The Netflix Playbook: Fewer Rules, Greater Results (TIP748)

Summary

• Investment Theme: The podcast emphasizes the importance of company culture as a significant driver of long-term value, using Netflix as a prime example of how culture can lead to immense shareholder returns.
• Company Insights: Netflix's culture is built on three principles: talent density, candor, and control reduction, which collectively foster a culture of freedom and responsibility, contributing to its success over competitors like Blockbuster.
• Market Insights: The discussion highlights the potential pitfalls of traditional business models that exploit customers, such as Blockbuster's reliance on late fees, and contrasts this with Netflix's customer-centric approach that disrupted the market.
• Management Practices: Netflix's unique management strategies include removing vacation policies, focusing on context over control, and encouraging transparency and feedback through practices like the 4A feedback guideline and live 360 reviews.
• Compensation Strategy: Netflix's approach to compensation involves paying top market rates to retain high performers and eliminating incentive-based bonuses, which aligns with research suggesting that large financial incentives can hinder cognitive performance.
• Innovation Framework: The podcast outlines Netflix's innovation cycle, which includes socializing ideas, testing them on a small scale, and encouraging sunshining of failures to foster learning and trust within the organization.
• Leadership Philosophy: Reed Hastings' leadership style at Netflix is characterized by dispersed decision-making, allowing employees to innovate without bureaucratic constraints, and focusing on alignment with the company's north star.
• Key Takeaway: The podcast underscores the critical role of a strong, adaptable culture in driving business success and innovation, suggesting that companies should prioritize talent density, transparency, and a supportive environment to thrive in competitive markets.

Transcript

(00:00) So the interesting thing about corrective  feedback is that it tends to have a much greater   impact on success compared to positive feedback.  A 2014 study concluded that by a 3:1 margin,   people believe that corrective feedback  is more effective in improving their   performance than positive feedback. Here  are some of the stats from that survey.  (00:17) 57% of respondents claimed they would  prefer to receive corrective feedback over   positive feedback. 72% felt their performance  would improve if they received more corrective   feedback. And then finally, 92% agreed  with the comment that negative feedback   if delivered appropriately improves performance. (00:36) I couldn't agree more with these results   and I think it really reminds me of something  that Monry said and I'm paraphrasing here,   but he said something along the lines that you  just learn most from your losses. [Music] Hey,   real quick before we jump into today's  episode, if you've been enjoying the show,   please hit that subscribe button. (00:59) It's totally free, helps out   the channel a ton, and ensures that you won't miss  any future episodes. Thanks a bunch. We're going   to discuss the book No Rules Rules by Netflix  founder Reed Hastings and author Aaron Meyer. Now,   there's a fascinating image that's been  circulating on the internet for the past   few years depicting the ultimate value  drivers of a business's long-term value.  (01:19) It's not sentiment. It's not multiple  rerating. It's not business cycles or even high   rates of capital efficiency that can create the  highest long-term value. It's culture. Netflix   is a prime example of how a company's culture can  generate immense shareholder value. Since it's an   initial public offering, Netflix has become an  1100 pegger, achieving just incredible results.  (01:42) Now, I didn't put much thought into  business culture before I joined TIP because   the culture at TIP is just so much different  from anything that I've ever used in the past.   But it's not really any coincidence that I think  Stig Broers gets all of his new employees to   read the book The Culture Code by Aaron Meyer. (02:00) So when I sought to research more about   Netflix and came across the book No Rules Rules  by Netflix founder Reed Hastings and Aaron Meyer,   I was very excited to read it and it was a  really really good book offering a ton of   valuable lessons that business owners  and investors alike can use to help   identify the nuances of a company's culture. (02:15) And that's what we're going to be   diving into very very deep today. So, the  book's central question is, "What if having   fewer rules makes your company better?" It's a  great question and one that I think that many   business owners and investors just never ask.  It's not something I necessarily place a lot of   importance on when I'm evaluating a business. (02:33) While I do like businesses that have a   high degree of decentralization, I never  really thought too hard about how that   relates to a company's culture. However,  just as decentralizing certain aspects of   a business can be value creative if done  correctly, Netflix has demonstrated that   taking that step to a business's underlying  fabric can be a truly powerful augmentation.  (02:53) Now, Netflix is interesting here  because much of its culture was developed   by Reed Hastings's own experiences. So, Hastings  sold a business called Pure Software, where many   of the foundational principles of Netflix were  first built. Throughout the book and this episode,   we're going to cover some examples of what  he learned specifically at Pure Software and   why he was so intentional about creating  Netflix's culture in the way that he did.  (03:16) So Netflix's culture is really based on  three primary principles and they're very simple.   So the first one is talent density. The second  one is cander and third is control reduction.   All three of these principles are designed to  create a culture of freedom and responsibility   which I'll refer to as FNR for the rest of the  episode. Hastings and Meer further break down FNR   into three steps for each of these principles. (03:38) So first you build up talent density,   you increase cander, and you begin removing  controls. Second, you begin fortifying talent   density, pumping up cander, and removing  even more controls. And then third,   you're just maximizing talent density, maximizing  cander, and eliminating almost all other controls.   So, let's use inversion here and examine a company  that I think failed to execute on probably two   of these, ultimately leading to its demise. (04:02) Most listeners above the age of 30 are   going to be very familiar with this company,  and even if you aren't, you probably know it   as Netflix's chief rival during Netflix's  early days, and this is Blockbuster. So,   Netflix soundly defeated Blockbuster because of  principles one and two. I can't speak to exactly   how Blockbuster was attempting to maximize talent  density, but I think that the culture inside of   Blockbuster was just not one of innovation. (04:25) Blockbuster reminds me of one of   these legacy businesses you  see today, like uh, you know,   a utility. These are rent seekers. They're  essentially just sitting on their assets   and milking every last dollar out of them while  they still can. The problem with this business   model is just capitalism. Capitalism allows  individuals to come and steal your customers   away with better products and better services. (04:46) If you intend to just rest on your laurels   and have too big of an ego to see that maybe your  industry is rapidly changing in front of you,   you're going to lose. I think this is precisely  what happened with Blockbuster. Now, in terms of   cander, it's hard to see how Blockbuster wouldn't  have had other upper level management types that   were observing Netflix's giant red boxes. (05:06) I remember seeing these giant red   boxes at Safeway down the road from where I used  to live. Then I remember seeing them popping up   in more and more locations. If Blockbuster  had a culture that encouraged, you know,   maybe some more cander, someone might have brought  up the issue that Netflix had come up with maybe a   crude way to improve the movie renting experience. (05:23) For those unfamiliar with Netflix's early   strategy, they had a few. So the first one was  that they would just mail you a DVD and then you   would mail it back after a predetermined period.  While doing that, they also had these physical red   boxes almost like a vending machine. You'd go to  the vending machine, you'd put some information,   put some money in it, and you'd get your movie. (05:43) It's very simple and low tech,   but it was an intriguing uh business proposition  at the time. No retail stores were needed. Minimal   storage was required to hold inventory.  Much fewer employees were needed, and you   had the luxury of putting the movie vending  machines in very hightra areas where you'd be   giving your partner a cut of these profits. (06:00) Additionally, and this is very, very   important, Reed Hastings noticed that Blockbuster  was profiting off its customers mistakes.   which he felt was just a horrible business model.  