Analyzing Netflix’s Growth and Enron’s Demise

Analyzing Netflix's Growth and Enron's Demise Using Schein's Organizational Theory

When Reed Hastings and Marc Randolph founded Netflix in 1997, Blockbuster was humming along as the largest video rental company in the United States with a large physical footprint and excellent brand recognition. As a retailer at the time, qualities like these were generally indicative of a healthy business with a positive outlook. Blockbuster exploited their strong position in the video rental industry by stocking their stores with a sparse selection of films and charging onerous late fees among other things. Using a high-volume, low-price business model, Blockbuster was able to price other video rental stores out of the market and limit the number of competitors they had in the industry.

Meanwhile, Netflix was struggling with how to make its grand idea of sending videos directly to customers work. Eventually they settled on sending DVDs to customers (a technology that had arrived in the U.S. only a year earlier) and using an innovative membership model. Initially this was perceived as a poor strategy as DVD players were prohibitively expensive and not many people would be able to afford them. This led to an opportunity for Blockbuster to buy Netflix for $50 million in 2000 when Netflix executives flew to Blockbuster headquarters in the midst of the tech bubble bursting, an event which resulted in Netflix struggling as a young company (Graser). Blockbuster ultimately declined Netflix's offer (according to Netflix officials present at the meeting, they were nearly laughed out of the office) to run its online service - and in hindsight - might have made one of the worst mistakes in business history. Instead Blockbuster opted to strike a deal with Enron to provide a video-on-demand service using Enron's fiber optic cables (Graser). This deal fell apart in short order due to the acrimonious and distrusting nature of their relationship. Within the year Enron had filed for bankruptcy and several of the company's executives were scheduled to appear for congressional hearings meant to obtain information on the rampant fraud within Enron. In 2010 - 10 years after a fledgling Netflix had offered to collaborate with Blockbuster from a position of weakness - Netflix was worth about $13 billion by market capitalization and Blockbuster was worth about $24 million and filing for bankruptcy (Graser). It is very tempting to attribute the upheaval of the video rental industry to the changing tides of the business and the role technology has played in these transitions. But looking just a little deeper suggests that something a lot more fundamental is the cause of this transition: one company was organized better (had a better culture) than the other and used the resources at its disposal more effectively to advance its plans. Technology might play a role, but doing something like ridiculing a competitor who flew in to meet with you says something about your company culture.

Culture

Edgar Schein summarized culture as a pattern of shared basic assumptions learned by a group as it solved its problems of external adaptation and internal integration, which, has worked well enough to be considered valid and, therefore, to be taught to new members (Schein, 1985) . Schein breaks this down in to three distinct levels for an organization: the organization's artifacts and behaviors, its espoused values, and the underlying assumptions shared by those within an organization. In 2004, Patty McCord, then Chief Talent Officer of Netflix, along with Reed Hastings, CEO of Netflix, wrote a PowerPoint deck that summarized the principles and values that underpinned Netflix's culture in its 12 year history. Since then, the deck has come to be known as the Netflix Culture Deck and has been shared more than 18 million times on the web. On the 6th slide of that deck, Enron's logo is at the top with the following text beneath it: Enron, whose leaders went to jail, and which went bankrupt from fraud, had these values displayed in their lobby: Integrity, Communication, Respect, Excellence. (These values were not, however, what was really valued at Enron)

The irony in Enron, a company that ultimately folded due to rampant corruption and fraud, using the phrase ask why as its slogan has been pointed out repeatedly. The company chose this as its slogan because they were apparently interested in questioning conventional wisdom. There are dozens of points throughout Enron's existence in which questioning conventional wisdom likely wasn't the wise thing to do. The book/documentary Enron: The Smartest Guys in the Room looks at the key players in the company's history and some of the decisions they made from the infancy of the company through its death. One of the first times Enron decided to question conventional wisdom was in 1987, about two years after the company was founded. It was revealed by employees of the company that there was a group of traders who had been stealing company funds and diverting them to offshore accounts. When Kenneth Lay, founder and then-CEO of Enron, was notified he decided not to fire the employees. The reason? Because they were making a lot of money for the company. In fact, instead of firing the traders Lay increased their trading limits (i.e. the amount of company funds they had access to). In this case, conventional wisdom dictates firing the employees who were caught stealing company funds, regardless of their contribution to the firm's bottomline. Instead, Lay did a calculation and determined profits were paramount and that things like integrity were secondary (he only fired the employees after the board of directors found out about the incident. He feigned shock when they asked him about it)(Enron: The Smartest Guys). This calculation would eventually send Lay on his way to prison (he died of a heart attack 3 months before his sentencing hearing. He was found guilty on 10 counts of securities fraud) and would bring about the demise of the company he founded.

