Tough Love at Netflix

Last summer, an internal Netflix file found its way onto the Internet. The 128 PowerPoint slides set out the company’s culture and talent management strategy. Observers speculated how leaders at the usually guarded Netflix had let such a document leak.

As the commentary—pro and con—continues to flow, Reed Hastings, Netflix’s chief executive officer, concedes that corporate leaders leaked the document intentionally "to allow job candidates to self-select."

Netflix has a controversial tough love approach to human capital management. It features a culture governed by few rules and zero tolerance for poor or average performers. Workers earn top-of-market pay but no bonuses or long-term incentives, and they are responsible for their own development. "It’s not the Bible; it’s just our documentation of what’s working for us," Patricia J. McCord, chief talent officer and one of the architects of the company, says of the approach.

Still, it’s hard to argue with success. If it works for Netflix, will it work for you?

The Beginning

In 1998, embarrassed at having to pay a hefty fine for a late movie rental, Hastings had a revelation while exercising at his health club. Could the club’s membership model work for movies? Why not turn customers into members paying monthly fees to rent unlimited movies—returning one before receiving another?

Today, the company delivers movies by mail and video streaming. At the end of 2009, it had 12.2 million subscribers, and revenue for the year reached $1.67 billion, up 22 percent from the previous year. Netflix recruiters have added staff at a rate of more than 20 percent annually. The company has 1,644 employees, about 500 of whom are salaried professionals.

HR Professionals Leading

At Netflix, HR professionals serve on the top management team,and McCord and Allison Hopkins, vice president for human resources, set the tone. McCord, who worked alongside Hastings in previous startups, is a seasoned HR executive with experience at Sun Microsystems, Borland Software and Seagate Technology. Hopkins had roles at E-Trade Financial and Hewlett-Packard.

"Most HR people derive their influence through knowledge of rules and regulations," Hopkins says. "Our power comes from influence, from the roles we play in helping the business succeed." Though Hopkins reports to McCord, they share responsibilities.

McCord is one of Hastings’ six direct reports. She is brash and outgoing, always questioning the status quo. "Straight-talking clarity is missing in our profession," she says. HR managers often act "because we think there’s a law that requires it. Often, that’s just not the case." For example, when she asked her HR peers in the Silicon Valleywhether the Family and Medical Leave Act or the Americans with Disabilities Act required Netflix to have a vacation policy, they said yes, yet when she talked to lawyers, "We found out it wasn’t so."

Software engineers, who make up the majority of the professional staff, are the creative lifeline of the organization, and McCord is obsessive about attracting and recruiting the best. Engineers, she observes, have little patience for bureaucracy. "When I come at them with esoteric ‘HR speak,’ they think I’m bullshiting."

McCord and Hopkins have recruited staff for the 33-person HR team carefully. "They have to demonstrate interest in and knowledge of our business," Hopkins says. In the interviews, "If they say they solve problems by making a policy, they’re not for us. If they say, ‘I talk to people and look for ways to solve it that will help the business,’ we’re interested."

Building the Core

In the startup phase, Hastings and McCord debated ways to define Netflix’s culture. They noted that venture capitalists tend to envision the culture they aspire to have; they decided instead to study people who had worked with them in the past, isolate characteristics that made them successful, and select a workforce that mirrors these values.

"The first couple of hundred you hire are young, smart, hardworking people who believe in your mission," McCord says. Usually, these were "people we knew."

When the business started to click, the challenges and required skill sets began to evolve. "Our problems were becoming more complex, and I realized we had the wrong people," McCord admits. They were "still good at what they do. But we weren’t doing that anymore. So, I had to get comfortable with turnover; I had to get used to saying goodbye."

A major goal, originally planned for fall 2001, was to go public. But the dot-com bubble burst in 2001, the business faltered, and Hastings put off the big day. By October 2001, he had laid off a third of the workforce.

Then, unexpectedly, by Christmas business was surging as the dismal economic climate became an advantage. People were staying home, "and rentals were taking off," McCord says. "We could barely keep up with the growth. But we were doing it and, surprisingly, we were serving twice as many customers with one-third less staff." In May 2002, Netflix went public, raising $82.5 million by selling 5.5 million shares.

McCord began to rethink her plan to double the employee base to keep pace with revenue growth. "Maybe I don’t need more employees," she recalls thinking. "Maybe I need fewer but better." Attracting them—in a competitive market—was the challenge.

Let Freedom Reign

Hastings and McCord recognized that elite talent in the Silicon Valley could pick and choose where they worked; many other employers also pay top dollar. What else could Netflix do to recruit? The key to differentiation, they concluded, was to deliver a culture that attracted people who identified with and understood the business, who yearned for a flexible work environment with few constraints, and who—more than anything—wanted to be rubbing elbows with the best talent.

At Netflix’s modern headquarters in Los Gatos, Calif., there are no badges or security checkpoints. There is also no dress code. People, most of whom are casually dressed, come and go continuously. In the sitting area, a modern coffee table holds well-worn copies of movie catalogs. The walls are bare except for a framed four-color chart showing Netflix dominating competitors in customer service ratings. The atmosphere is serious but informal.