Now, the mistakes I'm referring to here are late   fees. Any business that's just exploiting its  customers in this manner is going to be very,   very ripe for disruption. (06:18) And that is precisely   what Reed Hastings did. So, I recently  did an episode on customer loyalty   modes. It was tip 744. I'll link it  in the show notes. In that episode,   I discussed how businesses can build and create  modes by focusing on building customer loyalty.   And I think that's exactly what Netflix did. (06:35) They saw that the legacy model was simply   not built to foster customer loyalty and they in  turn targeted that audience to specifically build   customer loyalty. Now, since Blockbuster didn't  have many competitors, its customers had pretty   limited experience with switching to other movie  rental companies. And even if they tried another,   they were kind of a commodity product. (06:57) As a result, many of Blockbuster's   customers were satisfied with the status  quo. However, once Netflix entered the arena,   it showed Blockbuster's customers that there  was a superior option that was cheaper,   more convenient, and offered just a better  experience. Once Netflix achieved a critical   mass through its evolution into streaming  services, that was it for Blockbuster,   which now has just one remaining location. (07:18) One last part on Cander that I'd like   to share is that Blockbuster could theoretically  have been around today if they had just made one   different decision. So Reed was actually ready  to exit Netflix and sell out to Blockbuster for   a measily $50 million, but Blockbuster said no.  Now to be fair, given the information at the time,   it might have been the best possible decision. (07:39) The Netflix business recorded a loss of   $57 million. So, if Blockbuster had people willing  to speak their minds maybe to Blockbuster CEO,   perhaps they might have seen a path  to make the two of these businesses   work together and maybe make a path towards  Netflix achieving profitability. Or if they   had bought it, then maybe we'd be watching  Blockbuster on our TVs instead of Netflix.  (08:01) And those physical stores maybe  just would have been removed due to their   underlying weaknesses stemming from their  higher costs. However, let's start here with   the first layer of talent density, cander,  and control reduction. So, the first step   to building talent density is what Hastings  refers to as developing a work environment   that consists solely of stunning colleagues. (08:20) So, this concept was bred out of the.com   bubble, specifically in the spring of 2001.  Netflix was not a profitable company at this time,   and the funding available to internet related  companies was about as scarce as water in the   Arabian desert. As a result, Netflix had  to lay off a third of its workforce. And   while the experience was not enjoyable  at all for Netflix, Hastings actually   observed something that was astonishing. (08:42) Everyone who survived the layoffs   was pretty stable and calm despite the rapid  disruption. And after only a few weeks,   the atmosphere actually dramatically improved.  Hastings writes that we were in cost cutting   mode and let go a third of our workforce. Yet,  the office was suddenly buzzing with passion,   energy, and ideas. (09:01) By early 2002,   Netflix was cruising. DVD players  were selling like hotcakes,   providing a further headwind for Netflix's DVD  bymail subscription business. At this point,   Netflix was doing more than it had ever done with  30% fewer employees. Now, on the face of things,   it just didn't make much sense. One of Reed's  colleagues and Carpool partners, Patty McCord,   who he had brought with him from his days at Pier  Software, told Reed that it felt like everyone was   passionately in love with their work. (09:30) While on their carpool rides,   they began to disseminate what exactly  happened to cause Netflix to enjoy this   rapid productivity improvement. And the key  was in talent density. When they decided who   to let go and who to keep, talent was a key  factor in their decision. This meant that   80 leftover employees were the cream of the crop. (09:48) There was a lower number of people, sure,   but the average talent level rose substantially  as a result of letting go the less talented   individuals. This makes me think of critical mass  in a much different way. So most of the time in   a critical mass, you're adding things until  they can self-reinforce. But in this example,   it was really addition through subtraction. (10:06) By raising the average level of talent,   the business achieved a critical mass that  it may never have reached if the talent   density had remained the same at that  lower level. Now, I'd love to touch on   this a bit more as part of my job here with  TIP. So the hosts and our support staff are   very talented and I interact a lot with both. (10:25) But since TIP has so many great podcast   hosts, it raises the bar for everyone else. If  I want to search for inspiration on an episode,   a topic or a theme, I can go back and research  older episodes. Alternatively, I can reach out   directly to, you know, Stig, Clay, or William  for their advice on how they approach their work,   which helps me improve my own approach. (10:46) Because the talent density is high,   it just spreads. And Stig is very well  aware of this. He wants hosts who will   constantly raise the bar as much as they can  realistically do. And when you're around other   people who are very intentional about  improving their abilities in their job,   you get swept away trying to improve as well. (11:02) At least I know I do. In other jobs I've   had, talent wasn't something that management paid  too much attention to. If you accomplish the job,   that's all that really mattered. Sure, there  might be people better at it than others, but   even if you were objectively worse than others in  the company, it was unlikely that you'd be fired.  (11:20) This illustrates the importance of  culture. If you lack a culture of productivity   and innovation, it's unlikely that your business  will survive for very long. And it doesn't matter   if your business is a more complex one like  Netflix or a small simple business like a   restaurant with five employees. Here is how Reed  breaks down what happens if you have a team of,   let's say, seven people with five stunning  employees and just two adequate ones.  (11:44) So, the adequate ones are going to  do things like suck energy for management,   so management has less time to spend with top  performers. They're going to reduce the quality   of group discussions, which therefore reduces the  group's IQ. They're going to force outperformers   to develop ways of working around their  deficiencies, which further decreases efficiency.  (12:01) They're going to drive staff who  seek excellence to quit. And then lastly,   they're going to show that the business  accepts mediocrity, allowing employees to   justify a lower level of performance. So Aaron  Meyer mentions a particularly useful study in   this chapter that really contradicts a lot  of conventional wisdom. So, Professor Will   Phelps from the University of New South Wales in  Australia conducted the study, which examined the   contagious behaviors in work environments. (12:29) He created a team of four college   students, each tasked with accomplishing a  task in 45 minutes. the team that did best   received a $100 reward. Now, as in many of  these types of studies, researchers often add   their little variables to make the findings  more interesting. And in this case, certain   teams had actors who would play specific roles. (12:48) So, the roles were the slacker or people   who would be disengaged from the activity.  Then there would be the jerk who would insert   sarcastic remarks to his team. And then there  was the depressive pessimist who would make   depressing remarks about the unlikelihood of  success. Now, what Phelps found was that the   actions of just these one team members  actually brought down the overall talent   level of the other individuals on the team. (13:11) And this study wasn't just some one-off   affair. Phelps ran the study for a whole month and  had dozens and dozens of trials. And the results   weren't great. Groups with an underperformer did  worse than the other teams by 30 to 40%. Now,   I mentioned that this study contradicts  conventional wisdom, and that's because   with most previous research, the conclusions  were that individuals within a group would   conform to the group's values and norms. (13:36) Theoretically, one of these actors   in the presence of a talented individual should  actually elevate their performance rather than   dragging down everyone else. It's also important  to note that these results occurred over a short   45minute period. If you had, you know, years or  decades of underperformers, I'd assume that they   might drag down the outperformers even more. (13:57) The main takeaway from this chapter is   to focus on increasing talent density within your  workplace. As we'll discuss later in this episode,   this approach has many other benefits such  as paying your top performers more rather   than bringing in outside help and keeping  their salaries at or below market rates.   To accomplish this, you must monitor  the performance of your organization.  (14:15) This is why having a workplace that  prioritizes meritocracy is so essential. When   you do this, you can identify outperformers more  easily compared to just the adequate ones. And it   means it becomes easier to see who really deserves  promotions and who doesn't or who you might need   to let go of if layoffs become necessary.  