Gina Keating's new book reveals how Santa Cruz's Reed Hastings built the Netflix DVD empire.

Gina Keating’s new book ‘Netflixed’ chronicles the behind-the-scenes story of Netflix’s founding, the company’s amazing success in capturing the hearts of movie lovers, its role in crushing video-rental behemoths like Blockbuster, and the Qwikster debacle that destroyed most of the company’s market value, practically overnight. This excerpt focuses on the company’s beginnings in Santa Cruz. A longer excerpt can be found in the print edition of Santa Cruz Weekly.

LIKE ALL GOOD stories, the one about the founding of Netflix Inc., the world’s largest online movie rental company, mixes a little bit of fact with some entertaining fiction. The company’s official story is that Santa Cruz tech millionaire Reed Hastings had an epiphany for his next company after returning an overdue movie to his local video store and later dreamed up its signature subscription model on a treadmill at his gym.

“The genesis of Netflix came in 1997, when I got this late fee, about $40, for Apollo 13. I remember the fee, because I was embarrassed about it. That was back in the VHS days, and
it got me thinking that there’s a big market out there,” Hastings, Netflix’s chairman and chief executive, told Fortune in 2009, one year before the magazine named him its Business Person of the Year.

“I didn’t know about DVDs, and then a friend of mine told me they were coming. I ran out to Tower Records in Santa Cruz, California, and mailed CDs to myself, just a disk in an envelope. It was a long 24 hours until the mail arrived back at my house, and I ripped them open and they were all in great shape. That was the big excitement point.”

As a financial journalist, I heard that story a lot in the seven years I covered Netflix along with a handful of other U.S. entertainment companies and their executives. I thought I had the story down cold when in 2010 I began to research and write a book about Netflix’s rise from a start-up with no clear path to profitability to a
$4 billion movie rental titan with
 a stake in everything from postage rates to Hollywood movie deals to federal rules on privacy, broadband use, and Web traffic.

Some of the questions for which 
I could not get answers from Netflix included: What happened to Netflix’s other founder, Marc Randolph, and why is he never mentioned? Why was the Apollo 13 founding story, initially
 set at a Blockbuster store in Santa Cruz, then changed in 2006 to a now defunct mom-and-pop video store in La Honda?

Answering one question only led to another, and soon I was down a rabbit hole that changed everything I thought I knew about Netflix. It started with a conversation I had with Netflix’s other founder on a bright, windy day in Santa Cruz.


I WASN’T SURE what to expect when we met for the first time at a breakfast joint in Los Gatos in August 2010—no one else had been able to tell me the circumstances that had led to Randolph’s departure from the company he helped found.

The fit, animated man who walked up to my outdoor table dressed in 
a fleece pullover and jeans showed every sign of enjoying a rather footloose life since leaving Netflix. He sat down, ordered eggs Benedict, and plunged into a tale that upended a
lot of what I thought I knew—starting with the story of how Hastings’s
late fee for Apollo 13 resulted in the founding of the company.

“That’s a lot of crap,” Randolph told me. “It never happened.”

He explained that the Apollo 13 story started as “a convenient fiction” to describe how Netflix’s rental model works and became confused with 
its origins, because people wanted “a rage against the machine–type story.”

Six months and several conversations later I persuaded Randolph to show me where the true Netflix founding took place, which was on a quiet stretch of downtown Santa Cruz.

Randolph parked the Volvo at a meter on Pacific Avenue, and we began to walk—past the Del Mar movie theater, a few upscale chain stores, and local boutiques.

He pointed out Lulu Carpenter’s, the hip coffee joint where people sat out front at sidewalk tables in the weak morning sunshine. He and Hastings often met at this café to discuss business—and formed the plan that brought Netflix to fruition.

One particular day their debate centered on how to distribute the movies they hoped customers would rent via a hypothetical e-commerce Web site, and they decided they had to test whether the new DVD format that Randolph had heard of could travel across the country on a first- class stamp and survive the hazards of bulk mailing.

They couldn’t get their hands on 
a DVD, then available in only a half- dozen test markets, but Logos Books & Records a couple of blocks down the street sold compact disks. When we drove up that day, a giant Borders bookstore was liquidating its stock and preparing to shut down, another casualty of the inexorable move to online distribution of media that its parent company embraced too late. 
I wondered if Logos’s staff had any idea of the role their iconic indie store played in helping Netflix bring down another huge bricks-and-mortar entertainment chain.

A few doors down from the
 record store was the gift shop where Randolph and Hastings bought a greeting card with an envelope large enough to accommodate the CD after they stripped off its packaging.

They threw away the card, stuffed the CD into the envelope, and addressed it to Hastings’ home. They then walked to the central Santa Cruz post office, where they paid for first- class postage and sent the CD on its short but crucial journey.

They would later learn, through close collaboration with the U.S. Postal Service, that local mail was hand-canceled in Santa Cruz and not sent through postal service sorters—a fact that could have changed everything had they known it then, Randolph told me.

A day or two later, the two met up for their morning commute to Sunnyvale.

“It came,” Hastings told Randolph, as he climbed into the car. “It’s fine.”

“And I thought, ‘Huh, this might work after all,’ ” Randolph said, as he drove me back to the bus station. “If there was an ‘aha moment’ in the story of Netflix, that was it.”

Copyright © Gina Keating, 2012. All rights reserved. Reprinted by permission.