Netflix’s Origin Story: How the Streamer Killed Blockbuster Video, Snagged ‘House of Cards’ From HBO and Changed Hollywood Forever

“No late fees.”

When Netflix launched as a DVD rental service in 1998, that was its most effective pitch to potential customers — an unmistakable reference to the thing that people hated the most about Blockbuster. With more than 9,000 locations, Blockbuster was the biggest video rental chain in the world, but it was alienating members because its profits came from charging hefty fines for movies that weren’t returned on time.

“It was an obvious sore spot,” Reed Hastings, Netflix’s co-founder, says. “People loved renting movies and watching them at home, but the late fee became the symbol of everything painful about that model. So we decided to create something different.”

Netflix didn’t just do away with late fees by allowing customers to keep movies for as long as they wanted. It offered subscribers unlimited rentals for a monthly flat fee. As a bonus, it delivered DVDs directly to customers’ homes, eliminating the hassle of having to drive to the local Blockbuster to scour aisle after aisle of movies in search of something to watch. However, some of Hastings’ top lieutenants worried there were problems with Netflix’s business model.

“It was scary,” remembers Patty McCord, who was hired by Hastings in 1998, eventually becoming Netflix’s chief talent officer. “Late fees were the gas in Blockbuster’s tank; everybody hated them, but the company didn’t have great profit margins without them. So we all went, ‘How is this going to work?’ Lots of people thought getting rid of the late fees was crazy, but Reed was willing to bet the farm on it.”

That gamble paid off. Twenty-eight years after it debuted with little fanfare, Netflix, now under the leadership of Hastings’ successors, Ted Sarandos and Greg Peters, dominates Hollywood. Its market cap of $392.68 billion surpasses those of Disney, Warner Bros. Discovery, Paramount Global and Comcast combined. Getting to this point, however, involved fierce corporate battles, dramatic shifts in strategy and a passion for risk-taking. Netflix’s transformation is one of the most remarkable in corporate history, rivaling those of Apple and Facebook. But how the company pulled it off, and pushed Hollywood into the streaming era, is now only dimly remembered.

In its first year or two, Netflix was a ragtag operation. McCord and other executives were routinely asked to hit up their local Walmart or Costco to buy DVDs at full price, which the company would then rent to its small customer base. To grow, Netflix needed to establish relationships with studios that could sell them their discs in bulk and on better terms. In 2000, Hastings hired Sarandos, who had strong ties with the studios from his time working as an executive for chains like West Coast Video, to help him break into Hollywood. With most of the company composed of engineers who were stationed at its Los Gatos, California, headquarters, Sarandos spent his first three years as chief content officer working out of his bedroom in Los Angeles. It wasn’t glamorous. Yet because of his personal relationships and disarming personality, Sarandos was able to get DVDs from the likes of Warner Bros. and Sony.

“It helped that I wasn’t some Silicon Valley guy flying in with my lawyer or my agent to talk to the studios,” Sarandos says. “I knew these folks; we’d gone up the ranks together.”

It took time for Netflix to work out the kinks. There were issues with getting discs to customers quickly and efficiently. A large part of those early years was spent building out the company’s network of processing centers, so Netflix could cut down on the time people had to wait to receive their rentals. Slowly, the company made a name for itself.

“At first no one knew who we were,” Sarandos remembers. “But that began to change. I still remember the first time I saw a post office with a sign that said this box was dedicated for Netflix envelopes. And then there was a time where I’m going to my own doctor, and I saw the red envelopes in the outgoing mail bin. Eventually we became ubiquitous.”

Blockbuster initially shrugged off the competition. According to lore, the company turned down a chance to buy Netflix in 2000. With any good yarn, there’s dispute over the facts of what went down, though everyone agrees there was a meeting at Blockbuster’s Dallas headquarters. But some Netflix executives remember being “laughed out of the room” after they proposed a sale, whereas Hastings doesn’t think the talks ever got that far.

“They had us down there, but I don’t think it was serious,” he says. “They didn’t see us as a significant player. I think it was curiosity rather than anything else.” Over the next few years, Blockbuster mostly ignored Netflix. When it did acknowledge the company, it was usually with derision. As a ritual, Netflix executives would gather in the conference room to listen to Blockbuster’s earnings call, trying to get a sense of what they were up against.

