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[The Impact of the Internet on the Video Rental Industry: Blockbuster vs. Netflix]
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Table of Contents
INTRODUCTION 3
VIDEO RENTAL INDUSTRY ANALYSIS 5
BLOCKBUSTER BUSINESS DESCRIPTION 7
BLOCKBUSTER BUSINESS MODEL 7
BLOCKBUSTER HISTORY 8
BLOCKBUSTER SWOT ANALYSIS 10
NETFLIX BUSINESS DESCRIPTION 14
NETFLIX BUSINESS MODEL 14
NETFLIX HISTORY 15
COMPETING ONLINE SERVICES 16
FINANCIAL ANALYSIS 18
THE FUTURE OF THE VIDEO RENTAL INDUSTRY 24
CONCLUSION 25
REFERENCES 26
3
The Impact of the Internet on Video
Rentals: Blockbuster vs. Netflix
Could Brick and Mortar Video Rental Stores be a thing of the past? The Internet has
challenged the way movies are rented in the United States. Blockbuster, one of the
biggest video rental companies, has completely restructured its operations to meet the
market demands due to the emergence of the Internet and companies like Netflix. The
first impact the online video rental industry made on Blockbuster was making late fees
obsolete. Blockbuster enacted a “no late fees” policy in 2004 to remain competitive in the
industry. The company gave up about $450 million in late fee revenue and $250 million
to $300 million in operating income the first year the policy was enacted (Halkias). This
is not counting the increased number of new releases the company needed to purchase to
meet customer demand due to the policy. Under the "no late fees" program, a customer
was charged the purchase price for a movie if it was kept longer than 14 days. The charge
was dropped if it was returned within 30 days, and the customer was then charged a $1.25
restocking fee (Halkias). Blockbuster then created Blockbuster Total Access in attempts
to compete in the online video rental market. With Blockbuster Total Access, customers
would pay a subscription fee of $24.99 a month and rent up to 2 movies online at a time.
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Netflix, the online DVD rental pioneer, sold a similar service for $21.99 a month.
Company CEO, John Antioco, said the overall online subscriber market is about 3
million to 5 million households, and he believes Blockbuster can attract a 30 percent
market share (Halkias). Blockbuster spent between 70 and 90 million dollars on the Total
Access program in hopes of reinventing itself. Program costs and continued decline in
rentals caused the company’s 2004 earnings to fall about 10 percent below the $1.48 a
share earned in 2003 (Halkias). The company will have to continue developing in this $8
billion dollar a year industry as it continues to change. Within another four years,
customers are expected to spend about $1.7 billion getting movies from cable to watch at
their convenience (Cohen). The video rental industry is also moving to legal downloading
sites such as CinemaNow Inc. Founded in 1999, the service lets people download movies
as a rental with a viewing window, or buy the film outright and burn it on a disc (Cohen).
Blockbuster hoped to leverage its infrastructure of brick and mortar locations to compete
with Netflix and Video on Demand operations. In 2006 it gave its customers the ability to
return online rental movies to stores to receive a free in store rental in exchange. Antioco
says of the effort, "It puts the online customer in the store. It creates traffic and
incremental revenues” (Mohl). In the first quarter of 2007 Blockbuster added 800,000
online subscribers to its Total Access program in the first quarter to end with 3 million
subscribers, beating Netflix's 481,000 new customers in the same period (Halkias).
Despite the increase in online customers, stores were performing lower than expected and
online costs were high, leading to a stock price drop of 81 cents after the first quarter of
2007 to close at $5.40 a share (Halkias).In 2008 Blockbuster’s main competitor Netflix
stepped up the competition with online movie download services and plans to expand
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into TV downloads. "Internet to the TV is a huge opportunity," said Netflix Founder,
Chairman and CEO Reed Hastings (PR Newswire). The sale and rental of movies over
the Internet will grow dramatically over the coming years and could reach nearly 60
million (59.4 million) units by 2010, with revenues skyrocketing to over a half billion
dollars ($534 million) (Business Wire).
Video Rental Industry
Porter’s 5 Forces Analysis:
Threats of New Entrants:
When the home movie/video game rental industry commenced, the threat of new entrants
was very high because video rental stores were mainly small local businesses. Operating
costs and capital requirements were low because customers demanded less selection.
Currently, customer demands are high and there are no switching costs. Barriers to entry
are higher now because huge capital requirements are needed to provide variety to
customers. With the emergence of the digital video realm, it is easy for big name Internet
retailers to offer movie downloads and rentals. The increase of piracy sites that provide
free movie downloads are emerging, making it harder to be competitive in the industry.
