Netflix pay scheme inspires behind the scenes

May 9, 2011

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The star attractions at Netflix keep winning over new, and sometimes unlikely, fans. But one feature of the movie rental and streaming service’s business model is less well known: the unusual way it incentivizes and pays its staff. Rivals struggling to compete with the firm led by founder Reed Hastings may want to take a peek.

Defying and converting skeptics with innovation has become standard operating practice for Netflix. Another 3.3 million subscribers joined last quarter, bringing its total to 23 million, while operating margins held strong at 14 percent in the face of mounting questions about the rising cost of acquiring streaming rights to films and TV shows.

A new adversary sounds intimidated. Charlie Ergen, whose Dish Network just bought Blockbuster out of bankruptcy, said he doesn’t plan to go up against Netflix on streaming because of what looks like its “insurmountable lead.” Even Time Warner boss Jeff Bewkes, who once likened Netflix to the Albanian army, changed his tone last month and expressed some admiration for what the $12 billion company has accomplished.

Part of the success may stem from the uncommon way Netflix rewards its people. Like other freedoms in place at Netflix, including a generous vacation policy, employees eligible for stock options can tailor the mix of salary and equity in their compensation packages. The amount of options used to be restricted, but the cap was lifted last year. Hastings took only about 9 percent of his $5.5 million pay in cash.

Equally unusual is the way Netflix doles out options. They are granted monthly instead of once a year, as is typically done at most companies. Given the way Netflix shares swing wildly, this makes sense. About a fifth of them are also on loan to short sellers, who either think the company is overvalued or the business model isn’t sustainable.

This can help smooth out volatility and reduce some frustration that might otherwise discourage managers. To wit, on Nov. 1, the shares were at about $167. A month later they were up to $200. And they opened 2011 at just over $178. Because of the dollar-cost averaging afforded employees, they could worry less about option grants being underwater and more about how to keep Netflix a step ahead of the competition.

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