Decision-making is transparent, metrics are shared, and strategy and objectives are disseminated through regular meetings and instant messaging. People communicate regularly by e-mail, text and phone. They often check in or participate in meetings from their cars or homes. Hastings—always on the move, laptop in hand—doesn’t have an office. He responds to e-mail and suggestions in digital shorthand, often with a single letter.

There is no policy that tracks vacation time. Workers decide how much vacation and other leave to take and when to take it. There are limits: Being out sick for more than five days requires a doctor’s note, and time off beyond 30 days annually must be approved by an HR officer.

The advantages of trusting people to manage their time are clear, McCord says: "We focus on what people get done, not how many hours or days they worked. Have I ever fired a $100,000 employee for being tardy or late? Creative people come up with ideas outside of work."

Employees appreciate the freedom provided by the policy void. "If you hire the right people, it works well," says Walter Stokes, director of information technology operations. "I’ve never had an issue with someone taking advantage of it."

Employees are also given freedom when it comes to expensing travel and entertainment costs. People are expected to spend as if the money is their own. The written policy has five words: "Act in Netflix’s best interests." Gifts? "Disclose non-trivial vendor gifts." Despite what skeptics say, Netflix officials maintain that when employee discretion rules, adults can be trusted to do the right thing. If someone strays, peer pressure nudges them back, Hopkins says.

The "creative employee we compete for thrives on freedom," Hastings says. "We’re more focused on the absence of procedure—managing through talented people rather than a rule book." But the dearth of rules does not mean that it’s a free-for-all environment: The few rules are reviewed by counsel and are "in compliance with federal laws," Hastings says. "We try to manage by strong ethics; we’re strong on fairness and equity."

For Adults Only

You won’t see Netflix recruiters on college campuses or at entry-level career fairs. "We get a different kind of person than other software companies," McCord says. "Google, for example, wants to reorganize the world’s information. You do that by hiring as many smart, young people as fast as you can, put them in a petri dish, feed and water them, make it a place like home where they can live and collaborate all hours of the day."

In contrast, new hires at Netflix typically have seven to 15 years of experience. "They’re accomplished deliverers," McCord says. "You need to know your craft so you can make a contribution when you walk in. You need to be mature, with enough experience to be able to make independent decisions."

And you need to be drawn to the business: Netflix’s ranks overflow with film aficionados. People who are not interested in "the context" of the business need not apply. Steve Swasey, vice president of corporate communications, recalls preparing talking points for his first interview and his amazement at spending two hours discussing films.

Hiring is the HR priority. McCord heads an internal "boutique" search firm tasked with attracting talent. No one is offered a job until Hopkins or McCord has interviewed the individual and given her blessing. They spend two to three hours each workday interviewing candidates.

"Most people at our levels don’t do it, but for us it’s a priority; we have absolute veto," Hopkins says. "For example, a guy I interviewed recently expressed surprise at our open approach to vacation time. He said, ‘I’m a workaholic and never take time off; I need someone to make sure I take my time or I won’t use it.’ I told him, ‘We hire adults, and if you don’t know how to manage your vacation, you won’t fit in.’ "

In other companies, Hopkins says, "policies are written for the lowest common denominator. Here, we don’t have to do that. You don’t have to write things down. When someone does something wrong, we tell them it was wrong. After that, either they get it or they’re out." Hopkins contrasts Netflix with Hewlett-Packard, where, she says, "Everything was done by policy."

Playing Hardball

With freedom comes responsibility and accountability. The often-parodied Silicon Valley image of one big family, skateboards and free snacks does not fit Netflix. "We’re more like a professional sports team," McCord says. "Satisfaction comes from the work, not from the cookies."

Sports teams, of course, are about winning. To stay on the team, you have to produce. "When we play, we have to win," McCord says. Netflix’s definition of success: continuous growth in revenue, profits and reputation.

"We are a performance culture based on intellectual prowess," Hastings says. "We try to be fair, but [the length of an employee’s Netflix career] is not our primary concern. If someone is not extraordinary, we let them go." Based on personal observations, he says the payoff from an extraordinary performer vs. an average one in creative fields is tenfold.

Here, then, is perhaps the characteristic that distinguishes Netflix from others recruiting top talent: Leaders are unwavering in their quest for quality and results. If even one person is assessed as mediocre or average during the annual review process but permitted to continue working at Netflix, the elite aura surrounding the workforce will be compromised. Loyalty to people not producing or facing minor setbacks or personal distractions is tolerated, but not for long.

"Keeping the house clean is essential to who we are," Hopkins says. "Too often, really good workers are frustrated at having to work with others who they perceive as average or worse performers. When we ask people why they chose us, they tell us it’s not for the money. It’s the other stuff. [It’s] ‘the places we worked didn’t fire people they should have fired.’ "

Consider Stokes. He left the 140,000-employee Electronic Data Systems because he was attracted by the opportunity to work with high-caliber colleagues at Netflix. "Everyone is smarter than you," he says. "There’s no deadwood here. If the wrong person is in the job, the emphasis is on doing what you have to do to get the right person."