Nevertheless, copyright policy changes may hinder many new entrants from entering the
industry (Xie & Lin).
Bargaining Power of Suppliers:
Bargaining power of suppliers is very high since there are only a few of them in the video
rental industry. Revenue sharing agreements with movie production companies allow
major players like Blockbuster and Netflix to somewhat minimize supplier bargaining.
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Threats of substitutes:
Substitutes include movie theaters, satellite TV, and cable TV. The threat of substitutes is
high as customers can choose to go to a movie theatre for a different movie experience
and see movies before they come out on video. Movies on “pay-per-view” service from
cable companies are also attractive to the customer they are a very easy and convenient
option. Video on demand (VOD) allows users to select and watch video and clip content
through a network in an interactive television system (Xie & Lin). The main advantages
of video on demand and pay-per-view over movie rentals are that customers do not have
to leave their homes to go to a store and they do not have to worry about movie returns.
Rivalry among industry competitors:
The video rental industry is a highly competitive industry. Competitors range from
retailers such as Wal-Mart to Internet entertainment providers such as iTunes. Retailers,
like Wal-Mart and Best Buy sell movies in their stores and are now looking to sell online
movies as well. There are also video game and movie rental stores like Hollywood Video,
Blockbuster and Movie Gallery which provide brick and mortar locations. Netflix has
also become a major competitor with its online and mail delivery service. Publix and
McDonalds have also become competitors, as they have movie rental machines offering
movie rentals for one dollar a day. iTunes and many other Internet entertainment
providers are also entering the industry as competitors with movie downloads.
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Bargaining power of buyers:
Because customers have so many alternatives in the industry and switching costs are
almost nonexistent, their bargaining power is high. It is therefore important for businesses
in this industry to provide the variety of movie selection customers expect and the new
technology to ease transactions. Buyer bargaining power can be proven by the change in
customer preferences from VHS to DVD technology and with the recent introduction of
Blue Ray disks.
Blockbuster
Business Description:
Blockbuster Inc. is a global company in the industry of rental and retail sale of
entertainment movies and video games. By 2008, the company had over 7,800 stores in
the United States, its territories, and 21 other countries (Reuters). In Ireland it operates
under the Xtra-Vision brand and in Canada, Italy, and Mexico under the Game Rush
brand. Its stores offer movies and games for sale and rental. In 2008 they added to their
product line Blu-Ray DVDs. The company’s expansion and innovation has included
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offering monthly memberships, removal of late fees, movie home delivery, and now
online downloading.
Business Model: The key elements of Blockbuster’s business model are to:
Provide a large number of copies and broad selection of movie titles
Operate conveniently located and highly visible stores
Offer superior and consistent customer service
Optimize pricing to local market conditions
Nationally advertise and market the Blockbuster brand name
Improve efficiency and lower our costs through self distribution
History:
The Beginning: 1980s
Technological development has always been a part of Blockbuster’s business
model. In the 1980s, the video rental industry was very fragmented and was run mostly
by mom and pop shops. These small video rental shops had movies behind the desk to
discourage theft and movie selection was very limited. David Cook, former computer
software company owner, decided to streamline the video rental process through a
computerized system for inventory control and check out. In 1985, he opened the first
Blockbuster store in Dallas, Texas (Hoovers). The company was an instant success and
was taken over by investor Wayne Huizenga in 1987 (Hoovers). Huizenga invested 18
million dollars into Blockbuster. This was the start of the Blockbuster expansion.
The Expansion: 1990s
Acquisitions allowed blockbuster to have 1, 500 stores by 1990, just 5 years after its
opening (Hoovers). The company then started to expand internationally and opened
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stores in Australia, Chile, Mexico, Spain and Venezuela in 1991(Datamonitor). It also
became the largest video renter in the UK in 1992 by purchasing Cityvision (Hoovers).
Possibilities seemed endless until Viacom acquired Blockbuster in 1994 for 8.4 billion
dollars (Hoovers). Huizenga left Blockbuster immediately after the takeover and Steven
Berrand (Blockbuster’s CEO after the takeover) left only 2 years later. Bill Fields took
over the CEO position and restructured Blockbuster to not only be a rental store but to
also sell movies, books, CDs, gift items, and music. He resigned a year later and was
replaced by John Antioco. Antioco’s vision for Blockbuster was different and he started
undoing some of Fields’ efforts. In 1997 he forced the movie studios in a revenue sharing
agreement that replaced the standard practice of buying rental copies for as much as $120
each (Hoovers). It allowed Blockbuster to increase its movie variety and save more
money. The company winded up returning to its rental roots by selling Blockbuster
Music in 1998. By 1999 Viacom spun off a minority stake in Blockbuster (Hoovers).
