become so much richer over time. In watching the company, I've come to understand how Netflix has actually gotten good at going up and down in pursuit of their founding mission -- it's become an integral part of their ethos. Over the years I will be watching Netflix -- if not in the same way as most people do -- and speaking about the company in this context and how it can inspire us all.