Netflix Looking to the Sky

After lecturing Los Gatos’ mayor and council about their responsibility to “preserve this town,” the first of two dozen residents to speak against the expansion of Netflix’ headquarters there dropped a Freudian slip.

“This is not how we want this city to be,” he said, and immediately corrected himself: “Town,” he said. “Town. Because this is the Town of Los Gatos.”

Los Gatos is incorporated as a “town” under California Government Code Sections 34500-34504. And while “town” and “city” are explicitly interchangeable in that section, Los Gatans will frequently correct anyone who inadvertently slips and uses the C-word. There are also almost no buildings taller than 35 feet—except at the Netflix campus on Winchester Boulevard—thanks to a town ordinance.

Following Monday night’s public hearing, the council approved a development plan that will allow Netflix—by far Los Gatos’ biggest homegrown business success story—to expand that headquarters into two new buildings, one of which will stand five stories tall and measure 85 feet.

While the decision is being hailed as a coup that will help Los Gatos through the financial troubles that are plaguing all California municipalities, local leaders had to overcome opposition from passionate residents who experienced it as a civic identity crisis.

David Wells, Netflix chief financial officer—and a resident of Los Gatos himself—has been doing most of the public outreach for the company since the expansion proposal was initiated. “Netflix wants to stay here,” he said Monday, for perhaps the 50th time in the past year. “And [this] is the only place in Los Gatos that would allow us to stay here.”

As if to remind the council that the company was not interested in compromising on its requirements, Wells pointed out that “height is a key driver for us.”

“Collaboration is a is a very strong competitive advantage in our industry,” he said, “and we need the space, the density and the height to achieve that level of collaboration.”

On the face of it, Los Gatos’ decision to do whatever it had to do to keep Netflix in town may seem like a no-brainer. Two weeks ago, Netflix announced that its DVD rental division would move from Los Gatos to San Jose, taking 200 jobs and as much as $3 million worth of sales tax revenue away from the town. By approving the company’s headquarters expansion, the council would effectively replace that lost revenue.

According to an analysis by Town Manager Greg Larson, the Netflix deal will generate almost $2.5 million in one-time revenue, and around $2 million per year in annual sales tax revenue going forward. In addition, the company will pay more than $1 million per year to the Los Gatos School District—that’s all new money, because Netflix’ current headquarters is in the Campbell Union School District.

To sweeten the deal, Netflix also agreed to a one-time “community benefit” payment of more than $900,000.

To some angry Los Gatans, it appears that the town was paid off by the online movie-rental giant, convinced by the lure of tax dollars to surrender some of its semirural charm. Larson shrugs off these charges, pointing out that Los Gatos is in no way desperate for the money.

Since taking the job in January 2008, Larson has been squirreling money away in a rainy-day fund. Consequently, when responding to the announcement about the DVD division’s relocation plans last month, Larson was sanguine.

While Los Gatos was the point-of-sale for all of Netflix DVD rentals for the better part of a decade, the town collected sales tax on those rentals. According to state law, video streaming fees are not taxed. Of course Larson, who served as chief of staff to State Controller Steve Westly from 2004 to 2007, knows this and planned accordingly.

Unlike neighboring San Jose, which went on a spending spree when tax revenues inflated along with the dotcom bubble, Los Gatos was cautious. That prudence was likely the result of a fiscal disaster that was barely averted when many of the car dealerships that for years lined Los Gatos Boulevard pulled up their tent stakes and moved down Highway 85 to South San Jose and Gilroy—taking millions of dollars in sales tax revenue with them.

“We knew this day was coming,” Larson says. “DVD rentals have been a declining tax stream. And after all, the company is called ‘Netflix,” not ‘Discflix.’”

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