The Netflix DVD Business Was Silicon Valley Style Exploitation

Or: The Only Constants in Business Are Real Estate and Workers

It’s easy to have a lot of nostalgia for Netflix’s old DVD business. In fact, the service helped extend the reach of my cinephilia as a teenager. I grew up in the suburbs, which made me a child of Blockbuster and the occasional SunCoast Video Store—the latter which was mostly useful for anime DVDs at a time in which pirating was still facing numerous technological hurdles. These stores were good enough for new movies, but convincing my parents to shell $30 for a Criterion DVD of Seven Samurai was an uphill battle.

When Netflix came around, it solved a number of issues (1) No trips to the video store. (2) No “hurried” trips to return something to the video store on time and avoid late fees. (3) A single $20 a month fee, much less than most coveted DVDs that I couldn’t find at Blockbuster.

If people might put Netflix within the context of early Silicon Valley history, it is the story of disruption, specifically focused at Blockbuster. The chief reason everyone hated Blockbuster was (1) Late Fees, and (2) availability. You could perhaps call your Blockbuster and asked if they had any copies of Stealth¹ but mostly you had to gamble that it was there after you spent your time going in the store.

This is mostly just press release as history, a problem as old as the studios.

Given the announced end to Netflix’s DVD business—surprisingly resilient given that it remained operational at a net profit—I thought this might be a good place to start this conversation. Netflix is now synonymous with its exploits of labor through disruption of the Hollywood industry, but this is usually understood as a streaming problem. Put another way: Reed Hastings was the good disruptor, and Ted Sarandos was the bad one.

But Netflix’s DVD company was simply exploitative in different ways. Netflix’s opportunities in the business were no different than Uber and Lyft way before the change to streaming.

Time and time again, Silicon Valley has proven there are three things one can really do to transform a business. The first is to eliminate real estate costs. The second is to reduce labor costs. The third is to exploit public infrastructure.

Rather than build a single warehouse has Blockbuster had done, Netflix preferred to simply lease smaller, more anonymous distribution centers. At its peak, Netflix had around fifty centers. To put that in context, Amazon—which revolutionized the efficiency speed of delivery—currently has over 1,100. When Netflix opened distribution centers, placement was built around mailing facilities and where you could rent the office space for cheap. This meant mostly anonymous office parks outside of major cities.

Netflix avoided the second step of delivery by eliminating the store. This was a smart plan because the biggest cost for Blockbuster was real estate. Blockbusters required the right location—usually strip malls in suburban areas. Those spaces can wildly vary in cost. According to a 2003 10-K form,² Blockbuster had around 4,500 stores. During that year, they opened 180 stores in the US but also closed 119 stores, because they constantly had to chase changing demographics. Each one of those openings and closings costs money, which is something companies prefer to keep.³

Changing the location of work often changes labor relations. If you worked a Blockbuster, chances are it was within a 2-10 mile radius of your dwelling unit. If you lived in Oak Park, a neighborhood of Chicago, you had two options right within the area or a hop, skip, and a jump to Berwyn.

But what if you wanted to work for a Netflix operation? You would have to travel to an unknown location in Carol Stream, Illinois.

Netflix doesn’t pay for worker commutes. Workers do. The cost of a facility in Carol Stream is thus more advantageous than the cost of two stores near Oak Park.

Let’s talk employee numbers. Blockbuster had 81,350 employees—55,700 in the United States. Of those, 19,300 were full time with 34,900 as part-time employees.⁴

In 2008, Netflix used 2,200 part time and temporary employees for their fulfillment stores. That is of course a fraction of the labor involved to run a Blockbuster. More so, consider the kind of skills you change. Whatever you think of your average Blockbuster employee, and I know this from those awful personality tests they would force you to do online when I tried to get a summer job there, a big part of the job was customer relations and working well with a diverse set of individuals.

You of course still need customer service, but you are no longer required to distribute it evenly through the United States. Netflix did not outsource that service to India, instead opting for Portland, Oregon (actually Hillsboro—twenty miles outside of downtown), because of the friendliness of the people there (apparently). In reality, Netflix removed email as a form of communication mostly to push against churn. If you read between the lines of this New York Times article, you can see that the call center’s job is mostly to retain customers.