Additionally, meritocracy helps you bring out   the best ideas regardless of an employees tenure. (14:40) Ray Dalio said, "A system that doesn't   differentiate between more and less credible  thinkers will not produce consistently good   decisions." This transitions well into the  next chapter which is about increasing cander.   Hastings learned the power of cander as a  CEO of pure software. He admits to being   miserable at the people part of leadership. (14:59) One example was when he had a product   that he thought was just taking a little bit too  long to develop. Reed then actually went behind   this product developer at Pure Software and hired  an outside company to help get the project going.   Once his developer found out, he was furious,  telling Reed that he should have just told him   how he felt so that they could come to a solution  together rather than going behind his back.  (15:20) At Netflix, Reed realized that  reducing backstabbings and office politics   was a key to increasing efficiency. And if  his group of incredibly talented people had   ways of doing things faster and better, they  shouldn't be afraid to share their techniques   with anyone inside of the company. (15:36) As a result of this thinking,   Netflix came up with the term only say about  someone what you will say to their face.   So when someone would come to read with a problem,  he would directly ask them, "What did that person   say when you spoke to him about this directly?"  The interesting thing about cander is that most   people just don't really enjoy receiving it. (15:54) It can cut pretty deeply when someone   tells you that, you know, you're doing something  wrong or you're doing something less optimally.   Criticism triggers feelings like self-doubt,  frustration, and vulnerability. Examining this   in an evolutionary context, these  feelings tend to prompt response   that activates our fight orflight mechanism. (16:12) the same reaction towards a physical   threat. Another interesting perspective on cander  is how is it delivered. So there's a significant   difference between receiving criticism in  a one-on-one setting and receiving it in   a public setting. Warren Buffett has  said, "Praise in public, criticize in   private." And I think that's excellent advice. (16:30) The praise means a lot because it's   being said in a public domain where all your  colleagues can share in the appreciation for   your hard work and value creation. But things  obviously aren't all rainbows and butterflies.   If things aren't going in the direction that,  let's say, Warren wants, he'll address it,   but not in a manner that he feels  would maybe humiliate someone in   front of their peers or the general public. (16:49) Warren is an absolute master at this.   If you read his annual reports or listen  to him talk at any of his annual meetings,   he's constantly peppering praise to the  superstars who are part of Berkshire   Hathaway. He'll criticize certain, you know,  broad behaviors, but he's very rarely singling   out any individual. And in the rare case he does  single out an individual, it's not someone who's   inside of the Berkshire Hathway organization. (17:12) The book mentions some incredible data   about corrective feedback. So the interesting  thing about corrective feedback is that it tends   to have a much greater impact on success compared  to positive feedback. A 2014 study concluded that   by a 3:1 margin, people believe that corrective  feedback is more effective in improving their   performance than positive feedback. (17:29) Here are some of the stats from   that survey. 57% of respondents claimed  they would prefer to receive corrective   feedback over positive feedback. 72% felt their  performance would improve if they received more   corrective feedback. And then finally, 92%  agreed with a comment that negative feedback   if delivered appropriately improves performance. (17:49) I couldn't agree more with these results   and I think it really reminds me of something that  Mon Pry said and I'm paraphrasing here but he said   something along the lines that you just learn most  from your losses. When you have a win you just pat   yourself on the back and you move on. However,  the best feedback that you'll receive from   investing comes specifically from making mistakes. (18:09) In that case you can look at things you   overlooked or other errors and then examine  ways how you can prevent yourself from ever   making them again. If you do this long enough,  you'll make fewer and fewer mistakes, and your   results will improve. Feedback in a corporate  setting is going to be a lot different from what   you might experience if you were operating solo. (18:28) Netflix makes sure that feedback isn't   a one-way street. It's not meant for  managers to just give feedback without   hearing any in return. One way that Netflix  attempts to gather feedback from management   is by including it in their agenda for  their one-on-one meetings. As a manager,   this helps your employees provide valuable  feedback to management that can then be used   to elevate the entire organization. (18:49) But this culture, you know,   it's not normal. There's a great example in  the book when Netflix's chief content officer,   Ted Sarandos, who is now co-CEO of Netflix,  brought on someone named Brian Wright, a senior   vice president at Nickelodeon, to help improve  Netflix's young adult content. Brian here is   talking about a previous experience with feedback. (19:09) So he says, "In all my past jobs,   it was all about who's in and who's out of favor.  If you gave the boss feedback or disagreed with   her in a meeting in front of others, that would  be political death. You would find yourself in   Siberia." So in a group meeting that Brian  had with Ted on his first day at Netflix,   Ted was actually receiving criticism  about an idea from a lower level worker.  (19:30) Brian was astounded that someone would  speak to their superior in the way that he did.   But when the meeting was over, Brian noticed  that Ted put his hand on the guy's shoulder who   provided that criticism and said, "Great meeting.  Thanks for the input today." When Brian was asked   later about how his first day was going, he  explained that he was surprised at how the   guy seemed to be attacking Ted's idea. (19:51) Ted replied by saying, "Brian,   the day you find yourself sitting on your  feedback because you're worried you'll be   unpopular is the day you'll leave Netflix. We  hire you for your opinions. Every person in   that room is responsible for telling me frankly  what they think. The key here is truly in the   culture. Suppose you have management that  just can't accept criticism with open arms.  (20:10) In that case, it's very unlikely that  you'll foster a culture of cander. In the example   above, Ted made it explicitly clear that he  expected Brian's honest opinion, whether that was   good or bad. When you create this as an explicit  part of your business, you're helping to build a   culture that prioritizes improvement over ego. (20:28) If you're looking to give and receive   feedback optimally, the book provides a pretty  straightforward framework for doing so. It's   called the 4A guideline. So, there's two parts  to it. There's giving feedback and there's   receiving feedback. So, in giving feedback,  the first part is aim to assist. Feedback   should be given with positive intent. (20:47) It's not meant to, you know,   tear someone down, but actually build them  up. Feedback isn't a tool to hurt someone,   express your frustration, or further any specific  agenda. The second one is to make it actionable.   Great feedback will prompt the receiver to  instantly improve by adjusting their inputs.  (21:05) Vague feedback like it wasn't your best  work doesn't offer much help for someone. Instead,   explain what it was that they could specifically  improve on that is actionable. Then when it comes   to receiving feedback, the third one is  appreciate the feedback for what it is.   Remember the whole fight orflight thing that  I discussed earlier? When receiving feedback,   we want to try to avoid the desire to flee. (21:25) If you feel your blood pressure rising   while receiving feedback, remember that the  criticism is intended to help you improve at   your job. You can even show appreciation for  feedback and express gratitude to the person   providing it for trying to help you improve.  And the fourth one is to accept feedback or   discard it. Not all feedback is helpful. (21:44) You must decide whether to accept   the feedback and make adjustments or toss  it and continue as you were. This is a very   simple and practical framework. I resonate a  lot with the third A on appreciating feedback.   I get feedback from Stig on every single episode  that I produce for tip and he has a great job of   giving me both positive and negative feedback  even though I tend to remember the negative   feedback much more vividly than the positive. (22:08) However, this is very beneficial   because if I can continue to improve,  it enhances your listening experience,   making what I say more powerful and efficient.  