Redbox's Strategy in the Movie Rental Industry - case study

Case 7 Teaching Note Redbox’s Strategy in the Movie Rental Industry Overview Spotting what it believed was a promising opportunity in the self-service DVD rental business, Redbox in 2004 began deploying vending machine kiosks containing mostly new release movie DVDs in high-traffic shopping locations. The idea was that people could be easily enticed to rent movies at a place where they shopped regularly rather than making a special trip to a local movie rental store, especially if the rental fee was dirt cheap. Redbox charged a rental fee of $1 per day, and rented DVDs could be returned to Redbox kiosks at any location. Customers could also purchase new and used movie DVDs; Redbox typically sold previously rented movie DVDs for $7.

As of May 2010, Redbox had deployed 22,400 of its vending kiosks at locations in all states in the continental United States, Puerto Rico, and the United Kingdom. In the late-afternoon and early-evening hours of a typical Friday and Saturday in 2009, Redbox processed 70 to 80 rental transactions per second. It rented more than 365 million DVDs in 2009 and generated revenues of $773.5 million from rentals and sales of DVDs at its kiosks. On New Year’s Eve 2009, Redbox rented a record-breaking 2 million DVDs.

Redbox estimated that its share of the DVD rental market in the United States was 16.8 percent at the end of 2009, up from about 9 percent at the beginning of the year, with virtually all of the market share gains coming from rentals taken away from Blockbuster, Movie Gallery, and other local video rental outlets.

Redbox was a wholly owned and operated subsidiary of Coinstar Inc., which, in addition to its Redbox movie rental business, was also a leading provider of money transfer services and self-service coin-counting kiosks where people could convert coins to cash, a gift-card, or e-certificates, among other options. In 2010, Coinstar products and services could be found at more than 80,000 points of presence, including supermarkets, drugstores, mass merchants, financial institutions, convenience stores, restaurants, and money transfer agent locations. Coinstar reported 2009 consolidated revenues of $1.14 billion and net income of $53.6 million. Revenues from Redbox’s operations accounted for 67.6 percent of Coinstar’s 2009 revenues.

There is ample information in this case for class members to evaluate Redbox’s strategy, do a SWOT analysis apply the analytical tools discussed in Chapters 3 and 4 in evaluating Netflix’s external environment and internal circumstances, and there is plenty of information for them to draw upon the topical coverage in Chapters 1, 5 and 6 in critically evaluating Netflix’s strategy and business model.

Suggestions for Using the Case The Redbox is a short 8 pages and is focused squarely on the company’s strategy and recent performance. While it can be used a stand-alone case, it really intended to be used as a follow-on to the Netflix case , which contains essential information about Redbox’s principal competitors (Netflix and Blockbuster) and details the fast-moving changes taking place in the movie rental business. If you opt not to cover the Netflix case first, then it is strongly recommended that you ask the class to read pages C-88 through C-94 of Case 6 on Netflix so that class members will have some familiarity with

• The transformational changes underway in the movie rental industry.

• Netflix’s drive to win a commanding leadership position and be in the forefront of streaming movies to subscribers.

• Blockbuster’s troubles and its scramble to revamp its business model and strategy.

The Redbox case should inspire a first-rate class discussion. Redbox has enjoyed explosive success in deploying movie rental kiosks, but will its success be sustainable? Class members are likely to be at least modestly familiar with Netflix, Blockbuster, and Redbox, and have some strong convictions about how rivalry among the 3 companies is likely to play out. Class members should be expected to evaluate the pros and cons of Redbox’s strategy, do a SWOT analysis, identify the strategic issues that Redbox management needs to address, and propose action recommendations.

We think the Redbox case works best after you have covered Chapters 1-5. It is an ideal case for drilling students in SWOT analysis, strategic issue identification, and the development of pragmatic action recommendations. We recommend assigning Redbox in the first half of your module on single-business strategy (cases where the content of Chapters 1-7 comes into play) but Redbox is also an attractive candidate for oral team presentations and either an in-class or out-of-class written case.

Videos for Use with the Redbox Case. There are three videos that you might wish to show in conjunction with the Redbox case:

 A 2:18 minute YouTube video that discusses how Redbox is gaining on Netflix and Redbox’s competitive advantage. The video, with a date of May 29, 2010, is best shown at the beginning of the class period and can be accessed at http://www.youtube.com/watch?v=EdOtUKsEbH0. If you prefer, students can view this video on their own—just give them the link.