So what kind of work occurs in a distribution center? Here’s a nice description from The Seattle Times:

It all starts at 3 a.m., when dozens of employees in red T-shirts seated at rows of desks start tearing open thousands of the little red envelopes. For the next five hours, each employee repeats the same few steps over and over: Rip red envelope. Remove disc from white sleeve. Inspect disc for scratches and cracks. Make sure it’s the correct disc. Clean disc. Return to sleeve. Place in appropriate bin

And here’s a choice quote from Gina Keating’s Netflixed:

“The warehouse manager, a former aerospace engineer, had shown [a hedge fund manager] a series of charts posted on the wall; it had about two dozen optimum performance metrics. “As long as my performance is within this band, I won’t hear from senior management,” the man said, indicating the charts. “As soon as I move out of this band, I will get a call.”

You can see the same model as Amazon workers here. In an article where Chicago Tribune reporter Christopher Borrelli visited a Netflix distribution center where he observed, “Forty-two people work here, nearly every one in a red Netflix T-shirt, nearly every one in constant motion. Indeed, I was asked not to disturb their groove and hit them up with questions.” The point of distribution workers is to work fast and hard, essentially destroying the dignity of work.⁵

Beyond devaluing the worker, Netflix also created a two tier system of workers. Computer programmers were treated like gods—without contracts, without rules, without any inhibition to innovate. But those who worked in the material infrastructure of the business were given scraps and left out of the more generous policies of the company such as extended maternity leave. This is core to the Silicon Valley mind set, future value is critical and must be respected; infrastructure is simply to be used.

And this where Netflix truly flourished: using United States Postal Service. For as long as I’ve been alive, people have taken aim at the men and women in blue (our real American heroes). Netflix saw an advantage in its government run public infrastructure.

Netflix could have partnered with FedEx or UPS, but it wanted to slip in with what had already come to be mostly known as a junk mail service. In fact, the red sleeve were designed to be cheap and efficient—and more importantly, it was cheating the Postal Service. Usually, something like a DVD would require a cardboard holding and be charged as media mail. But Netflix wanted to send DVDs at the same rate as a letter to grandma.

Customers loved Netflix because it paid the two way postage, which at its peak was a bill around $700 million. It solved its issue by taking Facebook’s mantra of “move fast and break things” literally. Getting discs to customers was the goal; broken discs were worth the price. Because it was a subscriber based system, fixing a broken disc did not mean customers got their money back as much as they might get an extra disc for a time or a free month of service. Netflix made up that money quickly.⁶

In 2007, the USPS audited the Netflix issue and their classification as “machineable.” Instead, the discs would often “sustain damage, jam equipment and cause mis-sorts during automated processing,” amounting to an additional $61 million per year. The audit suggested forcing Netflix to pay an additional $0.17 per mailer, which would have cut its profits per customer by 67%.

The USPS then took a different route: what if American taxpayers covered the bill instead? Soon enough, they decided to divert “Netflix mail from the automated letter stream, shifting it to specially designated trays and containers, hand culling it, and hand processing it.” All for free!⁷

In fact, GameFly (a video game competitor) eventually sued for the USPS for its sweetheart dispensation with Netflix discs. Because USPS refused to remove the GameFly mailers for protection, it had to change its design and pay much higher prices to USPS. Like all court cases, this one took five years before an Appeals Court forced USPS to remedy the situation to 2014. By that time, none of this really mattered.

Make no mistake: Blockbuster was a bad company. It was poorly run, drowning in debt, and had little of the actual community value that a real movie rental store might have.

But Netflix did not get to its DVD peak by only becoming a Silicon Valley company when it turned to streaming. It was the bread and butter DNA of the company.

1. Chosen as the textbook definition of Pretty Good Movie

2. 10-K forms are the bread and butter of everything: it’s what you report to both the shareholders on a quarterly basis as well as the Securities and Exchange Commission.

3. One important issue we’ll continually address in this Substack is that money can be exchanged for goods and services.

4. According to this section, “We believe that our employee relations are good.” This is a way of saying there are no labor unions.

5. Obviously, working at Blockbuster is not necessarily dignified either. But it was more obviously a job with more service economy skills that theoretically developed one into more complex roles in the future. Plus, given the usual closeness of stores, one could more easily work the position part time while completing a degree.

6. One of the more strange elements of the Netflix vs. Blockbuster issue was revenue sharing. When DVD overtook VHS, Blockbuster decided to get out of the revenue sharing business with the studios. Netflix gladly embraced it, forking over half their revenue to studios essentially. Monopoly power is bad, but sometimes it makes your business do extremely stupid things.

7. This is where I note the Postmaster General John E. Potter was extremely positive about all elements of the Internet business, spent his time mulling service cuts, and apparently blatantly ignoring an early proposal for an electric vehicle fleet. He was involved in a sweetheart deal from Countrywide Mortgage, but Democrats decided against subpoenaing records.