Enron's problematic hiring and firing tendencies were a problem throughout its existence. This can partly be attributed to Jeffrey Skilling, then CEO/COO of Enron, who had a darwinian view of how the world worked, according to Bethany McLean, the Fortune reporter who co-wrote the book Enron: The Smartest Guys in the Room. According to Peter Elkind, McLean's co-author, Skillings' notion of how the world should work really trickled down and effected everything about how Enron did business. It's this kind of thinking that brought about Enron's notorious rank-and-yank system for evaluating employees' performance. Basically this system had employees evaluate and rank each other every year and assign their coworkers a ranking between 1 and 5. At the end of the evaluating process roughly 15% of employees were to supposed be ranked a 1 and therefore slotted to be fired. There was no rhyme or reason as to why this was done other than to satisfy Skillings' personal values and to perpetuate what he described as an aggressive culture (Sims and Brinkmann). Enron praised risk taking and it came to be central to their corporate strategy. While many of these risks were taken on disappointing and unfruitful business ventures, the culture or risk was cultivated by top executives with their actions outside of work. For example, Skilling liked to take trips with other executives, and occasionally clients, to rough locales to do dangerous things. Allegedly on one of these trips were they went motorbiking in Mexico, one of those attending required stitches, while another broke bones, and yet another was nearly killed when his jeep flipped. These types of stories made their way back to Enron and played a large role in how employees conducted themselves (Enron: The Smartest Guys).

The fact that employees were evaluated by their peers caused a great amount of distrust and paranoia among employees (Sims and Brinkmann). When discussing the culture at Enron, Charles Wickman, a former trader there, said, If I'm on my way to my boss' office talking about my compensation and stepping on someone's throat doubles it, well, I'll stomp on the guy's throat, you know, that's how people were (Enron: The Smartest Guys). The negative effects of the hyper-competitive environment that Enron employees were working in quickly superseded any perceived positive effects of such a system. The aforementioned values posted in Enron's lobby were incredibly difficult to adhere to in such an environment.

Like Enron, Netflix has sought to instill a high performance culture in which they expect a lot out of their employees. However, the ways they went about doing this are vastly different. In Netflix's culture presentation, seven aspects of their culture are identified. Some of them are Values are what we value, High Performance, Freedom and Responsibility, and Pay Top of Market. The rest of the presentation specifies exactly how those seven aspects would be applied at Netflix. On the High Performance slides, McCord writes were a team, not a family. We're like a pro sports team. Netflix leaders hire, develop and cut smartly, so we have stars in every position. While most sport teams do cut players every year, they don't set a percentage of employees to be fired and they don't have players evaluate each other creating a very uncomfortable environment like at Enron. Most times when teams decide to cut a player, it's based on the fact that their skillset or their impact on the team's chemistry is no longer needed. If team management is satisfied with the composition of the team, its morale, and its performance they won't cut players (barring injuries or compensation disputes). Along these lines, when Netflix deems one of their employees to no longer be of use, they fire them with a generous severance package. Enron fired employees using a voting-based ranking system whereas Netflix provided employees who were being fired with the specific reason for them being let go. For example, in an interview with NPR, McCord discussed the case of a product tester who was made redundant due to her role being automated and what she said to the employee: You're thewhy do you think you're the last one here'cause you're the best. You're incredibly good at what you do. We just don't need you to do it anymore (Henn). Netflix also mitigated the role that firing employees plays by hiring, rewarding and tolerating only fully formed adults (McCord).In the Harvard Business Review McCord writes, If you're careful to hire people who will put the company's interests first, who understand and support the desire for a high-performance workplace, 97% of your employees will do the right thing. Most companies spend endless time and money writing and enforcing HR policies to deal with problems the other 3% might cause. Instead, we tried really hard to not hire those people, and we let them go if it turned out we'd made a hiring mistake (McCord).

On the Values are what we value slides, McCord lists behaviors and skills that Netflix finds particularly valuable and also that they hire and promote people who demonstrate these nine behaviors and skills. Some of the behaviors listed are communication (you listen well instead of reacting fast, so you can better understand and you treat people with respect independent of their status or disagreement with you), innovation (you challenge prevailing assumptions when warranted and suggest better approaches), courage (you questions actions inconsistent with our values), honesty (you are quick to admit mistakes), and selflessness (you make time to help your colleagues). Another slide explained why Netflix doesn't like brilliant jerks, or in other words smart, productive employees with an abrasive streak. This is in contrast to Jeff Skilling at Enron who once said, I like guys with spikes. I like guys with something extreme about them (Enron: The Smartest Guys).

To crystallize the differences between Netflix and Enron, we can look at the circumstances behind the departure of two high-level executives: Patty McCord at Netflix and Lou Pai at Enron. Lou Pai was appointed CEO of Enron Energy Services (EES), a subsidiary of Enron that it intended to use to sell energy directly to consumers. Max Eberts, a former employee in Public Relations at EES, described Pai as a mysterious figure. Kind of like an invisible CEO (Enron: The Smartest Guys). This might be due to the fact that Pai spent significant amounts of time at strip clubs, both during and after work. According to Peter Elkind, He was [at the strip club] almost every night after work and sometimes he would bring traders along with him there were rumors that he brought strippers up to the trading floor. Aside from his questionable morals, EES lost hundreds of millions of dollars in the time Pai was CEO between 1997 and 2001 (losses that were hidden by fraudulent accounting practices). His time at Enron came to a mysterious end when he resigned for no apparent reason. There is a theory that this happened when his wife learned of his relationship with a stripper, leading to her wanting a divorce. In order to meet the terms of the divorce settlement, Pai needed a significant amount of cash and as result sold about $250 million in Enron stock. Instead of being fired or reprimanded for his questionable actions and the demonstrably poor performance of his divisions, Pai had the opportunity to resign and leave with $250 million dollars from the sale of stock with a high price, due largely to the fact that buyers of the stock weren't privy to the company's fraud.

