01: Lights… Camera… Disruption

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How the movie Jaws and a $40 late fee led to a complete disruption of the entertainment industry as we know it. Host Walter Isaacson explores a series of unusual partnerships, bold moves, and missed opportunities that defined television and film.

Disruption can come from the most auspicious beginnings. A $40 late fee at a Blockbuster – remember Blockbuster? – for keeping Apollo 13 out too long, for example. That was Reed Hastings’ impetus for the idea of Netflix, which has ultimately transcended its role as Blockbuster slayer and is currently trying to out-HBO HBO. It’s just the latest in a long line of unlikely revolutions that changed how we consume visual entertainment.

In 1895, two sets of brothers in two neighboring European countries kick-started the film projection industry, leading a cinema-centric culture that stretches from Hollywood to Bollywood and beyond. When television invaded our homes after World War II, who knew that cinemas would strike back with a shark, a summer blockbuster, and using television’s persuasive power to drive people back to the theater? Now, it’s hard to imagine summers without popcorn and a sojourn to a dark, air-conditioned room with hundreds of strangers.

Speaking of Blockbuster, the blue-and-yellow-tinged retail giant had quite the run: 60,000 employees and 8,000 stores. But then the red giant, Netflix, changed the game. With a first-class stamp, a DVD of what you wanted to watch came right to your doorstep. And when Netflix offered itself up to Blockbuster for $50M, they refused, and laughed the plucky upstarts out of the room. It was a fateful decision. Netflix is worth $60B today.

In January 2007, Netflix got into streaming, and digital access to content became Netflix’s calling card. But to really ramp up their profits, Netflix released they needed to cut out the middle man and produce content of their own. From House of Cards, to BoJack Horseman, to Beasts of No Nation and 200+ pieces of original content since, Netflix has become a critically-acclaimed visual media studio faster than you can spell H-B-O – leading HBO to launch a successful streaming service of their own.

And as for cinemas? Still moving the turnstiles, with the most immersive entertainment options they’ve ever had. It all goes to show you: Sometimes the most unlikely source of disruption, is when you have the willingness to disrupt yourself.

“The people at Netflix are very, very smart. They managed to disrupt themselves. They went from seeing themselves as a competitor of Blockbuster to a competitor of HBO.”

GREG SATELL, WRITER FORBES & HARVARD BUSINESS REVIEW

What you’ll hear in this episode

  • What is a magic lantern?
  • The $40 late fee that started an entertainment revolution
  • A $30M gamble that led to 24×7 content in our homes
  • A shark attack sneak-attack
  • You call them “late fees,” we call it “margin”
  • Blockbuster’s blockbuster bomb
  • Doubling down on your strengths can mean doubling down on disaster
  • Agility as the pathway to prosperity
  • The House of Cards that keeps stacking higher and higher
  • “We need to become HBO faster than HBO can become us”
  • Cinema’s century of dominance
  • Movie theater as white-knuckle thrill ride

Guest List

  • Greg Satell Is a speaker, writer and innovation adviser. He helps companies grow their businesses by identifying the right solutions to solve the right problems. He is also the author of Mapping Innovation: A Playbook for Navigating a Disruptive Age.
  • Kim Masters Is editor-at-Large of the Hollywood Reporter and host of KCRW's The Business. A former correspondent for NPR, she has also served as a contributing editor at Vanity Fair, Time and Esquire, and was a staff reporter for the Washington Post.
  • Mathew Ingram Is a veteran journalist and technology writer whose work focuses on the intersection between media, technology and culture.
  • Dennis McDougal Is journalist and author of several books on including “The Last Mogul: Lew Wasserman, MCA, and the Hidden History of Hollywood”

WALTER ISAACSON: The year is 1997, and the place a Blockbuster Video store. A 37-year-old computer scientist walks through the front door. He’s here to return a video, a copy of the Tom Hanks/Ron Howard space classic “Apollo 13.” The only problem is that he’s returning the video a little on the late side.

You see, the video was missing in action for a while, lost somewhere in his house. And now he’s here to make good by returning it. The clerk hands him a bill, and the computer scientist is floored. His penalty for hanging on to “Apollo 13” longer than he should have? It’s a whopping $40.