Conflict of New Technology and Competitors: The New Millenium
In 2001 Blockbuster adapted to new technology by reducing its VHS and video game
inventory by 25% to make room for DVDs. To emerge itself in the new technology it
acquired Movie Trading Co., a used DVD trading retailer, in 2003. Blockbuster in 2004
eliminated late fees on all of its in-store rentals at locations in the US and Canada
(Hoovers). This was an action Blockbuster took to stay competitive in the market and
therefore spent 60 million dollars in marketing. They also ended up losing more than
$500 million in late fee revenues. This caused many Blockbuster franchisors to drop the
promotion and continue charging late fees. In 2006 the company, due to competitor
pressure, introduced Blockbuster Total Access, a movie rental program that gave online
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customers the option of returning their DVDs through the mail or exchanging them at
more than 5,000 participating Blockbuster stores for free in-store movie rentals
(Datamonitor). In July 2007, there was another CEO change in the company as James
Keyes replaced John Antioco. In 2007 Blockbuster decided to roll out with Blue-ray
disks for rental to 1,700 corporate-owned stores (Datamonitor). Due to even more
competitor pressure, Blockbuster acquired Movielink to provide movie download
services in the US in August 2007 (Datamonitor). The acquisition gave Blockbuster
access to one of the largest libraries of downloadable movies and a large array of
television content. Currently, Blockbuster and 2Wire are introducing the “2Wire
MediaPoint” digital media player, an easy-to-use, on-demand video solution, which
offers instant access through their television sets to Blockbuster (Datamonitor).
SWOT Analysis
Strengths:
1. Brick and Mortar Locations
Having many store locations provides convenience to customers. It also allows
customers to communicate any problems or concerns face to face with the staff,
an advantage over online services.
2. Geographic Coverage
Blockbuster is a global company and has stores in the US and 22 other counties
(Xie & Lin).
3. Diversified Offerings
Blockbuster delivers its products through in-store products, by-mail and by
downloads. Blockbuster’s diversified services portfolio helps in attracting and
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retaining customers by providing them the convenience of renting movies online
or in-store, and enables Blockbuster to reach customers where the company does
not have convenient store locations (Datamonitor).
4. Strong Distribution Capabilities
Blockbuster has 35 distribution centers and a distribution headquarter in
McKinney, Texas, which allows for fast delivery (Xie & Lin).
5. Cost Reduction Mechanisms
It has revenue sharing agreements with suppliers to help cut down costs of
operations. The company also closes unprofitable stores to control costs. It closed
84 outlets in Spain and shut down 150 stores in the US in 2006 (Xie & Lin).
6. Strong Brand Name
Blockbuster has been in operations since 1985 creating its well-known brand
name and reputation.
7. Game Concept
Game concept is a unique offer from Blockbuster that most of its competitors and
substitutes don't provide. Blockbuster had 480 store-in-store game locations in
2004 and continually grows in game market (Xie & Lin).
Weaknesses:
1. Weak Operating Performance
The company’s operating profits recorded a year-on-year decline of 47% in 2008
to reach a value of $39.1 million (Datamonitor). The operating margin also
declined from 1.3% in FY2006 to 0.7% in FY2008 (Datamonitor). The cash from
operations has also decreased as well limiting the company’s ability to fund its
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debt
2. Weak Interest Coverage Ratio
In 2008, Blockbuster’s interest coverage ratio was 0.44, it has declined from 0.72
in 2006 (Datamonitor). This indicates the company is having trouble paying
interest on its outstanding debt.
3. Debt
As of 2006, Blockbuster has total debt of $984.2 million (Form 10-k, 2006). The
debt could be attributed to Blockbuster’s cash flow problem that originated with the
elimination of late fees.
4. Lack of Mature Web Technology
Customers sometimes have difficulty finding information they need because the
website does not have a search engine (Xie & Lin).
5. Shipping Problems
Customer complaints include delivery time, product availability and reliability.
Customers have also complained that desired movies are not available, that
reserved movies stay in the order queue too long, shipping takes too long, or that
DVDs arrived with quality problems (www.forums.slickdeals.net).