Saying Goodbye

Voluntary employee turnover at Netflix is low. The top six executives have been with the company from the beginning. When it comes to terminations, managers follow two rules:

No surprises. Employees must know where they stand. Annual 360-degree reviews provide "direct and honest feedback," Stokes says. "It’s tough to get used to doing them, but when they’re done right, they’re better than top-down evaluations."

During the annual review cycle, managers assess each employee against the "keeper test": "Which of my people, if they told me they were leaving in two months for a similar job at a peer company, would I fight hard to keep at Netflix?"

McCord says the numberof people who fail the keeper test annually from among the ranks of the 500 salaried professionals is often in double digits. These individuals are ushered out.

No-fault divorces. Wherever possible, an amicable departure is engineered. "We want them to keep their dignity," McCord says. "In many companies, once I want you to leave, my job is to prove you’re incompetent. I have to give you all the documentation and fire you for poor performance. It can take months. Here, I write a check. We exchange severance for a release. To make Netflix a great company, people have to be able to leverage it when they leave" by subsequently getting good jobs.

The line manager delivers the news with coaching from HR professionals. "We don’t coddle; it’s not about asking how does someone feel," Hopkins says. "Usually, people find new jobs quickly." To date, no one who has been terminated has sued.

Develop Thyself

Training, professional development and career planning are off Netflix officials’ radars. Hastings insists that courses, mentor assignments and job rotations are rarely effective.

"There’s no road map that plots out your career," Stokes adds. "I’ve been here three years, and so far my job and responsibilities have changed every six months."

Hastings says people should manage their own career paths and not rely on the company. "The way you develop yourself is to be surrounded by stunning colleagues. We surround people and let them develop themselves," he explains.

Formal training, except where mandated by law, is not offered. Hastings and HR leaders conclude that most training materials are not useful. "I used to worry that we didn’t do training and developing, but then we previewed some training videos and supporting materials," McCord recalls. "It was awful. Reed said, ‘This stuff is nauseating and a waste of time.’ " Mandatory diversity training is delivered via an online module.

Have-It-Your-Way Pay

Netflix does not pay bonuses or offer long-term incentives, but it does pay salaries at the top of the market. Each year, salaries are adjusted by answering three questions:

• What could this person get elsewhere?
• What would we pay for a replacement?
• What would we pay to keep this person if he or she had a more lucrative offer elsewhere?

Once a salary is established, each individual has the option of taking it in cash or a combination of cash and stock options. Options vest immediately and have the cash equivalent of approximately half the market price.

Health insurance is on par with what similar employers offer.

Netflix salaries are based on market conditions but not on company performance—a practice shareholders could find vexing if the company experiences a downturn. For now, the rationale—comparing top talent to major-league pitchers who receive star-level pay whether the team wins or loses—prevails. To be promoted, a person has to be a superstar in his or her current role and often be willing to take a reduction in pay to take on the new assignment. Executives want people to move up for the challenge, with the expectation that they will earn more once they have proved themselves.

Hastings says the no-bonus policy does not deter applicants, and he points out that employees who take compensation in stock options will only benefit if the stock price goes up. For 2009, because of economic conditions, most employees were paid at 2008 levels. Hastings earned $1 million in salary and $1 million in stock options.

A Better Way?

What types of companies can benefit from Netflix’s laissez-faire approach? If your business depends on creativity—say, advertising or software development—freedom and flexibility would be primary drivers of success. If you’re measured primarily by efficiency, like at UPS, Boeing or NASA, more structure and rules will be appropriate. "This culture would apply to any business whose primary risks are lack of creativity," Hastings says. "On the other hand, if lack of efficiency is the primary risk, a more rules-oriented culture may be preferable."

J. Lynne Cannon, principal at the Princeton Management Development Institute in Princeton, N.J., draws a parallel between Netflix and consulting firms like McKinsey & Co., whose leaders build their cultures around acquisition of mobile talent forces. She describes these cultures as edgy: "They attract independent, highly motivated strivers who believe they can move on easily. As a result, management is not worried how the employees feel about loyalty."

Of course, Netflix, for all its panache, remains a work in progress. "They’re in an early growth stage, operating in a relatively unsophisticated business mode," Cannon says. The larger a company gets, the more difficult it becomes to foster freedom, she notes. "Good people can do bad things and can’t be relied on to police themselves." But structure need not be onerous, she points out. "In larger organizations where rules are unavoidable, they are drafted to support the adult conduct of the mainstream 90 percent, not the outliers."

Since the PowerPoint slides describing Netflix’s culture hit the web, McCord and Hopkins have been amazed at the feedback from HR executives who yearn to be cut loose from bureaucracy. "Patty and I are on the periphery of how many HR people are thinking," Hopkins reflects. "Many HR people are dying to work in organizations like this. But it can only work if the CEO believes in it, too."

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The author, a contributing editor of HR Magazine, is a lawyer and a professor of management studies at Marist College in Poughkeepsie, N.Y.

Web Extras

• PowerPoint slides: Reference Guide on Our Freedom and Responsibility Culture (Netflix)