 A 3:40 minute YouTube video, with a date of September 3, 2010, that is best shown near the end of the class period when class members are debating whether Redbox can compete with Netflix in using the Internet to stream movies to customers TVs. This YouTube video, titled “Redbox: We Will Stream Movies”, can be accessed at http://www.youtube.com/watch?v=LvNplvEAumo&feature=channel. If you prefer, students can view this video on their own—just give them the link.

A 4:58-minute video that deals with a Pew report about “More Americans Watching Online Video.” This video is on the Instructor’s Resource DVD set provided by the publisher.

In the event you have not assigned the Netflix case, we definitely suggest showing the third video. This particular video will give students a stronger appreciation of the potential importance of how Internet delivery of rented movies and VOD can transform the movie rental industry and weaker demand for renting movie DVDs for home-viewing. It should be shown right after the SWOT analysis discussion (Assignment Question 2) or just before you are ready to ask the class what strategic issues face Redbox management (Assignment Question 3).

The Connect-based Exercise for the Redbox Case. We developed an exercise for Redbox for inclusion in the publisher’s Connect™ Management web-based assignment and assessment platform. It concerns the following 3 recommended Assignment Questions for the case:

1. What does a SWOT analysis reveal about the attractiveness of Redbox’s situation and future prospects?

2. What strategic issues and problems does Redbox management need to address for the company to be more financially and competitively successful in the years ahead?

3. What actions do you recommend that Redbox management take to deal with each of these issues/problems? Your recommended actions must be supported with convincing, analysis-based arguments.

It should take class members roughly 45 minutes to complete. The SWOT analysis portion of the exercise is automatically graded, but the last 2 questions call for short-answer/essay answers on the part of students and will require instructor evaluation and grading.

You may want to consider having class members complete this exercise in lieu of doing a written case analysis. If your classroom has wireless access and class members have laptops, then the exercise can be done in-class, which eliminates the problem of class-member collaboration in completing the exercise outside of class.

What to Tell Students in Preparing the Redbox Case for Class Discussion. To give students guidance in what to do and think about in preparing the Redbox case for class discussion, we strongly recommend two things:

1. If you have not previously assigned the Netflix case, then have the class read pp. C-88 and C-94 of the Netflix case.

2. Either have class members complete the Connect-based exercise for the Redbox case or (if you are not using the Connect platform as part of your class coverage of the text) provide them with a set of assignment questions and insist that they prepare good notes/answers to these questions before coming to class. Our recommended assignment questions for the Redbox case are presented in the next section of this TN.

To facilitate your use of assignment questions and making them available to students, we have posted a file of the Assignment Questions contained in this teaching note on the student section of the publisher’s Online Learning Center for the 18 th edition (www.mhhe.com/thompson). (You should be aware that there is a set of assignment questions posted in the student OLC for each of the 28 cases included in the 18th edition.)

In our experience, it is quite difficult to have an insightful and constructive class discussion of an assigned case unless students have conscientiously have made use of pertinent core concepts and analytical tools in preparing substantive answers to a set of well-conceived study questions before they come to class. In our classes, we expect students to bring their notes to the study questions to use/refer to in responding to the questions that we pose. Moreover, students often find having a set of study questions is useful in helping them prepare oral team presentations and written case assignments —in addition to whatever directive questions you supply for these assignments. Hence, we urge that you have students make full use of study questions—either those we have provided or a set of your own questions—in preparing each and every case assignment.

Suggested Assignment Questions for an Oral Team Presentation or Written Case Analysis. We heartily recommend use of the Redbox case for written assignments and oral team presentations. Our suggested assignment questions are as follows:

 Redbox has employed you as a consultant to assess the company’s overall situation, identify the strate - gic issues that management needs to address, and recommend a set of actions to improve the company’s future prospects. Please prepare a report to Redbox management that includes (1) a complete SWOT analysis (as described in Chapter 4), (2) a complete list of the strategic issues/problems that management needs to address, and (8) a set of action recommendations to resolve the issues problems that you identify. Your report should contain detailed and convincing reasons in support of each one of your recommendations. It is imperative that the support offered for each of your recommendation be based on analysis-based conclusions.

Assignment Questions 1. What are the chief elements of Redbox’s strategy? Which of the five generic competitive strategies

discussed in Chapter 5 most closely fit the competitive approach that Redbox is taking? What type of competitive advantage is Redbox trying to achieve?

2. What does a SWOT analysis of Redbox reveal about the overall attractiveness of its situation and future prospects?

3. What strategic issues or problems does Redbox management need to address? Draw upon the discussion on p. 125 in Chapter 4 to develop your “worry list” and to state the issues/problems in the recommended form.