For starters, there was no way he was ever going to be able to tell his wife about this. But perhaps even more importantly, this exchange gave him an idea, or at least the seed of an idea. What if there were a better way to rent movies, one with no due dates, no late charges? One whose business model was built on convenience rather then built on penalties? The computer scientist’s name was Reed Hastings, and he went on to form a company that you just might have heard of. It’s called Netflix.

[MUSIC PLAYING]

In the world of entertainment, Netflix has changed everything. It’s a true disruptor for our times. Here’s the interesting thing about any great disruptive technology– once it gets folded into our lives, it quickly becomes impossible to imagine a world without it. I’m Walter Isaacson, and this is “Trailblazers,” an original podcast from Dell Technologies.

[MUSIC PLAYING]

MAN: The scope of the motion picture is tremendous.

MAN: People first saw them in a penny arcade.

MAN: There’s this wonderful thing about television.

MAN: The greatest medium for entertainment the world has ever known.

MAN: The new world of electronics. The world of tomorrow.

[MUSIC PLAYING]

WALTER ISAACSON: In this episode, we’re focusing on the roller-coaster world of the entertainment industry. It’s easy to get seduced by the bright lights. But beneath all the Hollywood glamour is the story of how technology has completely transformed what we watch and how we watch it. And in order to understand how we got to where we are today, we first have to go back, way back, to November 1, 1895.

[MUSIC PLAYING]

We’re in the center of Berlin, at the majestic Wintergarten Theatre. A large crowd has assembled to see what has been advertised all over town as the most interesting invention of the modern age. It was something called Bioscop, a new invention by two brothers, Max and Emil Skladanowsky.

The brothers are already well-known in Berlin for their magic lantern shows, a crude form of entertainment that combines projected images, live narration, and music. But tonight, they’re presenting something entirely different, something that has the potential to disrupt magic lantern shows forever.

[APPLAUSE]

The lights in the theater dim. The audience sits back in their seats. And much like the ads promised, they were truly amazed. For the first time in history, a paying audience was witnessing the magic of moving images. The films were short, just about six seconds long. And they were played in a loop with live musical accompaniment. One wonderfully odd clip showed a boxing match between a human and a kangaroo.

The crowd was intrigued, and the bookings at other theaters across Europe began to flood in. But these bookings never came to be because only eight weeks later, Max and Emil Skladanowsky’s moment in the sun was disrupted by another pair of brothers living in the next country over.

[MUSIC PLAYING]

Those brothers were known as the Lumiere brothers, and their much more advanced film technology left the Skladanowsky brothers in the dust. Once the Lumiere brothers debuted their projector to a paying audience in Paris, it was game over for the Skladanowskys. This new way of projecting films was the first, and perhaps the quickest, disruption that the entertainment industry would see. But it was certainly not to be the last, not by a long shot.

[MUSIC PLAYING]

Cinema continued to dominate for decades. And one of the great things about the movies is that the characters behind the scenes are often as colorful as the ones that the movies are made about. Take Lew Wasserman, for example– a man who perhaps rode the waves of technological disruption better than anyone before or since. Dennis McDougal wrote the book, “The Last Mogul– Lew Wasserman, MCA, and the Hidden History of Hollywood.”

DENNIS MCDOUGAL: Lew was a poor immigrants’ kid from Cleveland, Ohio. He came out to Hollywood with his wife in the late 1930s to conquer Hollywood. And almost from the outset, he had his eye on what was going to be the next big thing, what was going to generate money not today but five, 10, 15 years from now.

WALTER ISAACSON: After the Second World War, a piece of technology came along that had the world in its grasp.

[TELEVISION TURNING ON]

WOMAN: It’s something else we do very well.

WALTER ISAACSON: That medium, of course, was television. Television was a medium driven on advertising, making the end result a relatively inexpensive appliance that people could afford to bring into their homes. The popular thinking was that television was just a fad and that, like all fads, it would quickly fade away.

Wasserman, however, wasn’t convinced. He felt that rather than ignoring this young upstart, the smarter move would be to embrace it. His entire career was built on an unspoken credo– the deal, no matter how cynical, is an end in itself. Wasserman biographer Dennis McDougal—

DENNIS MCDOUGAL: He bought one of the first television sets in Hollywood. This was long before any of the television programming really began to get a grip on the rest of the country. Lew saw well ahead of everybody else what this would mean, that this was not a flash in the pan, that this was technology that was going to last.

