Netflix’s ‘Keeper Test’ Is the Secret to a Successful Workforce
Tags: Netflix, Leadership, CEO, Business, Book Excerpts

Reed Hastings. Photo: Ethan Miller/Getty Images

Inthe 1990s, I liked to rent VHS videos from the Blockbuster down the street from our house. I’d take two or three at a time and return them quickly to avoid late fees. Then one day I moved a pile of papers on the dining room table and saw a cassette that I’d watched weeks ago and forgotten to return. When I took the movie back to the store, the woman told me the fee: $40! I felt so stupid.

Later, that got me thinking. Blockbuster made most of its margin on late fees. If your business model depends on inducing feelings of stupidity in your customer base, you can hardly expect to build much loyalty. Was there another model to provide the pleasure of watching movies in your own living room without inflicting the pain of paying a lot when you forgot to return them?

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In early 1997, when our startup Pure Software was acquired, Marc Randolph and I started thinking about opening a movies-by-mail business. Amazon was having good luck with books. Why not films? Customers would rent VHS cassettes from our website and be able to return them via the mail. Then we learned it would cost $4 to mail the VHS cassette each way. There wasn’t going to be a big market. It was too expensive.

But a friend told me about a new invention called DVDs, which would be coming that fall. “They’re like CDs but hold a movie,” he explained. I raced to the post office and mailed myself several CDs (I couldn’t find an actual DVD for my test). Each cost thirty-two cents to mail. Then I went back to my place in Santa Cruz and waited anxiously for them to arrive. Two days later they dropped through the mail slot, unharmed.

In May 1998, we launched Netflix, the world’s first online DVD rental store. We had 30 employees and 925 movie titles, which was almost the entire catalog of DVDs available at the time. Marc was the CEO until 1999, when I took over and he became one of our executives.

By early 2001, we’d grown to 400,000 subscribers and 120 employees. I tried to avoid the leadership fumbles of my Pure Software days, and although we avoided implementing excessive rules and controls this time, I also couldn’t characterize Netflix as a particularly great place to work. But we were growing, business was good, and work for our employees was OK.

After the layoffs, with only the most talented 80 people, we had a smaller amount of talent overall, but the amount of talent per employee was greater.

Then, in the spring of 2001, crisis struck. The first internet bubble burst, and scores of dot-coms failed and vanished. All venture capital funding stopped, and we were suddenly unable to raise the additional funds we needed to run the business, which was far from profitable. Morale in the office was low, and it was about to get lower. We had to lay off a third of our workforce.

I sat down with Marc and Patty McCord — Patty had come with me from Pure Software and was head of Human Resources — and we studied the contribution of each employee. We didn’t have any obviously poor performers. So we divided the staff into two piles: the 80 highest performers who we would keep and 40 less amazing ones we would let go. Those who were exceptionally creative, did great work, and collaborated well with others went immediately into the “keepers” pile. The difficulty was that there were many borderline cases. Some were great colleagues and friends but did adequate rather than great work. Others worked like crazy but showed uneven judgment and needed a lot of hand-holding. A few were exceptionally gifted and high performing but also complainers or pessimists. Most of them would have to go. It wasn’t going to be easy.

In the days before the layoffs, my wife remarked how on edge I was, and she was right. I worried that motivation in the office would plummet. I was convinced that, after I’d let go of their friends and colleagues, those who stayed would think that the company wasn’t loyal to employees. It was bound to make everyone angry. Even worse, the “keepers” would have to shoulder the work of those let go, which seemed certain to lead to bitterness. We were already short on cash. Could we bear a further collapse in morale?

The day of the layoffs arrived, and it was awful, as expected. Those who we laid off cried, slammed doors, and shouted in frustration. By noon it was finished, and I waited for the second half of the storm: the backlash from the remaining employees…. But, despite some tears and visible sorrow, all was calm. Then, within a few weeks, for a reason I couldn’t initially understand, the atmosphere improved dramatically. We were in cost-cutting mode, and we’d just let go of a third of the workforce, yet the office was suddenly buzzing with passion, energy, and ideas.

A few months later the holidays arrived. DVD players were popular that Christmas, and by early 2002, our DVD-by-mail subscription business was growing rapidly again. Suddenly, we were doing far more work — with 30 percent fewer employees. To my amazement, those same 80 people were getting everything done with a passion that seemed higher than ever. They were working longer hours, but spirits were sky-high. It wasn’t just our employees who were happier. I’d wake up in the morning and couldn’t wait to get to the office. In those days, I drove Patty McCord to work every day and when I swung up to her house in Santa Cruz, she would practically leap into the car with this big grin: “Reed, what’s going on here? Is this like being in love? Are these just some wacky chemicals and this thrill is going to wear off?”

Patty had put her finger on it. The entire office felt like it was filled with people who were madly in love with their work.

I’m not advocating for layoffs, and fortunately we haven’t had to do anything like that at Netflix since. But in the days and months following those 2001 layoffs, I discovered something that completely changed the way that I understand both employee motivation and leadership responsibility. This was my road to Damascus experience, a turning point in my understanding of the role of “talent density” in organizations. The lessons we learned became the foundation of much that has led to Netflix’s success.

If a person on your team were to quit tomorrow, would you try to change their mind? Or would you accept their resignation, perhaps with a little relief?

Patty and I spent dozens of car rides following the 2001 layoffs trying to figure out why the work environment had taken a sharp turn for the better and how we could maintain this positive energy. We came to understand that what Patty referred to as our dramatic increase in talent density was behind the improvements.

Every employee has some talent. When we’d been 120 people, we had some employees who were extremely talented and others who were mildly talented. Overall we had a fair amount of talent dispersed across the workforce. After the layoffs, with only the most talented 80 people, we had a smaller amount of talent overall, but the amount of talent per employee was greater. Our talent density had increased.

We learned that a company with really dense talent is a company everyone wants to work for. High performers especially thrive in environments where the overall talent density is high.

Our employees were learning more from one another and teams were accomplishing more — faster. This was increasing individual motivation and satisfaction and leading the entire company to get more done. We found that being surrounded by the best catapulted already good work to a whole new level.

Most important, working with really talented colleagues was exciting, inspiring, and a lot of fun — something that remains as true today with the company at 7,000 employees as it was back then at 80.

In hindsight, I understood that a team with one or two merely adequate performers brings down the performance of everyone on the team. If you have a team of five stunning employees and two adequate ones, the adequate ones will:

sap managers’ energy, so they have less time for the top performers,

reduce the quality of group discussions, lowering the team’s overall IQ,

force others to develop ways to work around them, reducing efficiency,

drive staff who seek excellence to quit, and

show the team you accept mediocrity, thus multiplying the problem.

For top performers, a great workplace isn’t about a lavish office, a beautiful gym, or a free sushi lunch. It’s about the joy of being surrounded by people who are both talented and collaborative. People who can help you be better. When every member is excellent, performance spirals upward as employees learn from and motivate one another.