4. What recommendations would you make to Redbox management? At a minimum, your recommendations should cover what to do about each of the strategic issues/problems identified in question 3. In addition, each recommendation should be supported with convincing arguments based on your analysis of Redbox’s situation.

Teaching Outline and Analysis 1. What are the chief elements of Redbox’s strategy? Which of the five

generic competitive strategies discussed in Chapter 5 most closely fit the competitive approach that Netflix is taking? What type of competitive advantage is Redbox trying to achieve?

Redbox’s strategy in 2010 included the following key elements:

 Rapidly deploy vending machine kiosks containing mostly new release movie DVDs in high-traffic shopping locations.

Redbox leveraged Coinstar’s expertise and reputation with retail chains in securing new locations for Redbox kiosks. Most Redbox kiosks were located in the area between a retail store’s cash registers and front entrance. In many instances, retailers had historically generated little revenue from this space, which made it appealing to put a potentially high-traffic Redbox kiosk in that space (perhaps along with a Coinstar self-service coin-counting machine and/or a Coinstar electronic money transfer service) and better optimize revenue per square foot.

As of May 2010, Redbox had deployed 22,400 of its vending kiosks at locations in all states in the continental United States, Puerto Rico, and the United Kingdom.

Such locations for Redbox kiosks made it convenient for customers to rent a movie DVD from Redbox at a place where they were already shopping rather than make a special trip to a movie rental store. In mid-2009 Redbox’s CEO, Mitch Lowe, estimated that every week 150 million people walked within 10 feet of one of Redbox’s locations.

 Charge a rock-bottom $1 per day rental fee. This low price was highly attractive to shoppers looking to rent a movie DVD.

Customers could also purchase new and used movie DVDs at Redbox kiosks; Redbox’s typical price for a previously rented DVD was $7.

 Make it simple and easy for customers to use a Redbox kiosk. If a customer knew what movie title he or she wanted to rent, the rental process could be completed in less than a minute.

 Build stronger brand recognition. More Redbox kiosk locations and the distinctive red color of the kiosks promote growing consumer awareness of Redbox.

Which of the Five Generic Strategies Is Redbox Employing? In our view, Redbox is employing a low-cost provider strategy. No other renter of movie DVDs charges $1 per day. And the company has sufficiently low costs to enable it to operate profitably at the $1 per day rental fee (as documented in case Exhibit 3).

Some class members may propose that Redbox’s strategy is more akin to that of a focused low-cost provider. However, the evidence for this is thin, since Redbox is rapidly expanding the number of Redbox kiosk locations and endeavoring to make its kiosk locations accessible to a broad range of shoppers and potential customers. It is true that Redbox is well-positioned to serve those movie renters who decide on the spur of the moment to rent a movie because they see a Redbox kiosk where they are already shopping —this is a small and well-defined type of movie rental customer that Redbox can serve. But Redbox seems to be clearly aiming to attract a broader customer clientele than just the impulse renter of movie DVDs.

Redbox’s Efforts to Build Competitive Advantage. It seems clear that Redbox’s strategy is aimed at building a competitive advantage based on

 Convenience

 Low price

 Growing consumer awareness of Redbox and the alternative of renting a movie DVD at a Redbox kiosk (as opposed to making a special trip to Blockbuster or other local movie DVD rental store)

 Redbox’s unique ability to draw upon Coinstar’s reputation and resources in securing the deployment of additional Redbox kiosks

2. What does a SWOT analysis of Redbox reveal about the overall attractiveness of its situation?

Redbox’s Resource Strengths and Competitive Assets

 The dominant leader in the vending kiosk segment of the movie rental industry, with a total of 22,400 kiosks in operation as of May 2010.

 Good capability to secure attractive locations for its DVD rental kiosks (the number of requests from retailers to install Redbox kiosks has been far greater than the number being deployed, owing to Redbox’s strict internal rate of return hurdle). Redbox’ corporate parent, Coinstar, has proven and strong relationships with chain retailers that have given Redbox unique ability to secure deployments of kiosks in attractive retail locations. Without access to Coinstar’s considerable resource strengths and collaborative relationships with prominent chain store retailers, Redbox would never have been able to deploy so many kiosks in prime retail locations so quickly.

 The capability to deliver good value to customers from the standpoints of both a low price and convenience.

 Its online reservation feature.

 A very high percentage of Redbox customers are currently very satisfied with their experiences of renting movie DVDs at Redbox kiosks.

 A strategy that seems to be working and a business model that is delivering acceptable financial performance.

 Growing brand name recognition and brand power—growing consumer awareness of Redbox helps attract more customers.

 An apparently capable top management team.

