This tweet storm dates back to the 2003/2004 timeframe and involves a little DVD rental company called Netflix. If you read the book Netflixed, I was quoted saying:
“There's not a snowball's chance in hell that Blockbuster can do this”
🎥💿📭🏡 (1/x)
“There's not a snowball's chance in hell that Blockbuster can do this”
🎥💿📭🏡 (1/x)
This is the story behind that quote and about one of the best investor meetings I ever had
While I was fortunate enough to have met with Reed and Barry a number of times before the company become really well followed, neither of these two, nor any senior staff for that matter, were present for this meeting
Sometimes the best insights into a company do not come from visiting with senior management. This particular meeting took place in a warehouse off the Long Island Expressway with a former operations engineer named Rich. I remember his full name to this day
If you like to play in ‘low barrier to entry, high barrier to success’ businesses, especially with a concentrated portfolio, getting very granular looks and understanding the details can be critical to success. Many internet/growth plays fall under the ‘low barrier’ category
Finding details and hidden nuances can help confirm that perhaps a seemingly low barrier to entry business is actually anything but. In the case of Netflix, leadership in physical rentals was absolutely critical to becoming what it is today
Physical media was the king of the hill back then which may seem silly to many now. Netflix had humble beginnings for sure and existed by piggybacking off home video sell through (the big profit driver for studios at the time) to offer subscription rentals by mail
This is all to say that these innocuous warehouses were THE battleground for DVD rental supremacy at the time. If these warehouses didn’t work well or were easily replicated by others then Netflix wasn’t even going to make to the streaming wars
So we asked to see the secret sauce, a DC in action, looking for more clues that might allow us to better understand how defensible the biz was. Netflix shares had been weak & we hoped management would ok a visit after doing them a bit of a favor (a story for another day)
An under-appreciated way to develop a good working relationship with executives is helping them with insights or intel that are unknown or invisible to them. This helps build long-term relationships and can pay dividends for years to come
I’m not talking about recommending adding a turn or two of leverage to fund a buyback either. I’m talking about real insights that can assist a management team in performing better or accelerating value creation
We’ve done this many times with a number of companies over the years. Focused investment managers can add tremendous value by having unique insights & finding obscure intel that insiders may miss
Leveraging your work to help a company is a natural extension for better informed investors
Anyway, management ok’d visiting their New York DC and meeting with Rich. They asked if we would mind if another analyst attended as well. We lied and said that we did not care
Soon my analyst & I found ourselves in the back parking lot of an unspectacular building maybe 45 minutes from NYC. There were no identifying signs for the building. We later found out that this was to prevent consumers from attempting to return DVDs to the facility themselves
We tried a few doors and found one that opened into the back of the facility. Someone led us to Rich who was expecting us. We introduced ourselves and chatted a bit. He joked that he didn’t get many people that wanted to talk to a guy that stuffed envelopes all day for a living
We waited for the other analyst to show and began the tour. The facility was somewhat unkempt. There were lots of workers who sat at tables with stacks of DVDs. There was also a massive sorting machine
It quickly became obvious the other person was a skeptic/short. He took off after the tour, leaving the rest of the meeting all to us
We bombarded Rich with questions for hours. We felt a little guilty taking so much of his time but he assured us that it was fine. We craved learning all the details of the business. Here are some observations I can recall from a dusty corner of my mind…
Rich showed us a dozen performance charts that hung on the wall - downtime, accuracy, turnaround time etc. He said he didn’t hear from anyone in CA as long as he stayed within the acceptable bands but that the moment he breached one that he’d get a call from management
As an ops geek, this one I absolutely loved...Rich brought us to a workstation & explained what was going on. He said the DVDs that came in generally went right out. DVDs found a house, as opposed to employees searching for the right DVD to send to a house
The return envelope was opened and the DVD sleeve scanned in so that it could be matched with a household that had it at the top of its queue. A successful match meant the DVD went right back into a newly printed red envelope to be sent out without being stored anywhere
This meant there was no wall of inventory & far less movement in the warehouse fulfilling orders. There were just stacks & stacks of DVDs at every workstation looking to be matched to a household
This sounds pretty obvious now but images from Blockbuster’s warehouses at the time confirmed that they got this critical piece wrong in their DCs
Three trucks went out late in the day to deliver to the USPS - one to Manhattan, one for northern NJ and one for southern CT. It’s funny how one little truck a night met the entertainment needs of a million NYC residents for years
We also learned that dealing with the USPS wasn’t easy. The DVDs had to be sorted in a very specific order so that the USPS would accept them. Anger the USPS enough and the DVDs don't make it to their destination
I could go on but you get the idea. We saw the secret sauce in action and it was readily apparent that the warehouses were very complicated operations that had been built over time by solving numerous problems and bottlenecks along the way
As we left the warehouse we were certain that Netflix’s operations were not going to be easily replicated by Amazon, Blockbuster or Wal-Mart
We knew what we saw didn’t guarantee success but we were becoming convinced that Netflix didn’t have a true peer. Blockbuster was simply not going to be able to topple Netflix hence...
“There's not a snowball's chance in hell that Blockbuster can do this”
“There's not a snowball's chance in hell that Blockbuster can do this”
We visited two more DCs in CA & GA after NY but those visits mostly repeated what we had already confirmed. I’ve had some great meetings over my career but I do not think I have ever topped the Long Island warehouse meeting with the guy that stuffed envelopes for a living
Reed is probably the smartest and most talented CEO I have met in my investment career. He saw where the puck was going before anyone knew they were in a hockey game
Barry, who was the CFO at the time, is as smart & sharp as they come. If you asked him a dumb question he was sure to let you know so :)
Getting to physical rental supremacy against competitors with greater resources was an absolutely amazing feat. Doing it again in the streaming wars, almost from scratch, is a true testament to how much talent there is in the organization (fin)