Lou Pai's departure from Enron doesn't remotely resemble Patty McCord's departure from her post of 14 years at Netflix. Unlike Pai, McCord's contributions??” being instrumental to shaping the culture at Netflix among other thingswere hugely beneficial for her company and helped its progress. Per Netflix's system, McCord was rewarded for her contributions throughout tenure there (Pay Top of Market from the presentation went through how Netflix evaluated compensation every year and increased pay for the best employees), but when her talents were no longer required she was let go. According to Steve Henn at NPR, McCord was let go because she backed a disastrous plan to split Netflix into two companies - one for DVDs and one for streaming. Customers would have to pay more, and many just hated it. Eight-hundred-thousand cancelled their subscriptions. To put it simply, McCord did her job poorly resulting in damage to the company and she was dealt with accordingly. So to summarize, at Enron, the absentee CEO whose divisions lost hundreds of millions of dollars over a four year period wasn't fired but instead was allowed to leave with hundreds of millions of dollars shortly before the company collapsed, and the executive at Netflix who fundamentally transformed how her company operated over a fourteen year span and aided in its significant growth was let go after backing a bad plan once. It doesn't take much more than that to see why one company failed miserably and the other one has been very successful.

According to Edgar Schein, there are six culture embedding and reinforcing mechanisms that determine an organization's culture: (1) deliberate role modeling, teaching, and coaching; (2) how leaders recruit, select, promote, and excommunicate; (3) how leaders allocate rewards and status; (4) how leaders allocate resources; (5) how leaders react to critical incidents and organizational crises; (6) what leaders pay attention to, measure, and control on a regular basis. (Schein, 2010, as cited in Ganon M., et al). In my opinion, Enron's collapse can be attributed to poor use of these mechanisms resulting in a culture that severely hurt the company. For example, on the role modeling and teaching mechanism, Enron's C-suite wasn't exactly a paragon of moral behavior and caution. There are several instances that demonstrate this. The incident in which Enron's founder Kenneth Lay essentially rewarded the thieving traders in 1987, implying to other employees that unethical behavior is alright as long as you don't get caught and you are making executives richer. There are also the questionable actions of Jeff Skilling with his dangerous trips and Lou Pai with his stripper obsession and basically absconding with $250 million. On recruitment and excommunication, [Enron CEO] Skilling perpetuated a focus on short-term transactional endeavors from the very beginning by hiring employees that embodied the beliefs that he was trying to instill: aggressiveness, greed, a will to win at all costs, and an appreciation for circumventing the rules (Sims and Brinkmann). Employees were fired using the rank-and-yank rating system which was ineffective and bred a counterproductively hyper-competitive workplace. On the allocation of resources and rewards, the company consistently gave resources and rewards to the worst actors in the company. The way to obtain resources and rewards in Enron was to be an aggressive fraud, as in the case of Andrew Fastow, the CFO that set up the fraudulent partnerships that hid Enron's losses and made him $30 million richer by skimming funds, or like all the other executives that partook in those activities. On reactions to crises, when Enron executives learned that the company's fraudulent activities would be exposed within a matter of months, they kept this information to themselves and began to secretly sell their stock. The employees who had their live savings invested in Enron stock, as Enron suggested they should do, were left with nothing when the company's stock price tanked (Enron: The Smartest Guys).

Applying Schein's six mechanisms to Netflix provides a much different picture. According to the Promotion and Development slides of Netflix's culture presentation, they don't like the idea of mentors. Instead they like to surround employees with stunning colleagues and challenging work. For this, employees have the founders of the company to look to, especially Reed Hastings, and (for most of the company's history) executives like Patty McCord as teachers and role models. They built a company that has consistently driven innovation in the entertainment industry from being the first to ship DVDs, to developing a streaming platform which they shrewdly built by collaborating with major studios for programming, to then reducing their dependence on those studios by introducing their own programming. Also, the company doesn't tolerate behavior that takes away from the working environment. One can look to the firing of Chief Communications Officer Johnathan Friedland after he used a racial slur in a meeting to see an example of that (Sandberg and Goldberg). In addition to firing people that don't match their values, Netflix fires people if their contributions are no longer necessary or if they perform poorly, as in the case of the product tester who was fired due to her role being automated or when Patty McCord backed a plan that led to 800,000 subscription cancellations. The company gives it resources and rewards to the super productive superstars that best embody the seven aspects of their culture and consistently demonstrate the nine behaviors and skills listed in their culture presentation. And on reaction to crises, the company has consistently reacted in a manner consistent with their beliefs. For example when the company lost 800,000 subscribers due to a proposed plan, instead of flailing and hurting the company further they walked the plan back and fired the executives responsible for the plan in the first place.

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