WALTER ISAACSON: So at a time when no one in the film business wanted to touch this new medium, Wasserman made the move to expand MCA’s business into television, and in a big way. He knew in his gut that no matter what the size of the screen, content was still king. So in 1957, he paid Paramount Pictures $10 million for their pre-1948 library. It was a collection of around 700 films that most felt were relics. But Wasserman had a vision.

Within one week of acquiring Paramount’s library, he managed to sign $30 million in TV licensing deals for the content. And that was only the beginning. Writer Dennis McDougal– DENNIS MCDOUGAL: It took a Lew Wasserman to recognize that the appetite of television audiences was endless and that ideally, eventually you would fill the airwaves 24 hours a day, seven days a week with something. And there would always be somebody out there who would be tuning in to watch it. And Lew saw that and translated that into his business model for the next 40 years.

[MUSIC PLAYING]

WALTER ISAACSON: But it wasn’t really until the 1970s, when he was running Universal Studios, that Wasserman found a way to truly marry the mediums of television and films together. And he did it to create the first real summer blockbuster. It was 1974, and a 27-year-old filmmaker by the name of Steven Spielberg had just finished up principal photography on a horror flick that took place on the high seas.

Spielberg was relatively untested, and the film had run over budget and over schedule. A mechanical shark– nicknamed Bruce, after Spielberg’s lawyer– that they had used to shoot some of the scenes had been a nightmare. And any hopes that the studio may have had for the movie to make its money back were fading quickly until one test screening.

[MUSIC – “THEME FROM ‘JAWS’”]

Lew Wasserman decided to sit in with the audience.

[MUSIC – “THEME FROM ‘JAWS’”]

He was amazed at the reaction of the crowd.

[GASPING]

True, enjoyable horror. Wasserman knew that with the right touch, not only could the movie do well, but it actually had the potential to bring the theatrical movie business back to its glory days. And what he did next, when taken in the context of the time, is kind of amazing. [MUSIC PLAYING]

Rather than shun television as a medium to market movies, which is what most studios had done since television took over, Wasserman chose to embrace it. His idea– use television’s popularity to boost the release’s chances at success. The movie, of course, was “Jaws,” and it quickly became a hit. Wasserman biographer Dennis McDougal—

DENNIS MCDOUGAL: Lew Wasserman invented the summer blockbuster. With “Jaws,” he did what nobody had done before at any studio. He used television in this genuinely innovative way, saturating the airwaves with teasers from the movie and getting people primed for getting into the theater and waiting to be thrilled by the attack of a great white.

And it was the beginning of an annual ritual. Now, every year right around Memorial Day, you can count on the beginning of television commercials nonstop about the latest big-tint thriller that’s going to show up at your local multiplex. All of that goes back to “Jaws” and Wasserman and the beginning of saturation advertising on television.

WALTER ISAACSON: “Jaws’s” opening weekend saw the shark flick take in $7 million. And by the time it was done in its initial theatrical run, it’d become the highest-grossing film up to that point, taking in more than $123 million. By getting into bed with television, the disrupter, Wasserman has been called, quote, “the man who ruined movies.” It’s an argument that could possibly be made from a quality perspective, but certainly not from a financial one. Thanks to Wasserman and the invention of the summer blockbuster, cinema was firmly back.

That is, until another technological disruption came along and stood again in its path.

[MUSIC PLAYING]

The rise of VCRs in the 1980s was such a threat that film studios tried their hand at legal action. They even tried to ban people from owning VCRs in their homes as a violation of copyright laws. In testimony in front of a congressional committee, the Motion Picture Association of America president, Jack Valenti, was blunt.

JACK VALENTI: How big is the problem? Blank videocassette sales in 1986– 275 to 300 million will be sold. That’s a lot of blank cassettes if all you’re doing is time-shifting or taking home movies of Aunt Sadie and little Bubba. You’re doing something more with those blanks.