 The financial strength to deploy additional kiosks—a Redbox kiosk has an installed cost of about $15,000, a relatively small number given the size of Redbox’s operating profits (case Exhibit 3) and the potential for annual revenues of $50,000 for kiosks in attractive locations.

Redbox’s Resource Weaknesses and Competitive Liabilities

 No Internet­delivery capability (the company’s strategy and business model is not readily adapted to Internet   delivery   of   rented   movies). This makes Redbox competitively vulnerable to growing consumer preferences for Internet delivery of rented movies and to competition from VOD providers. This is a huge resource weakness and competitive liability for the road ahead.

Redbox’s External Market Opportunities

 The potential for growing revenues at kiosks recently deployed to an average of $50,000 annually per kiosk after three years.

 Geographic expansion—deploying more kiosks in geographic areas, communities, and neighborhoods in the U.S., Puerto Rico, and the United Kingdom that are currently underserved or not served at all.

 Continuing to attract customers away from traditional local movie rental stores (particularly Blockbuster).

 Expansion into additional foreign country markets.

External Threats to Redbox’s Future Profitability

 Growing preferences on the part of individuals/households for Internet delivery of movie rentals. The practice of renting physical movie DVDs seems to be on the verge of permanent and potentially rapid decline. In the years to come, more and more individuals/households will watch movies via Internet delivery directly to their TVs or else watch movies on a pay­per­view basis from video­on­demand providers (such as cable and satellite providers).

 Blockbuster moves aggressively to deploy Blockbuster­branded kiosks.

 Consumers, for any of several reasons, become less interested in watching movies at home.

Conclusions concerning Redbox’s situation. You should not let students escape with just compiling four SWOT lists. The really important part of SWOT analysis comes from drawing conclusions about what we learn from the four SWOT lists.

All things considered, we think the four SWOT lists indicate that Redbox’s near-term situation is attractive and that there is further room for growth in revenues and operating profits as more Redbox kiosks are deployed. However, longer-term, Redbox’s growth and profitability are vulnerable to the transformational shift to Internet delivery of rented movies and the competitive efforts of VOD providers to attract more customers to their pay-per-view delivery model (via a few clicks of their TV remotes). It is very unclear whether Redbox can successfully become a competitive force in the Internet delivery segment of the movie rental business.

3. What strategic issues or problems does Redbox management need to address? Draw upon the discussion on p. 125 in Chapter 4 to develop your “worry list” and to state the issues/problems in the recommended form.

In light of the upcoming transition to Internet delivery of rented movies and the mounting competitive efforts of VOD providers (discussed in the Netflix case—pp. C-88-C-94), this case literally screams for class members to identify what issues management needs to address. Issue identification (or compilation of a “worry list”) is a way for students to draw conclusions from all the preceding analysis, plus it sets the stage for asking class members to propose what actions they think Redbox management should take.

We see two top-priority strategic issues that Redbox management must deal with:

 How many more attractively profitable retail locations are there for Redbox to locate additional Redbox kiosks. Given the accelerating shift to VOD and Internet delivery of rented movies, management needs to guard against overexpanding and deploying kiosks that underperform. The window for profitable deployment of thousands more Redbox kiosks is closing (the issue, of course, is how rapidly?). On the other hand, there would seem to be potential for gaining additional revenues and market share at the expense of Blockbuster. Blockbuster is far more vulnerable to the deployment of additional Redbox kiosks than is Netflix.

 Whether and how Redbox can profitably enter the Internet delivery segment? Redbox is competitively vulnerable to competition from VOD providers, from Netflix, and from other movie rental providers with Internet delivery capability. What can Redbox do to counteract this?

 Should Redbox expand internationally and, if so, what types of country markets would seem most appealing?

4. What recommendations would you make to Redbox management? At a minimum, your recommendations should cover what to do about each of the top priority issues identified in question 3. What analysis and convincing arguments can you provide to support your recommendations?

A reasonable set of action recommendations might include the following:

 Continue to deploy more Redbox kiosks but with growing caution and continued emphasis on requiring that new kiosks meet an attractively high internal rate of return hurdle. Overexpansion must be scrupulously avoided, due to the looming threat of perhaps accelerated shifts on the part of individuals/households to Internet delivery and VOD providers—consumer switching costs to such providers are attractively low.