While I know I sometimes feel defensive when   receiving negative feedback from Stig or the  audience, I understand that they're doing so   in the best interest of making the show better. (22:25) After taking a moment to think about it,   I genuinely appreciate the feedback  because I believe it helps me elevate   my own podcasting skills. As I read the book,  the connections between Netflix and Bergkshire   Hathway became increasingly apparent. The  concept that really cemented this for me   has to do with Netflix's culture of FNR. (22:42) So at Bergkshire, Buffett trusts   many of his businesses to just simply do the  right thing. And it's not too different at   Netflix. So the next part of the book that I'd  like to discuss is how to cultivate this culture   towards what Hastings calls a culture of freedom  and responsibility. The first point that he makes   on building FNR is to remove the vacation policy. (23:03) One of the reasons that Hastings thought   this was beneficial was because he didn't  believe that a person's value should be   measured specifically by time. Let's say you had  two people who can accomplish the same amount of   work, but someone else can do it in half the time.  Why should they be punished if they want to take   more time off than the person who is slower?  Hastings right, when it comes to how we judge   performance at Netflix, hard work is irrelevant. (23:25) Another hidden benefit of vacations   that Netflix noted was the increased clarity  and innovation that some people experienced   after taking time away. For instance, Neil  Hunt, one of their chief product officers,   loved vacationing in extreme outdoor places. When  Neil took off on a vacation, it was often to some   remote location that nobody had ever heard of. (23:46) And upon his return from one such   vacation, Neil conceived a new algorithm that  could be used to enhance Netflix's movie selection   for its customers. So, one problem with having  a no vacation policy was that employees might   not take advantage of it if they didn't observe  their boss taking advantage of it as well. So,   in some workplaces, you may arrive before  the boss and leave after they depart.  (24:08) And that demonstrates that you're  putting in a lot of hours and working hard.   And while this is not the culture that Netflix  promotes, this is the culture that probably   most people are used to rather than Netflix's  more radical approach. So to combat this issue,   it had to start from the top. Reed would ensure  that he vacationed for more extended periods just   to set the tone for everybody underneath him. (24:31) Additionally, he would actively discuss   these adventures with his colleagues. This  was done intentionally to ensure that all   levels of employees at Netflix knew that  everyone else was taking vacations and that   not taking a vacation would make them into an  outlier. This type of leadership modeling was   the first step that Hastings suggests. (24:48) However, there are additional   roadblocks to consider. So, let's say  you're running a large organization.   You can't necessarily have employees just  taking vacations around huge deadlines,   especially if they're key personnel in that  initiative. So, this led Netflix to focus on   reinforcing context to guide employee behavior. (25:09) This meant that a business or a management   team must provide context to their employees,  helping them better understand when and how   long they can take a vacation. So that could  mean things such as giving advanced notice   of vacations that are longer than two  weeks, but maybe not giving any notice   for just taking an extended weekend. (25:27) Jim Ran once said that you're   the average of the five people you spend the most  time with. And I really could not agree with him   more. And one of my favorite things about being  a host of this show is having the opportunity to   connect with highquality like-minded people  in the value investing community. Each year,   we host live in-person events in Omaha and New  York City for our tip mastermind community,   giving our members that exact opportunity. (25:54) Back in May during the Bergkshire weekend,   we gathered for a couple of dinners and social  hours and also hosted a bus tour to give our   members the full Omaha experience. And  in the second weekend of October 2025,   we'll be getting together in New York City for two  dinners and socials, as well as exploring the city   and gathering at the Vanderbilt 1 Observatory. (26:16) Our mastermind community has around 120   members. And we're capping the group at 150,  and many of these members are entrepreneurs,   private investors, or investment  professionals. And like myself,   they're eager to connect with kindered  spirits. It's an excellent opportunity to   connect with like-minded people on a deeper level. (26:35) So, if you'd like to check out what the   community has to offer and meet with around 30 or  40 of us in New York City in October, be sure to   head to the investorspodcast.com/mastermind  to apply to join the community. That's the   investorspodcast.com/mastermind or simply  click the link in the description below.   If you enjoy excellent breakdowns on individual  stocks, then you need to check out the intrinsic   value podcast hosted by Shaun Ali and Daniel Mona. (27:07) Each week, Shaun and Daniel do in-depth   analysis on a company's business model and  competitive advantages. And in real time,   they build out the intrinsic value portfolio  for you to follow along as they search for   value in the market. So far, they've  done analysis on great businesses like   John Deere, Ulta Beauty, AutoZone, and Airbnb. (27:28) And I recommend starting with the episode   on Nintendo, the global powerhouse in gaming. It's  rare to find a show that consistently publishes   highquality, comprehensive deep dives that cover  all the aspects of a business from an investment   perspective. Go follow the Intrinsic Value podcast  on your favorite podcasting app and discover the   next stock to add to your portfolio or watch list. (27:52) The interesting thing about having the no   vacation policy is that it can work wonders  as a benefit to certain companies. Aaron   Mayer mentioned a business called Mammoth  that decided to clone Netflix's policy   and test it out for themselves. So, the no  vacation policy was then ranked number three   in terms of the benefits behind only health  insurance and the business's retirement plan.  (28:14) So, for companies that are looking  to retain talent, a policy such as this   could actually be a significant draw for  both attracting and retaining top talent.   So, here's another example of just how  disruptive travel and expense approvals   can be for a company such as Pure Software, Reed's  first company. So, he tells the story of one of   his sales directors, this gentleman named Grant. (28:33) While on a work trip, he rented a car. As   part of his job, he went to a party and he knew  that others and himself would probably consume   alcohol. So, he took a taxi to and from the  event. Now, when he provided Pure Software with   the invoice for his taxi, he was actually denied. (28:52) So, according to Pure Software's employee   handbook, employees are permitted to either rent  a car or take a cab, but they must choose one or   the other. His point was that according to the  handbook that Pure Software gave him, he should   have just drunk and drive, which is obviously  nonsense. Months later, Grant resigned because   he felt that management was just wasting too much  time on non-productive tasks such as editing the   employee handbook, which was not well written. (29:18) Now, when Netflix was started,   this lesson was top of mind for a read. So,  he decided that his first expense guideline   would be to spend company's money as if it were  your own. Now, while this sounded good on paper,   the problem was that not everyone spends their  own money frugally, which was what Reed was   kind of hoping for when he wrote that guideline. (29:38) The book shares a story of David Wells,   who served as the VP of finance and later became  Netflix's CFO. So, Wells was a frugal guy, and   on a work trip to Mexico, he was very surprised  to find a bunch of his colleagues in first class   seats while on his way to his seat in economy.  And these colleagues were embarrassed for David,   not because he was in economy and they  were in first class, but because an   executive like David would ever be in economy. (30:02) So this indicates that individuals have   varying perspectives on how they would allocate  their own money. Some people are naturally more   frugal than others, but assuming everyone  will treat the company's money responsibly   is very unrealistic. Because of this event,  Netflix changed its spending and travel   guidelines to act in Netflix's best interest. (30:24) To help clear up any confusion once   Wells became the CFO of Netflix, he helped  set the context of this guideline for new   employees. And it was pretty simple.  He told them to imagine that he or she   was standing in front of her boss and the  CFO and explain why they chose to purchase   that specific flight, hotel, or phone. (30:42) If they can comfortably explain   why it was in the company's best interest  to make that purchase, then they proceed.   If on the other hand, you feel any discomfort  explaining yourself, then you should probably   consider skipping the purchase, checking  in with your boss, or just buying something   cheaper. Hastings makes the point that this  FNR probably increases Netflix's expenses   compared to having a more set of rigid rules. (31:06) However, he believes the cost of giving   them that freedom is less than having a workplace  where they must ask about every little thing,   wasting times on these tasks rather than  creating, you know, new and innovative   products and features. We've now covered the  first steps to how Netflix has created their   culture. So, here's what Hastings says. (31:24) Once you have a workplace made up   nearly exclusively of high performers, you  can count on people to behave responsibly.   