WALTER ISAACSON: Not only was the film industry threatened by the VCR, the television industry was, as well. No longer did people need to watch television commercials. They could simply fast forward, or worse, rent movies that didn’t have commercials in the first place. Enter Blockbuster. Greg Satell is a journalist who’s covered many business stories, including lessons learned from the fall of Blockbuster.

[MUSIC PLAYING]

GREG SATELL: Blockbuster was an amazing innovator in the video industry. A guy named John Antioco came to run it who had been very successful in the retail business. And what he saw was the dynamics of the business were very unfavorable because they had to pay these sky-high fees to buy the movies from the movie studios. And it was very difficult to predict which movies they were going to make money off of.

So what he did is he went to the movie studios, and he said, instead of buying movies from you, why don’t we give you a cut of the rental revenues? And that way, we can get the movies we need, and we’ll both make more money. And he absolutely changed the industry. And obviously, Blockbuster became, well, a blockbuster.

WALTER ISAACSON: At its peak in 2004, Blockbuster consisted of nearly 60,000 employees and over 8,000 stores. At one point, they were opening up a new store every 24 hours. Matthew Ingram is a senior writer for “Fortune” magazine, and he watched the business evolve.

MATTHEW INGRAM: Well, I think Blockbuster was one of the first sort of moderately digital entities, one company that really saw the sort of digital future coming and kind of invested all its resources in it. So that’s all they were interested in. And it was a huge customer service business. So people got what they wanted, and it was at a reasonable price, and all of those other things that good retail businesses do. The problem for Blockbuster is that they became entrenched in that one model.

[MUSIC PLAYING]

WALTER ISAACSON: The secret to Blockbuster’s financial success? Late fees. In the year 2000, Blockbuster took in a staggering $800 million in late fees alone. It accounted for 16% of their yearly revenues. Customers hated these late fees, but there wasn’t much they could do about it until, of course, Reed Hastings, the cofounder of Netflix, was faced with his $40 late fee to return his copy of “Apollo 13.”

[MUSIC PLAYING]

Reed, along with Netflix cofounder Marc Randolph, decided to start their own video rental company, a company that would approach the video rental business model from a very different perspective. Hastings took the point of view of the customer. In particular, he aimed his business model at customers who were tired of paying these exorbitant late fees.

He also saw the opportunity in the physical size of DVDs. Unlike video tapes, they were small and thin. Once out of their bulky covers, they were cheap to ship. A single first-class stamp, and a DVD could be at your doorstep. And in the new world of Netflix, you could keep it for as long as you liked with no late fees.

By all accounts, the company began doing well– so well, in fact, that in the year 2000, Netflix founder Reed Hastings flew to Dallas.

[AIRPLANE FLYING]

He was there to meet with, of all people, Blockbuster’s CEO, John Antioco. Hastings proposed a partnership. He offered to sell Antioco Netflix for a price of $50 million. Antioco’s take on Netflix was that the DVD mail service was a very small niche business. And the idea that Blockbuster might need to partner with a company as insignificant as Netflix seemed ludicrous to Antioco. Hastings got laughed out of the room.

[MUSIC PLAYING]

Today, Netflix is worth $60 billion. And Blockbuster? Well, we all know how that one ended. In 2010, they filed for bankruptcy. It’s a story that’s still being taught in business schools across the world on what happens if you don’t stay agile in a market that’s constantly changing. Journalist Greg Satell—

GREG SATELL: That was probably one of hundreds decisions John Antioco had to make that day. When you’re in a position of responsibility and you’re running an actual business, you’re gonna get stuff wrong.

[MUSIC PLAYING]

WALTER ISAACSON: When it comes to business decisions, hindsight is always 20/20. It’s easy to look back at this moment as one of the biggest business blunders of the 20th century. But in order to truly judge, we first need to take a closer look at the context. Senior “Fortune” writer Matthew Ingram—

MATTHEW INGRAM: So was that the right decision to make? No, clearly not. But at the time, it’s difficult when you’re running a multibillion-dollar business based on a specific model that you’ve structured the company to operate under to suddenly say, you know what we have to do is completely re-engineer our business and destroy a lot of what we’ve built and kind of reinvent it as something else.

WALTER ISAACSON: I had a chance to interview Reed Hastings as he was accepting an Aspen Institute Henry Crown Leadership Award. Here’s what he had to say when I asked him about the challenges that legacy companies have when faced with potential disruption.