“One time, an analyst asked Blockbuster CEO John Antioco what he thought of Netflix, and he basically said, ‘They are nothing. They are no one. They are a gnat,’” McCord says. “I looked across the room we were in, and there was a chart of our subscriber numbers on the wall. The arrow was going straight up. That’s when I realized,‘They don’t get it.’”

Blockbuster eventually got it. In 2007, the company launched a service, Total Access, that allowed customers to rent a DVD online and get a new movie free when they returned it to any of its stores. Since Blockbuster had thousands of physical locations, customers could easily exchange a disc when they wanted to instead of having to wait for another one to arrive by mail. Initially, Total Access caught on, with Blockbuster attracting 2 million online subscribers in its first year, more than a quarter of Netflix’s user base, but the offer was unsustainable. Instead of making money, Total Access put Blockbuster, a legacy company with massive overhead, in a financial hole; after shipping and other costs were factored in, it was losing $2 on every disc it rented.

Blockbuster had other hurdles that it couldn’t overcome. It was saddled with $1 billion in debt after it was spun off from its parent company, Viacom, in 2004. As its popularity waned, it ultimately had to declare bankruptcy in 2010. Blockbuster also operated under a franchise model, licensing its brand to store owners who didn’t want the company to devote financial resources to its online operations at their expense.

“Blockbuster’s corporate interests and those of its franchisees weren’t aligned,” says Michael D. Smith, a professor of information technology at Carnegie Mellon University. “That’s why the company took too long to pivot.”

People at Netflix say that the company’s decisive victory over Blockbuster wasn’t inevitable. There were times when Netflix faced setbacks. An initial public offering was canceled in the wake of 9/11 and the dot.com bubble burst- ing, and the company’s idea of concentrating more on growing its subscriber base than achieving profitability carried risks.

“Now, it looks obvious to everyone that we would win, but at the time it didn’t feel that way,” says Jay Hoag, an early investor in Netflix and a member of its board of directors. “We were locked in a price war with Blockbuster. Our stock was bouncing around a lot. It was a challenging time for the company. But Reed and Ted had a vision to offer a better service, and they stuck to it.”

In his pitch to Sarandos to join Netflix, Hastings was already looking beyond DVDs. The internet was still in its infancy — it was slow and clunky, and barely anyone could imagine watching a feature-length movie online — but Hastings dreamed of turning Netflix into a streaming giant. Of course, that term didn’t exist at the time. But Netflix’s name — a combination of “flix,” slang for movies, and “net,” a reference to the internet — signaled his ambitions.

“When I first met Reed, he described Netflix almost exactly like it is right now,” Sarandos says. “He didn’t use the word ‘streaming.’ He called it ‘downloading videos’ then, but he was very clear that he thought all entertainment would come into the home on the internet. And this was at a time when no entertainment came into the home that way.”

From its inception, the idea was to build Netflix on two tracks. The company would continue attracting customers with the DVD-by-mail business while ramping up its infrastructure so that as soon as internet speeds improved, subscribers could watch longer movies and shows online. By 2007, digital technology had caught up with Hastings’ vision, and Netflix launched its streaming service.

It was a hit with subscribers, allowing the company to more than double its customer base from 7.3 million to 18.3 million in three years. But getting movies and shows for the service presented a fresh set of challenges. Studios still preferred to send their first-run movies to traditional cable channels after they finished their theatrical runs, leaving Netflix to sign deals with more fringe players. For two years, it also bought and distributed its own movies — ultra-low-budget indies like the Maggie Gyllenhaal drama “Sherrybaby” — and released them under a short-lived label called Red Envelope.

“There wasn’t much available for us,” says David Hyman, Netflix’s chief legal officer. “It was really niche stuff, just edgy and avant-garde. It was pretty hit-and-miss.”

In 2008, Netflix figured out a workaround. It negotiated a pact with Starz, then a middling cable service, that allowed Netflix to stream roughly 1,000 movies a year. Many of those films were newer releases, such as “Ratatouille” and “Superbad,” that Starz had licensed from Disney and Columbia.

But Sarandos knew that it was only a stopgap measure. He realized that other studios wouldn’t always be interested in sharing their content with a business that was going after the same customers. Netflix needed to take its destiny into its own hands.

Just as Hastings initially identified Blockbuster as his chief competitor, Sarandos came to see HBO, considered the flashiest brand in cable thanks to “The Sopranos” and “Sex and the City,” as its next rival. He saw no reason why Netflix couldn’t produce its own watercooler shows and buzzy movies.