Once you've developed a culture of cander,  employees will watch out for one another and   ensure their teammates actions are in line with  the good of the company. Then you can begin to   remove controls and give your staff more freedom. (31:40) Great places to start are the lifting of   your vacation, travel, and expense policies.  These elements give people more control over   their own lives and convey a loud message  that you trust your employees to do what's   right. The trust you offer will in turn instill  feelings of responsibility in your workforce,   leading everyone in the company to  have a greater sense of ownership.  (32:01) So the next section of the book  outlines the three principles and further   refineses them. So the first section is once again  regarding talent density. However, this time it   involves compensation. The title of the chapter  tells you much of what he thinks about how to   compensate employees. Pay top of personal market. (32:18) Netflix has reached its current position   primarily due to its high talent density. But  hiring talent is different than keeping talent and   Hastings is very well aware of this. So he came  up with offering his employees just rockstar pay.   So he came to this conclusion through trial and  error. Reed was an engineer and was very familiar   with this concept called the Rockstar principle. (32:38) So, the Rockstar principle originated from   a famous study that was conducted in Santa  Monica in 1968. At the bright and early hour   of 6:30 a.m., nine trainee programmers were  led into a room filled with computers. Each   of them was tasked with accomplishing a  series of coding and debugging tasks that   they would have to complete to the best  of their abilities in the next 2 hours.  (32:58) The researchers hypothesized that the  best performers would outperform the average by a   factor of maybe two or three. However, within that  group of nine, the best performers outperformed   the worst by a significantly larger margin. The  best guy was actually 20 times faster at coding,   25 times faster at debugging, and 10  times faster at program execution than   the programmer with the lowest rank. (33:21) So Reed's conclusion here was   simple. He had a fixed amount of money to spend  on talent. So with his funds, he could either   one hire 10 to 25 average engineers or two hire  one rockstar and pay them significantly more.   This is a fascinating subject because it genuinely  relies on culture that prioritizes productivity.   If you have that type of culture, you should be  able to then have a smaller and more efficient   workforce that can produce at a much higher  level than a larger and less efficient one.  (33:50) It's kind of the dream scenario, isn't  it? Reed admits that the performance gap might   actually be even greater than what was quoted  in that study. So Reed Hastings was on the   Microsoft board and Bill Gates once said, "A  great la operator commands several times the   wages of an average LA operator, but a great  writer of software code is worth 10,000 times   the price of an average software writer. (34:13) If you manage businesses where the   majority of your talent is in kind of  operational roles, this framework may   not be the best fit. If you operate something  like an ice cream parlor, your best ice cream   scooper can probably scoop maybe at double the  pace of your worst one, but there's no chance   they're going to scoop 10,000 times faster. (34:32) So, this framework really depends   on what type of employees you have. If you only  require operational people, then you can get away   with paying market rates for average employees, as  you won't get the same torque from your rockstars.   But if you own a business that requires your  workforce to innovate and execute creatively,   then having a few rock stars is a better  decision than having a diluted group of people.  (34:52) And for any startup founders out there  listening, there's good news. If you want to   pay top of the market to bring in exceptionally  talented people, a study concluded that 44% of   people would be willing to leave their job if they  got paid more elsewhere. And this figure won by a   landslide as a second category was only 12%. (35:10) Now comes an area of Netflix's   compensation that I was kind of shocked to see  to be honest. If you've listened to any of my   episodes over the years, you know how much  emphasis I place on the power of incentives.   One of, if not the greatest thinkers of our  generation, Charlie Mer said that he always   underestimated the power of incentives  despite the fact that he thought that he   understood it better than 95% of other people. (35:31) So I was stunned to see that Netflix   does entirely away with incentive based  bonuses. Hastings developed this framework   early in Netflix existence around the year  2003. So Reed was having a meeting with his   chief marketing officer, Leslie Kilgore. While  trying to find what KPIs worked best for her, he   came up with an incentive based on new customers. (35:50) Seeing as Kilgore's job was in marketing,   this made sense theoretically. But she told  Reed, "The number of customers we sign is no   longer what we should be measuring. In fact, it's  irrelevant." She went on to show us numerically   that while new customers had been the most  important goal last quarter, it was now the   customer retention rate that really mattered. (36:10) Reed's takeaway was that as Netflix   scaled up, its KPIs would change for a CMO,  should her KPI be tied to new customers or some   sort of customer retention metric. With how fast  Netflix was really just disrupting its industry,   Reed felt that it was nearly impossible  to know the answer to that question.   Many of Netflix employees had jumped ship from  companies such as, you know, Warner Media or NBC.  (36:35) And in those places, it was customary to  get incentives based off of KPIs. But Netflix was   a different type of company just doing other  things. At Warner or NBC, employees might be   compensated to increase operating profits by,  let's say, 5% in a year. And that's fine given   what those companies were doing. But at Netflix,  what if employees needed to take maybe a loss on   something in order to make the business better  a few more years down the road? In that sense,   a KPI like this would actually serve to  block innovation and creativity, which  (37:05) is what Netflix is all about. Reed  also had a hunch that high performers don't   require a bonus to incentivize them. If  they're paid well, they will do whatever   it takes to continue performing well. Aaron  Mayer added that Reed's hunch was actually   true and that research by renowned behavioral  economist Daniel Erily actually confirmed it.  (37:25) So he had a study which involved  tasks that required things like attention,   memory and creativity and he found that offering  a higher bonus actually led to worse performance   when the tasks involved cognitive skills. So  initially tested in India where the highest   bonuses was equivalent to about 5 months  pay, participants who were promised the   most significant rewards performed the worst. (37:45) A follow-up study at MIT showed the   exact same. Higher bonuses improved results for  purely technical tasks but harm performance when   even basic thinking was involved. The takeaway  for cognitive work large financial incentives   can actually reduce effectiveness. Now I find  this fascinating because it potentially shows   that incentive based compensation works  best for jobs that have very specific   tasks and that's mainly mechanical based jobs. (38:15) But jobs which require creativity can   actually be harmed by these incentives. I'm  still not completely sold on this premise   though. There's just too many examples of  executives performing at a very high level   and it's hard not to believe that they are  performing at that level specifically because   they're being incentivized correctly. (38:31) When I'm analyzing a business,   I'll always look at executive compensation and  I want to know a few things. Number one, what   is their base pay? Number two, what is their bonus  pay? And three, how do they maximize their bonus?   Perhaps the difference comes here in the fact  that someone making $300,000 per year isn't   going to try too much harder if they can  earn an additional, say, $50,000, but this   isn't necessarily the case with executives. (38:56) Some executives can earn multiples of   their base salary if they achieve their KPIs.  And in those cases, I think that's a really   huge incentive. And whether that incentive is  achieved through mechanistic or creativity,   my guess is they'll use whatever is possible to  achieve their incentive. I will say that I do   like one part of this incentive system. (39:14) So in many corporations, if an   executive is underperforming, they still get  their incentive, but Netflix has a culture, as   I've discussed, that just removes underperformers  from the company. If you want to cruise along at   your job and take it easy, Netflix is not the  place to do that. But I think there are some   corporations where the CEO is doing just that. (39:34) And often that comes at the expense of   shareholders. I try to avoid these situations  at all costs. Now, back to that study.   