REED HASTINGS: Pretty much every shipping company didn’t get into railroads. And every railroad company didn’t succeed in airlines. And you look on a very broad range of where once you get to be a significant size, you specialize because you’ve got competitors. And you get very good at whatever your business is. And then it’s extremely hard to shift.

WALTER ISAACSON: What turned Netflix into a true disruptor wasn’t the mail-order DVD business it had spent years perfecting. It was something else, something that would change the way most of us consume media—

REED HASTINGS: Streaming.

WALTER ISAACSON: Streaming.

Kim Masters is a journalist who has written extensively about Netflix for the “Hollywood Reporter.”

KIM MASTERS: They very brilliantly started out as a mail-order service of old movies. And then they transitioned people almost seamlessly into streaming. And I think that Reed Hastings, the founder of Netflix, saw that the future would be digital. But he started out with a different format, knowing that at some point he would have to get consumers to figure out how to stream this stuff when the technology was good enough to make a decent quality stream available.

WALTER ISAACSON: By 2004, Netflix began facing serious threats to its DVD-by-mail business. [MUSIC PLAYING]

As a last-ditch effort to stay solvent, Blockbuster had gotten into the mail-order DVD game and was undercutting Netflix’s price point. And rumors were circulating that Amazon was going to enter the mail-order DVD business in the US, as well. Amazon had already been successful in the UK, and their expansion into the US market seemed inevitable. So analysts downgraded Netflix’s stock value, and the company was forced to slash its prices. Things were not looking good for the mail-order startup.

[MUSIC PLAYING]

But when Reed Hastings took a look at the world around him, he saw that smartphones and tablets were everywhere. And he realized they brought with them a potentially huge opportunity for Netflix in the world of streaming. Why wait for the DVD to be delivered to your door when it was even more customer-friendly to deliver that content instantly?

But there was one big problem– digital access to content. In order to make streaming a reality, Netflix was forced to enter into complicated license agreements with distributors and studios, many of which Netflix was threatening to disrupt. The distributors knew it was a seller’s market. Without their content, Netflix was dead on arrival. Kim Masters—

KIM MASTERS: They had a lot of old television shows. And initially, the studios were completely thrilled because in many cases, these seemed to be kind of played out. It didn’t seem like it was going to be some kind of a great thing to have. So they were like, hey, somebody’s giving us money for this stuff that’s in our vaults.

WALTER ISAACSON: If this strategy sounds like a familiar one, it’s because it is. Netflix was in the process of doing what Lew Wasserman and MCA had done almost 40 years earlier. Both Wasserman and Netflix went on the hunt for materials that the studios thought was played out and had very little value. And both turned around and used that content to build new businesses. By January 2007, Netflix began streaming.

The early reviews of the Netflix streaming selection weren’t all that kind. Some equated the experience of choosing a movie on Netflix to choosing a video in a small-town video store– they’ll never have exactly what you’re looking for. But with enough hunting around, you’ll probably eventually be able to find something to watch, even if it’s not your first, second, or third choice.

Streaming was convenient, and it started to catch on. But Reed Hastings realized that in order for Netflix to truly make their content viable, they needed to do something bold. Rather than remain dependent on content deals with studios, they needed to become both the distributor and the producer. They needed to provide exclusive content that wasn’t going to be available anywhere else, a huge risk that came with a huge price tag.

TV networks and studios were originally very happy to get in bed with Netflix, but they quickly began to realize this wasn’t just a new revenue stream. It was a disruption to their way of delivering entertainment. Netflix knew if they remained reliant on getting content from traditional sources, then they were putting themselves in a negative bargaining position. Their very survival depended on this one massive risk. Journalist Greg Satell—

GREG SATELL: The people at Netflix are very, very smart. They not only managed their rise and the competition with Blockbuster well, but they also managed to disrupt themselves and went very quickly into streaming. They recognized the need for original programming, which was a huge change in their business model. They basically went from seeing themselves as a competitor to blockbuster to a competitor of HBO. And they managed that very, very well.

WALTER ISAACSON: In February 2013, Ted Sarandos, Netflix’s chief content officer, told “GQ,” “the goal is to become HBO faster than HBO can become us.”

