How Netflix got started

Netflix founder and CEO Reed Hastings tells Fortune how he got the idea for the DVD-by-mail service that now has more than eight million customers.

(Fortune Magazine) -- 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.

So I started to investigate the idea of how to create a movie-rental business by mail. 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, Calif., and mailed CDs to myself, just a disc 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.
Don't be afraid to change the model

Early on, the first concept we launched was rental by mail, but it wasn't subscription based, so it worked more like Blockbuster. Some people liked it, but it wasn't very popular. I remember thinking, God, this whole thing could go down, and we said, Let's try the more radical subscription idea. We knew it wouldn't be terrible, but we didn't know if it would be great. We launched the service on Sept. 23, 1999, and we could tell within a month that we had a renewal rate. It was a free trial, but only 20% didn't go from the free trial to the paid. We're up to 90% renewal now.
You know it's working when...

I was down in Arizona in 2003 visiting one of our distribution centers on the outskirts of Phoenix. It was raining, and my umbrella wasn't working, so I walked the half mile from the distribution center to the hotel. I got the message on my BlackBerry that we hit a million [subscribers] that day while I was walking in the rain. It was this beautiful moment where I was just so elated that we were going to make it, and that was also the first quarter that we turned profitable. It was a magic walk.
In my queue

I've seen well over 1,000 movies. The one I remember most was Sophie's Choice, because I was taking European history in college at the time, and I was totally bored with the topic. And then I saw the movie, and I started to care. It changed my perspective. I could relate to the trauma after seeing the movie in a way that I couldn't by studying it.
Secrets of my success

* Target a specific niche: When there's an ache, you want to be like aspirin, not vitamins. Aspirin solves a very particular problem someone has, whereas vitamins are a general "nice to have" market. [The Netflix idea] was certainly aspirin.
* Stay flexible: We named the company Netflix (NFLX), not DVDs by Mail because we knew that eventually we would deliver movies directly over the Internet. DVDs will be around a long time, but we're building for the day when they're not.
* Never underestimate the competition: We erroneously concluded that Blockbuster (BBI, Fortune 500) probably wasn't going to launch a competitive effort when they hadn't by 2003. Then, in 2004, they did. We thought, Well, they won't put much money behind it. Over the past four years they've invested more than $500 million against us.
* There are no shortcuts: Occasionally great wealth is created in a short amount of time, but it's through a lot of luck in those situations. You just have to think of building an organization as a lot of work. It may or may not turn into great wealth.