So Aaron writes, "If part of what you focus  on is whether or not your performance will   get you that big check, you are not in  that open cognitive space where the best   ideas and most innovative possibilities reside. (39:52) You do worse." An interesting part of   how Netflix does things is to allow its employees  to take calls from its competitors. For instance,   Reed learned that one of his top engineers, this  guy named George, was offered a higher pay to work   at Google. At first, he was just insensed  at the lack of loyalty that this employee   displayed by taking that call with Google. (40:12) But as he thought more and more from   a rational standpoint, he understood that George  took the interview to better understand what he   was worth. And since George was irreplaceable,  Netflix ended up paying him top of market value.   Additionally, this would dissuade other tech  companies from thinking they could come and   poach talent from Netflix's talent pool. (40:29) As a result, they ended up paying   George even more than he  would have gotten at Google.   Then they made a list of employees who Google  might contact within Netflix and just paid   them out more as well. I think what Reed was  doing here was just trying to get ahead of his   competitors. And if these top engineers  were really worth, you know, 100 times,   a thousand times or 10,000 times more than  a potential replacement, then bumping their   salary a little bit would have a massive ROI. (40:54) The following section I want to discuss   is based on pumping up cander. So the chapter is  based on secrets and how keeping them often does   more harm than good. So, the book discusses  something they call the stuff of secrets,   SOS. And these are composed of things like  whether to tell employees you're considering a   reorganization that could cost them their jobs. (41:14) Whether you should discuss with other   employees why someone was fired, as the  real reason may harm their reputation,   how much insider information you should  share with others that risks being leaked   to potential competitors if someone were to  leave. Dulging personal mistakes that could   hurt your reputation or ruin your career. (41:30) the rocky relationship between two   leaders that if made public would cause  unrest inside of a company and expressing   vital financial information to employees who could  theoretically be sent to prison for sharing that   information. So Reed has many ways to handle  all of these problems and he has an interesting   term that he used when it comes to secrets. (41:48) He calls it sunshining. Here's what   he says about it. Big things, small things,  whether good or bad. If your first instinct   is to put more information out there, others will  do the same. At Netflix, we call this sunshining,   and we make an effort to do a lot of it. I  think this is smart, and if you want to build a   culture of trust, sunshining is the way to do it. (42:08) People shouldn't be afraid to highlight   mistakes and vulnerabilities, as dealing with  those things by talking about them with others   can be a great way to improve. You may notice  in my episodes that I often highlight a number   of my own investing related mistakes. I love  sunshining these because it shows that I'm   just very far from perfect and it lets me  express my mistakes in my own way so that   I can do my best to avoid making them again. (42:33) I could easily hide my mistakes and   deal with them internally. But for me, this  isn't an optimal way to help myself improve   and to be transparent, which is one of TIP's  primary principles. Now, the book poses four   questions related to transparency from  what I was just discussing here and   gives Reed's response to each one of them. (42:52) So the first one here is in regard   to releasing information to your employees  that would be illegal to leak to the public.   In Netflix's example, this would be specific  financial information. The question here is,   do you continue sharing numbers with your  team after Wall Street knows or do you give   numbers to Wall Street before sharing  them with your team? Reed would choose   to continue sharing this information with his  employees before Wall Street and put trust in   his employees to just do the right thing. (43:19) The reason he takes this approach   is that he wants transparency in the business  from top to bottom. And if all your employees   are correctly trained to read a profit and loss  statement, it can be a massive advantage. Here's   a passage from the book I highlighted. My goal was  to make employees feel like owners and in turn to   increase the amount of responsibility  they took for the company's success.  (43:41) However, opening company secrets  to employees had another outcome. It   made our workforce smarter. When you give  low-level employees access to information   that is generally reserved for highle  executives, they get more done on their   own. They work faster without stopping to ask  for information and approval and they make better   decisions without needing input from the top. (44:02) It's worth noting that if you take this   route, you will encounter some bad actors, but you  can just deal with them on an individual basis. So   the second question here relates to possible  organizational restructuring. So the example   here is when a restructuring relates to how you  might handle employees who may potentially lose   their job as a result of the reorganization. (44:20) So there's a couple questions here.   The first one, do you let time take its course  and wait to tell your employees that they may be   let go while nothing is for sure? Do you hint  at what could maybe happen without revealing   the full potential of what could happen? Or do  you just tell them the truth that they may lose   their job in 6 months and if they need to make  necessary arrangements in the future to do so?   You probably won't be surprised at this point  to see that Hastings chooses the final option.  (44:43) If you want a culture of transparency,  then keeping secrets such as potential firings   makes you a hypocrite. It also will erode trust  in the company's culture. Another point that I   appreciate is that if the company culture is  transparent and the business genuinely cares   about its employees, it should treat them fairly. (45:01) And that means allowing your employees to   seek alternative employment before it's too late.  The third one here is how do you handle postfiring   communication? Do you tell your team the truth?  describe some of the truth or cover for them.   This is more of a question related to employees  who are maybe highly likable and decent in terms   of effectiveness, but certainly not rock stars. (45:21) When you fire them, they will likely   be upset, and after it's done, you're probably  going to have employees who want to understand   better why he or she was let go. Reed would  choose the first option and tell the truth,   but with a caveat. So, in the spirit of  transparency, Netflix decides not to try   to spin things to its employees to make itself or  even a former employee look better than reality.  (45:42) It's better to tell other employees  why the fit wasn't right, but to respect the   dignity of the person leaving. So, this leads to  the caveat. Netflix had an employee who checked   himself into rehab for alcohol addiction and  had to take 2 weeks off of work. In this case,   Reed believes that personal matters  such as these can be left for the   person to reveal if they wish to do so. (46:01) Reed has a heristic he uses when   describing why someone was fired. He asks managers  to be able to respond yes to the question,   "Would I feel comfortable showing the person I let  go of the email I sent?" So, the fourth one here   is in handling personal mistakes. Let's say you're  managing a startup with 100 employees. Let's say   over 5 years you hire and fire sales directors. (46:20) Do you hide the mistake you made in   your judgment of these hires or do you  share these mistakes with your employees?   You can probably guess Reed's answer  to this one is to tell the truth. Reed   provides a superb example from real  life as the question is actually based   on Reed's history at Pure Software. (46:36) Reed had actually hired and   fired five sales directors over 5 years and  believed it to be just an egregious mistake.   He took the issue to the board and offered  his resignation as a result of these mistakes,   but they didn't accept it. The board appreciated  his honesty and showed an even stronger belief   in his leadership as a result of this honesty. (46:54) Reed felt better about being honest and   about showing some of these vulnerabilities  that he had. So this part about displaying   vulnerabilities leads to a phenomenon  known as a pratt fall effect. The prat   fall effect is a psychological tendency  in which people tend to like someone   more after they make small relatable mistakes  provided that person is otherwise competent.  (47:12) And being transparent is just a great  way to take advantage of the prat fall effect   because you will inherently be more honest  about your past mistakes. And chances are   the people with whom you're discussing the error  can actually resonate very well with that error,   which helps you improve your connection with them. (47:29) Let's transition here and discuss some   additional details on how we can release more  control to a business's employees by removing   unnecessary approvals. So, one quote from this  chapter that I found powerful was, "Don't seek   to please your boss, seek to do what is best  for the company." This is an interesting quote   because it doesn't apply to a large percentage of  businesses simply because most companies are run   where making your boss happy is a primary lever  for furthering yourself inside of a company.  (47:55) For instance, at Netflix, they aim  for a culture where decision-m can be made   throughout the entire company rather than just  being concentrated at the very top. This allows   everyone to just flex their creative muscles and  innovate at high levels without the bureaucratic   red tape that suppresses this at many companies.  When Aaron was working on this book with Reed,   she asked him when he'd have time  to work on it and was very surprised   that his schedule was pretty much wide open. (48:21) She writes, "Reed believes so deeply   in dispersed decision-m that by his model, only a  CEO who is not busy is really doing his job." This   is fascinating to me because I see some parallels  between this specific framework and how Stig runs   Tip. Stig is pretty hands-off when it comes to me  running the two communities that I'm involved in.  (48:40) While I run things by Stig and  he will definitely give his opinion,   he's very fond of finishing it with all that  said, I rely on your better judgment. Hastings   says that if an employee comes to you with an  idea that you might not necessarily agree with,   ask yourself four questions. Number one, is the  employee stunning? Number two, do you believe   they have good judgment? Number three, can  they make a positive impact? And number four,   are they good enough to be on the team? If the  answer is no to any of these, then you should   fire them. And we'll be covering that in (49:08) some more depth shortly. But if   the answer is yes to all of them, then that means  you can put more responsibility on them to make   the right decision. And even if you don't  think it's the best idea, you should give   them a leash to try it out. You'll probably  be shocked by how successful their ideas are,   if they are truly exceptional employees. (49:25) This framework is ideal for   companies that require innovation to  continue thriving or to even survive.   If you're running a business that doesn't  require much innovation, then I can see how this   framework wouldn't necessarily be the best fit.  However, with the increasing pace of innovation   just everywhere, it's becoming increasingly  rare to find companies that can just stay in   business without requiring any innovation. (49:47) Let's have a look at the innovation   cycle that Netflix have created. So,  you start by analyzing an idea by doing   the following. You farm for disscent or you  socialize the idea. If you have a big idea,   you test it out. And as the informed captain,  you make your bet. And lastly, if it succeeds,   celebrate. And if it fails, sunshine it. (50:07) So farming for descent means you   actively seek contrary opinions to your idea.  This is so important for Netflix that Reed made   a fundamental rule. It is disloyal to Netflix when  you disagree with an idea and do not express that   disagreement. By withholding your opinion, you  are implicitly choosing not to help the company.  (50:26) This is an interesting rule because  while I agree with it, it could also cloud   the person's judgment with the idea. I was just  reading a quote that I had from Jim Rogers who's   one of the best international investors of  all time. And this is from the book Money   Masters of Our Time. The important thing in his  view is to develop a way to think independently   as he and George Soros did so profitably. (50:47) He says, "I have always found it   much better just to sit and do your own reading.  When I talked to people, it would muddy up my   thinking. I was much more successful just sitting  back and reading and figuring things out. Now,   the idea here really depends on your personality.  I think if you're a solo employee running,   you know, a fund, then discussing your  strategy with others who might have   misaligned incentives is probably a mistake. (51:10) However, if you're a business like   Netflix with just a ton of very well-aligned  employees trying to move the company forward,   it makes a ton of sense. Now, socializing an idea  refers to sharing with others internally just to   kind of gauge the temperature of that idea. It  may reveal that you have overlooked things and   maybe open up new opportunities or illuminate  just a dead end that you thought might have   had potential. Next up is testing ideas out. (51:35) And this is vital to a good business.   If you have a good idea that  you can test out for, let's say,   $100,000, why try rolling out the entire thing  for a million dollars? you're basically just   increasing the risk on that idea if it hasn't yet  been validated by the market. A great example of   this was Starbucks's order and pay service. (51:54) So they created this mobile order   and pay service specifically in Portland,  Oregon to test out and gauge the reception   and it was a massive success and today  I see mobile orders at pretty much every   single Starbucks that I've ever visited. The  third part of this framework is about being   the captain of your idea and making your bet. (52:11) So this refers to the fact that Netflix   does not foster a culture where consensus is  required to move forward with a decision. Sure,   it's great to get the opinions of others, but  ultimately the decision maker must either proceed   with the decision or move on from it. And lastly,  there's kind of this post-mortem of a decision.  (52:27) If it's a win, celebrate it. And if  it's a loss, sunshine it. The sunshining part   is probably most crucial as that's where you're  going to learn the most and will be able to pass   on those learnings to your colleagues so they  don't make the same mistakes that you did.   It also builds trust and fosters innovation.  When employees know they won't be punished for   thinking of innovative ideas, it encourages  them to continue innovating rather than doing   what is safe but may not actually move  the company forward. Now we move to the  (52:52) final section of the book which aims  to maximize talent density, cander, and then   eliminate nearly all controls. To maximize  talent density, Netflix does something called   the keeper test. It's a very simple heristic that  Netflix asked their managers. Which of my people,   if they told me we're leaving for a similar job  at another company, would I fight hard to keep.  (53:14) The point here is to keep the ones that  you would fight tooth and nail to stay around and   let everyone else go. Another concept I enjoyed  from this chapter is how Netflix doesn't think of   themselves as a big family. This thinking can  be rife with errors for specific businesses.   The problem with thinking of a  company like a family is that,   you know, inside of a familial unit, mistakes and  shortcomings are often accepted because they're   just seen as being part of a family. (53:38) Nobody's perfect. However,   in the cutthroat world of business, especially  a hyperco competitive one like Netflix,   they can't accept this. Otherwise, a company would  never have grown to where it is today. Instead,   Hastings has used the term team instead of family.  On a team, underperformance is just unacceptable.   A sports team can sign, trade, or release  players as it sees fit to construct the   best possible roster to help it win. (54:01) And this is what Netflix tries   to do. Athletes on a professional sports  team demand excellence. Train to win and   know that effort isn't enough and understand  that performance it really is everything.   There's no place for just adequate performance at  Netflix. However, if you do perform adequately,   you will be offered a very generous severance  package to facilitate your job search elsewhere.  (54:23) The severance package provides about 4  to 9 months of salary. though it's very overly   generous. Now why is it so generous? Reed believes  that performance improvement plans pips are costly   and timeconuming. Instead of taking months to  complete these pips to save time and protect   the company from lawsuits, Netflix eliminates  them, pays its former employees a substantial   severance package, and requires that they sign  a document stating they won't sue Netflix.  (54:47) Now, we've spoken a lot about feedback  today because it's vital to Netflix's culture,   but Hastings was very aware of how feedback is  often just a one-way street. Managers provide   feedback but very little is returned. In a culture  of transparency, this just is not a good fit. So   Reed Hastings came up with two workarounds. (55:04) So the first one was something called   a 360 written report and the second one is  called a live 360 dinner. So the written   report might seem standard, but it's not.  