[MUSIC PLAYING]

With its first hit, “House of Cards,” that risk paid off handsomely. Just three years later, Netflix released more than 125 original series or films, more than any other network or cable channel. In 2014, I asked Reed Hastings about the secret to creating a company that’s been able to shift business models as successfully as Netflix has.

REED HASTINGS: Short-term optimization about being efficient is the death of long-term success and innovation. And that we should build a company in Netflix that tolerated some short-term chaos. And we manage right on the edge of chaos. And the value of that is keeping and stimulating the amazing thinkers so when the market shifts– like DVD to streaming or license to expand to original content– we have within Netflix all kinds of original thinkers. And that’s the long-term optimization that all of us in organizations want.

WALTER ISAACSON: And it’s exactly that kind of thinking that has separated Netflix from its competitors in the world of entertainment. Kim Masters—

KIM MASTERS: They have brought a very Silicon-Valley type of culture into Hollywood. And they have played a pretty hardball game. Yeah, I mean, unlike the TV competitors they have, they know exactly how much you watched. They know if you watched 13 minutes and stopped. They know if you’ve watched to the end. They know if you binged. That’s the kind of information TV networks don’t have. They don’t have that kind of granular information.

But again, with Netflix, it may not even be whether you watched. It maybe whether you think you want to watch at some point. Netflix has been going worldwide. So it can give you the potential of a humongous global audience. They’re rolling out all over. The question is what happens when you’ve sort of saturated the planet? They’re spending at such a rate right now that a lot of people think, how can this be sustained?

[MUSIC PLAYING]

WALTER ISAACSON: Since Netflix’s grand digital disruption of the world of entertainment, legacy companies are trying to fight back, some more successfully than others. HBO is a great example. Owned by the giant Time Warner, HBO is in a unique position in the market because it has its own content library of high-quality programming.

In 2010, HBO launched its own on-demand service, HBO GO. It’s a service that has experienced substantial growth over the past few years. HBO now makes up about 20% of Time Warner’s total revenues. In an attempt to have an even stronger foothold in the digital streaming market, Time Warner also bought a stake in Hulu, another online streaming service. It’s an example of a traditional media and entertainment company that is aiming to become more innovative and hopefully ahead of the curve when it comes to digital disruption in the entertainment industry. It’s a company willing to disrupt itself.

[MUSIC PLAYING]

And what about those dear old movies? Despite prognostications of doom, it seems that disruptions like Netflix haven’t really damaged the business of movie theaters, for the moment, anyway. Their real threat? Other live spectacles– sporting events, nightclubs, anywhere people can congregate for collective entertainment.

As a result, theater chains have made deals with third-party providers to raise the bar on just what a moviegoing experience can be. Want your seat to move along with the action on the screen? Visit a theater with the special D-BOX seats. Want to feel the wind in your hair and rain in your face? Then you want to visit a cinema with 4DX.

Today, moviegoers are being brought into the film-going experience like never before. It’s a far cry from the early days of the magic lantern shows. Unlike some of the other facets of the entertainment industry, it’s cinema that seems to be the most resilient. Well over 100 years after its first introduction, it’s a business that just won’t quit. The technology has certainly gotten better over the years, providing all sorts of bells and whistles.

But fundamentally, the moviegoing experience has remained the same– people together in the dark watching a story unfold on a screen in front of them. But in this world where unpredictable digital disruption is lurking behind every door, just how long can its reign continue?

[MUSIC PLAYING]

I’m Walter Isaacson, and you’ve been listening to “Trailblazers,” an original podcast from Dell Technologies. There’s obviously many more nuances to this story that we weren’t able to cover here, and you can find some of those at delltechnologies.com/trailblazers1. That’s “trailblazers,” and then the number 1.

For example, despite our reliance on streaming, the physical DVD industry is not actually dead. Believe it or not, when it comes to total revenue, physical DVDS still outpace streaming. Again, you can find this all at delltechnologies.com/trailblazers1.

You can subscribe to the show in iTunes or wherever you get your podcasts from. And if you like it, please leave us a rating and review. It makes a huge difference. Thanks for listening.

[MUSIC PLAYING]