“Ted really kept us focused on HBO as the target,” Hastings says. “He wanted us to see ourselves as a content network rather than an Amazon-like retailer. Later, he came to regret that slightly, because he said it should have been HBO and CBS. Because we didn’t want it to be just elite programming, we wanted it to be mainstream as well.”

Like Blockbuster before it, HBO publicly scoffed at any notion that Netflix was on its level. In 2010, Jeff Bewkes, the head of Time Warner, the cable channel’s parent company, likened Netflix to the Albanian Army, which, of course, no one is afraid of.

“We all went out and got Albanian Army military insignias that we wore,” Hastings says. “It was accidental on Jeff’s part, but he definitely helped us. That’s when the press positioned us as the challenger versus the incumbent, which legitimized us.”

Sarandos knew that he needed to sign a statement-making deal to signal the scope of Netflix’s ambitions. He found it in “House of Cards,” a remake of a BBC miniseries, which swapped the British Parliament for the U.S. Con- gress. Every network and cable channel was desperate to land the project because of the talent involved — David Fincher was producing and directing the first two episodes, with Kevin Spacey and Robin Wright set to star as a villainous power couple.

Sarandos learned one weekend that Fincher planned to pitch his show to the networks. After combing through data to see more about viewership of Fincher’s and Spacey’s movies on Netflix, he found that both were popular with the service’s subscribers. He worried initially that the show would be too focused on politics, but after reading the script for the first episode, Sarandos appreciated that “House of Cards” was more interested in Shakespearean backstabbing than the intricacies of turning a bill into law.

“It had sex and revenge — everything you want from television,” Sarandos says. “We had to have it.”

He called the producers and said he wasn’t interested in hearing a pitch for “House of Cards.” Instead, he wanted to sell Fincher and his collaborators on why they should go with Netflix, despite the fact that it had no track record for making shows. In the meeting, Sarandos said he would commit to spending $100 million on the series and he’d pick the show up for an unheard-of two seasons — this was before a pilot had even been shot. He also agreed not to give Fincher any notes, guaranteeing him full creative control. It was a deal so rich that no one, not even HBO, could match it.

At Netflix, colleagues worried Sarandos was making a mistake. “I wasn’t comfortable with it,” admits Hastings. “It seemed perilously aggressive to me — just on the edge of reckless. We’d been working together for a decade, so I’d come to trust Ted’s instincts. But they were definitely not my instincts.”

Sarandos wasn’t done shaking things up. After “House of Cards” was bought and made, he pushed for it to release its entire season at once, instead of debuting a new episode every week, the way every other broadcaster and cable network did. He had seen how Netflix users liked to binge older shows, streaming one episode after another in single sittings, and it gave him a disruptive idea.

“I got a phone call from then CBS head Les Moonves, who said, ‘Do you know how television works?’” Sarandos remembers. “He goes, ‘You give them one at a time, and you can drag it out over 13 weeks before you need to find something new.’”

When it debuted in 2013, “House of Cards,” with its twisty look at Beltway maneuvering, earned rave reviews and attracted waves of new subscribers. It also showed that Netflix could produce the kind of glossy, highbrow TV that had made HBO famous. In the process, it put Hollywood on notice.

Over the ensuing decade and change, filmmakers and showrunners would flock to Netflix, lured by promises of greater creative freedom as well as the vast sums of money it was willing to throw at them. The shows and movies coming out of Netflix — from “Stranger Things” to “Roma” to “Squid Game” — garnered awards, acclaim and an ever-expanding global audience. Its success would lead nearly every other entertainment company to launch in-house streaming services, some of which, such as Disney+, have been embraced even if they fail to match Netflix’s user base of 300 million subscribers. Because of the revolution in programming and distribution that Netflix sparked, streaming has become the dominant way that viewers watch movies and TV.

“Netflix changed the entertainment industry,” Smith says. “They did a lot of things right, but they also did the right things at the right time.”

As for Netflix’s original DVD-by-mail business, with the company devoting more resources to making programming and delivering it via streaming, fewer and fewer customers used the service. In 2023, Netflix shipped its last red envelope, ending the service that had grown less important to its bottom line, to become a streaming-only company. Netflix’s metamorphosis was finally complete.

“They had the courage to kill the first business to feed the second one,” McCord says. “That’s the Netflix story. How many other companies could have pulled that off?”