The written report requires the names of   people providing the feedback and removes any  numerical ratings. Netflix also doesn't link   these reviews to raises or promotions. (55:23) These reports are open to anyone   who wishes to help provide constructive  feedback. Netflix utilizes the start, stop,   continue method to provide feedback. So, the  start, stop, continue method helps make sure   that the feedback is genuine and honest. It can  be easy to simply give your co-workers a high   score and avoid any constructive feedback. (55:41) So, this method allows feedback to   be constructive for the person who's receiving it.  After all, since Netflix requires only rock stars,   all employees need to know what they can do  to maintain that rockstar designation. So,   while these 360 written reports were good,  there was one issue. So, Aaron Meyer writes,   "Although the 360 written exercise  established regular candid feedback,   and many chose to discuss the feedback after  the reports came out, it didn't ensure that   those open discussions were actually happening. If (56:10) Chris Anne gives written 360 feedback to   John Paul that his whispering in client meetings  is hurting his sales, but John Paul never talks   to Chris Anne or anyone else about the comment,  it turns into the stuff of secrets. Reed's next   process was put in place in order to help address  that problem. So the solution was a live 360.  (56:30) This would be a live discussion where  Netflix workers would openly discuss feedback   and level up together. So the framework for this  was to keep the length to several hours and do   it outside of the workplace. So you wanted  to keep the group size small. For let's say   a group of eight, it might take 3 hours. (56:44) For a group of 12, it might take 5   hours. And all feedback given during these live  360 should follow that 4A feedback guideline   which I've already gone over. It should all be  very actionable. You can use the start, stop,   continue method, but 75% of the feedback  should focus on the start and stop to   make sure that time is spent efficiently. (57:03) And then to just set the tone of   some of these types of meetings, you might want  to get the person who can provide the harshest   feedback to go first. One Netflix employee  when speaking about her first live 360 said,   "I hated that evening at the Waldorf, but  without it eventually, I would have failed   the Keeper test. I don't think I'd be at Netflix. (57:21) " While these live 360s are probably an   experience that would take some time to get used  to, it's probably worth it as long as you're open   to improving and accepting feedback that will  make you better at your job. The final chapter   really resonates with me because it's all about  taking responsibility as a way to achieve freedom.  (57:38) The way to accomplish this is through  context, not control. So, let me explain that.   Aaron Mayor makes a great point that there's  nothing wrong with leadership from control or   from context. Some businesses that must focus on  error prevention are best led through control. She   gives the example of Exxon Mobile which has these  safety protocols that it must follow closely to   ensure the safety of everyone who works there. (58:01) In Exxon's case, control makes a lot of   sense because they don't want people  dying under their watch. Therefore,   they have hundreds of safety protocols that must  be followed very closely. But the problem with   control is that it can stifle innovation. If you  put clamps on what people can and cannot do in   a creative setting, you're basically just  handicapping their abilities to innovate.  (58:22) So culture of control is not something  that would have worked well at Netflix. Reed   Hastings says that leading through context  requires four key elements. High talent density, a   focus on innovation rather than error prevention,  work that is loosely coupled, and alignment. We've   already spent so much time on the first two here. (58:39) So let's look closer at this concept of   work that is loosely coupled. So coupling can  be either tight or loose. For tight coupling,   two things are directly connected  and depend heavily on each other.   If you change one, you almost always have  to change the other. An example might be   when you know two gears are locked together. (58:57) If one turns differently, the other   one must also adjust. But for loose coupling, two  things work together but have minimal dependency.   You can change one without breaking the  other. An example of loose coupling is,   you know, a TV and a remote. You can replace  the remote without having to rewire the TV.   Tight coupling is closely tied to control. (59:16) A culture that requires a high   degree of control will be tightly coupled. Any  significant changes to the company's culture   might be at odds with a tight coupling of that  business. Netflix follows a loose coupling model   where changes can occur throughout the system  and do not require significant and disruptive   changes to other parts of the company. (59:35) Now, let's talk about alignment   because it's vital to making context work.  In Netflix, they have a north star that   they seek to achieve. How you get to this  northstar is completely up to you. Now,   I just love this concept of having a north star.  On a personal note, a north star is something   that helps me guide me to where I want to go. (59:52) In the richer, wiser, happier master   class, we have discussed extensively what we  would like written in our orbituary. If you   have a northstar that's aligned with what you  want in your obituary, it can then help you   take the steps to actually get there. But two  people can have a similar northstar and get to   that northstar in completely different ways. (1:00:10) This is where context comes in at   Netflix. So the book presents an excellent analogy  for thinking about control and context through the   lens of hierarchies. This is to think of context  as a pyramid or as a tree. So in a pyramid,   the bottom level has to ask the next level  up for permission to do something creative.  (1:00:31) In the movie industry, the bottom  might be someone like a creative executive   and that might go all the way up to the CEO.  However, you might have multiple levels on   this pyramid between those two positions  and that means that significant decisions   have to go through various layers to determine  whether they can ever actually be implemented.  (1:00:47) This is pretty normal in many  businesses. But Netflix uses the tree   analogy. So in this analogy, you can imagine  just a tree growing out of the ground. The CEO   is actually at the bottom of the tree and as the  trees branch out, decisions are made by what's   called informed captains. And the informed  captain does not need to look anywhere other   than inside themselves to make the decision. (1:01:09) I'll once again use myself as an   example here. So Stig is very good at setting  context for the host at TIP. He seeks excellent   podcast episodes that empower investors and to  foster genuine connections and help build TIP's   brand. So I'm really able to make episodes  about anything that I think is pertinent to   helping our audience become better investors. (1:01:29) And I have free reign to really take   this in whatever direction I want. I can discuss  the pros and cons of discounted cash flow analysis   or I can take a different approach and explore the  concepts of financial independence. Alternatively,   I can discuss Netflix's unique  culture as I'm doing with you today.  (1:01:45) One area that is crucial when it comes  to leading through context is dealing with people   who make mistakes that the CEO or management  believes should not have been made. In this case,   it's up to the manager to take responsibility  for not sending the proper context. Reed suggests   asking the following questions in this case. Are  you articulate and inspiring enough in expressing   your goals and strategy? Have you clearly  explained all the assumptions and risks that   will help your team to make good decisions?  And are you sure your employees are highly  (1:02:12) aligned on vision and objectives?  He points out that managers must continuously   ask themselves these questions when meeting their  managers to ensure everyone is aligned correctly   and on the same page. If you skip this crucial  step, you risk having poor context, which can   negatively impact efficiency and performance. (1:02:29) As long as you set the context, your   informed captains can make the right decisions to  help your business move towards its north star.   That's all I have for you today on Netflix's novel  culture that was created by Reed Hastings. Want to   keep the conversation going? Follow me on Twitter  at irrational KTS or connect with me on LinkedIn.  (1:02:47) Just search for Kyle Griev. I'm  always open to feedback, so feel free to   share how I can make the podcast even better for  you. Thanks for listening and see you next time.   I think this is why hidden monopolies resonates  with me so much because similar to that aspect   of Scuttlebutt, it focuses heavily on the  customers of a business rather than its   competitive positioning against competitors. (1:03:08) And at the end of the day,   it's the company's customers who are signing  those checks which determine how attractive   that investment can be. So why is customer loyalty  so important? Because if you have loyal customers,   your benefits are significantly higher compared to  businesses that just don't have loyal customers.  (1:03:23) This means that a company with loyal  customers will have more repeat customers.