How long can Netflix keep managing ‘at the edge of chaos’?

Netflix’s unique and risky corporate culture works well in Silicon Valley, but will it survive Zoom meetings and a broader global ‘keeper test’?

Netflix CEO Reed Hastings. Picture: Bloomberg

The best way to stay innovative, many bosses will tell you, is to hire the best people and let them get on with it. Few take this as literally as Reed Hastings of Netflix. The video streamer’s employees can take as much holiday as they fancy and put anything on the company’s tab so long as, to cite the entirety of its corporate expense policy, they “act in Netflix’s best interest”. Anyone may access sensitive information such as a running tally of subscribers, which Wall Street would kill for. Executives seal multimillion-dollar deals without sign-off from top brass. High-achievers are rewarded with the plushest salaries in the business. Underperformers are unceremoniously cut loose.

It sounds like a recipe for anarchy. But managing “on the edge of chaos”, as Hastings puts it, has served Netflix well. Most of its 7900 full-time workers seem happy being treated like professional athletes, paid handsomely as long as no one can do their job better. Each generates $US2.6m ($3.5m) in annual revenue on average, nine times more than Disney employees, and $US26.5m in shareholder value, three times more than a Googler does.

Investors lap it up as hungrily as Netflix binge-watchers, who now number 193 million worldwide. Since going public in 2002 the share price has risen 500-fold. This track record has earned Hastings kudos. A PowerPoint “culture deck” outlining his management philosophy has been viewed 20 million times since he posted it online 11 years ago. A new book in which Hastings fleshes out those 125 slides is destined for the bestseller list. But are the No Rules Rules of the title the right set as Netflix metamorphoses from California start-up into global colossus?

It is easy to put too much stock in corporate culture, which can be a story triumphant companies tell themselves after the fact. GE’s rise in the 1990s had more to do with financial engineering than with the much-aped habit introduced by Jack Welch of ranking employees and “yanking” the bottom 10 per cent. Netflix would not be where it is without its boss’s uncanny foresight to bet on streaming in the late 2000s, or the flat-footed response from Hollywood. Investors have displayed deep reserves of cheap capital and deeper ones of patience. During the past year the firm’s revenue generators each burned through $US123,000 of cash; this year quarterly cashflow turned positive for only the first time since 2014. Luck played a role, as when cut-price DVD players debuted in time for Christmas in 2001, months after the dotcom crash forced Hastings to lay off a third of 120-odd workers from what was then a DVD rental service.

Still, as Michael Nathanson of consultancy MoffattNathanson observes: “Every time that Netflix faced a roadblock it found a clever way to work around it and emerge stronger.”

Netflix’s way of doing things doesn’t always work with the Hollywood studios it partners with. Picture: Bloomberg

Most notably, when television networks and studios at last woke up to the reality of streaming and began to hog content licences, Netflix started producing its own shows and later feature films. The swivel might have taken longer with employees bogged down in chains of approvals. “Radical candour”, whereby everyone’s ideas, from Hastings down, can be challenged by all comers, helps weed out bad ones. “Sunshining”, the stomach-churning spectacle of publicly explaining choices, helps not to repeat mistakes. Senior Netflixers’ “ability to swallow their pride is truly exceptional”, says Willy Shih of Harvard Business School, who has written two case studies on the firm.

Now this innovation-friendly culture is under fire on three fronts. The first two — the firm’s growing size and scope — are internal to Netflix. The third source of pressure comes from the outside. Start with size. The flat hierarchy and frankness that work in Silicon Valley, with its narrow range of temperaments and socio-economic backgrounds, is harder to sustain in a global workforce that has swelled nearly fourfold in five years. Negotiating “context”, as Netflix managers and their subordinates do constantly in the absence of explicit rules, offers useful flexibility. But it takes time that could be spent perfecting a product. Revenue per worker is down by 7 per cent from 2015.

Many countries grant workers more protections than the US does. This is a problem for the “keeper test”, which requires managers constantly to question if they would fight to stop their underlings from leaving — and, if the answer is no, immediately send the individual on their way with generous severance. These golden handshakes, which range from four months’ salary in the US to more than six months in The Netherlands, are “too generous” to reject, says Hastings. Netflix has not been sued even in Brazil, where employee lawsuits are a national sport to rival football. The bonhomie may not last. A larger workforce poses a separate risk to internal transparency. Even while the attrition rate hovers at around 10 per cent, the number of ex-Netflixers with knowledge of the firm’s finances and strategic bets is growing by hundreds each year. Unwanted disclosures have been rare and, says Hastings, immaterial. But, he concedes, serious leaks may be “a matter of time”.

The second challenge has to do with Netflix’s sectoral girth. In its first decade it was primarily a firm of technologists such as Hastings, whom his co-founder, Marc Randolph (who left the firm in 2003), likened to the hyper-rational, emotionless Mr Spock in Star Trek. That was never entirely fair — Netflix products are data-driven but Hastings attaches as much weight to judgment in managing people as Captain Kirk ever did. Still, by the standards of Tinseltown, he and his firm can come across as robotic. One producer who has worked with Netflix detects hints of its horizontal hierarchy permeating Hollywood “by osmosis”. This can speed things along. But, she grouses, “sometimes you need a production assistant to assist, not commission scripts”.

At the same time, Netflix missed a chance to revolutionise other old studio ways. The $US150m five-year deal it signed in 2018 with Shonda Rhimes, a star TV producer, may be more generous than most networks can afford. But it is Hollywoodian in its structure, says a former executive — and antithetical to the keeper test.

Netflix may have no choice but to expand into new industries. This would be a departure from its laser focus on its core product: quality streamed entertainment. But show business is increasingly the preserve of conglomerates. Disrupting sluggish behemoths is one thing. Competing with them head-on may require a different trade-off between flexibility and efficiency.

The third set of challenges is external. COVID-19 has muted the exchange of ideas. It is also harder to evaluate — and dismiss — people by Zoom; Netflix’s 12-month rolling attrition rate has declined by a third, to 7 per cent. Hastings says he does not see “any positives” to home working.

Then there is public pressure for corporate America to care more about diversity. Hastings added inclusion to Netflix values in 2016 but it barely features in his investor letters or annual reports. He acknowledges a tension between the desire for diversity and Netflix’s arch-meritocratic ideals. Its corporate temperament screams “hypermasculine”, as Erin Meyer, Hastings’s co-author and professor at INSEAD, has noted. And one person’s radical candour is another’s microaggression.

Netflix shareholders and their board have confidence Hastings can reconcile these strains. But he knows his position is safe only as long as he can keep the magic going. The keeper test applies to him as well.

No Rules Rules: Netflix and the Culture of Reinvention by Reed Hastings and Erin Meyer (Penguin).