 Begin a concerted effort to explore the merits and potential profitability of entering the Internet delivery segment and competing against Netflix. In our view, it is not obvious that Redbox has the resources or the market positioning to make the transition to Internet delivery. Its current strategy and business model is not conducive to Internet delivery (streaming of rented movies)—and the capital requirements could be formidable compared to investing in additional kiosks. Netflix would seem to be a very formidable competitor, and we are highly skeptical that Redbox can profitably and successfully compete head-to-head against Netflix—Netflix has huge first-mover advantages in the Internet delivery/streaming segment that Redbox is unlikely to overcome. Moreover, entry into the Internet streaming segment is likely to be very capital intensive. In our view, Redbox is far better positioned to outcompete Blockbuster and to steal revenues and market share from Blockbuster over both the near-term and long-term than it is to attempt to modify its long-term strategy and business model to compete against Netflix. Nonetheless, Redbox management is obligated to explore whether and how it might be a profitable competitor in the Internet delivery segment.

 Continue to build the Redbox brand and to make households more aware of Redbox—this will be very important in stealing additional sales and market share from Blockbuster and maintaining rapid growth of the business. Most households know there is a Blockbuster/local video rental store alternative, but all households/individuals need to know more about the advantages of the Redbox alternative and they need to know why renting a movie DVD at a Redbox kiosk is easy, convenient, and economical.

 Consider expanding outside of the U.S. Puerto Rico, and the United Kingdom. Countries with the most promising expansion potential would seem to be those where:

• Netflix is not a strong competitive presence.

• VOD and Internet delivery of movies have, as yet, very limited appeal.

• Incomes are relatively low but where many households still have TVs and DVD players (and where high-speed broadband access is not affordably priced for a big fraction of the households).

Physical rental of movie DVDs will continue to be a big enough market segment in many (most?) countries to be attractive to a low-cost provider like Redbox. Redbox’s strategy and business model is uniquely well-suited to being the dominant provider of physical movie DVD rentals in most all countries, including the U.S. But while the growth potential for Redbox seems to be shrinking rapidly in the U.S., many/most of Redbox’s presently deployed kiosks may continue to be attractively profitable for many years to come.

Epilogue At the end of 2010, Coinstar had approximately 30,000 DVD rental kiosks and 18,900 coin-counting kiosks in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants.

In January 2011, Coinstar announced that it expected revenue for the fourth quarter of 2010 to increase 31% over the 2009 fourth quarter to $391 million, but this was below management’s earlier fourth quarter 2010 guidance of total Coinstar revenues in the range of $415 million to $440 million. The lower-than-expected revenues were due to weak rentals of titles released during the 2010 fourth quarter holiday season, particularly higher-priced Blu-ray titles, despite a 16% lower box office for scheduled releases compared with those in fourth quarter 2009. In addition, Reddbox consumers utilized “rent and return anywhere” to a higher level than expected, which caused temporary imbalances in available titles across the Redbox kiosk network.

As a result, management said it expected Coinstar to report fourth quarter 2010 earnings per share (EPS) from continuing operations of $0.65 to $0.69 on a fully diluted basis, compared with prior guidance in the range of $0.79 to $0.85.

Paul Davis, chief executive officer of Coinstar, Inc., said:

Nevertheless, Redbox revenue grew 38% year over year in the fourth quarter,” Davis continued. “Consumer demand for Redbox DVD rentals continues to be robust, and consumers and retailers appreciate the value and convenience offered by Redbox. Consumers rented over 144 million movies during the quarter and same store sales increased 12.5% year over year in the fourth quarter. Our unit economics for single and dual kiosks remain strong, and we believe in the future prospects for DVD kiosk rentals. Additionally, we are pleased with the continued strong performance of our coin business, especially its year over year 10% growth in same store sales during the fourth quarter, and remain focused on driving profitable growth across the organization.

Redbox accounted for approximately 80% of Coinstar’s total revenues in 2010. The company expects fourth quarter adjusted EBITDA from continuing operations between $78 million and $82 million, a year over year increase of 38.8% to 45.9%, compared with guidance in the range of $84 million to $90 million. EBITDA was impacted by lower revenue and gross margin.

Management’s announcement of the disappointing results prompted Coinstar’s stock price to drop from a close of $56.95 on January 13, 2011 to a close of $41.50 on January 14, 2011.

As a consequence of the weaker than expected 2010 results, Coinstar management revised its initial outlook for full year 2011, saying it now expected:

 2011 revenue between $1.70 billion and $1.85 billion (down from previous guidance of $1.80 billion to $1.95 billion).

 Adjusted EBITDA from continuing operations between $325 million and $355 million (down from prior guidance of $350 million to $380 million).

 EPS from continuing operations between $2.60 and $3.10 (down from previous guidance of $3.00 to $3.50 per share), based on a share count of 33.3 million.

Please check the investor relations section and the press releases at www.coinstar.com for the latest developments on how Redbox is faring.