Opportunities:
1. Movie Download Service
Blockbuster’s acquisition of Movielink will allow Blockbuster to offer unlimited
access to download movies. Business in the content downloading industry will
reach $1 billion by 2010 according to John Antioco's estimation (Xie & Lin).
2. DVD Vending Kiosks
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Blockbuster has started an initiative with NCR to launch DVD vending kiosks.
The company had a goal of 50 Blockbuster branded kiosks by the 3 rd
quarter of
2009 (Datamonitor). These kiosks will offer DVD rentals but, in the future, could
offer downloads and sales. DVD vending kiosks are expected to grow more than
60% in the next three years (Datamonitor).
3. Booming Video Game Market
According to industry trends, the worldwide gaming market is expected to grow
at a CAGR of 11.4% during 2007-10 to reach $46.5 billion in 2010
(Datamonitor). This could be beneficial for Blockbuster because of their
significant investment in gaming.
Threats:
1. New Technologies
The new video format video-on-demand, pay-per-view, and Internet downloading
method made new released movies immediately available from the studios before
they reach the video retailers (Xie & Lin). Online offerings are also taking
customers from in store rentals. The internet video downloading business requires
less capital requirements and therefore is appealing to more entrants.
2. Stiff Competition
Blockbuster is facing fierce competition from low priced DVDs sold by retailers
such as Wal-Mart and Target video-on-demand from cable companies, and on-
line DVD rentals by Netflix and iTunes (Xie & Lin).
3. Movie Piracy
Movie piracy is on the rise in both the US and international markets. Piracy has
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increased because of technological advances that allow for the conversion of
programming into digital formats to display over the Internet.
Netflix
Business Description:
Netflix is one of the world's largest online movie rental services that provide more
than eight million subscribers (Datamonitor). The online service includes over 100,000
DVD titles and over 12,000 of those are available for online viewing (Datamonitor).
Their online service includes movie ratings and recommendations. They have followed
Blockbuster’s footsteps in establishing revenue sharing relationships with studios and
distributors to save money. The company ships and receives DVDs through the post
office with postage paid return envelopes. Netflix can now also stream movies instantly
to members’ TVs through Netflix Player by Roku and PCs (Datamonitor).
Business Model:
The key elements to their business model are:
Customer service innovation
Expansion of internet delivery
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Market leader in content selection
Personalized choices for customers
Quick delivery with over 55 distribution centers
History:
Reed Hastings founded Netflix in 1997 and opened the world’s first internet store
to offer DVD rentals in 1998 (Datamonitor). That same year Amazon.com and Netflix
entered into a marketing relationship, where they would direct their customers to the
other. In 1999 Group Arnault invested $30 million dollars in Netflix, which allowed the
company to launch its subscription service (Datamonitor). To maintain an edge in this
highly competitive industry Netflix entered an agreement with TiVo in 2004 to develop a
technology for digital distribution. In order to improve their customer service to
customers they developed the feature “profiles” in 2005. This allows individual family
members to have their own movie queue in a single account. ForeSee Results twice
independently ranked Netflix number one in customer satisfaction across all of e-
commerce in 2005 and 2006 (Datamonitor). In further efforts to continue as number 1 in
customer service they introduced a new feature “Previews” in 2006 on their website that
allows members to watch movie trailers that have been personalized for them based on
their movie tastes.
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Competing Online Services:
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Financial Analysis
The Internet and the Netflix model, based on its use for connecting with the customers
and coordinating the distribution of different media, have affected Blockbuster in many
ways. One of the easiest ways to analyze the effect of the Internet in Blockbuster’s
operations is to examine its financial statements before and after the “boom” of the new
model and compare them with the ones of Netflix and the market trends.
Stock Price
The stock price reflects the present value of the future cash flow of a company, thus it is a
valid indicator to compare how the market forecasts the performance of each company.
The following graph presents a comparison between the historical stock prices of both
companies:
Figure 1 –Blockbuster and Netflix stock prices from August 1999 to December 2008
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Although Blockbuster’s stock has been traded before Netflix’s, it only took the new
competitor around one year to surpass its price. In addition, Netflix’s stock has reached
levels as high as $73, which Blockbuster’s stock has never achieved. Also, it is clearly
distinguishable that at the same time that Netflix’s price has risen, Blockbuster’s stock
behaves contrary, decreasing its value. Currently Blockbuster stock is trading at around
$0.80, while Netflix’s value is around $46. Since the first time Netflix outdid
Blockbuster, the old market leader has never been able to recover its superiority, so a
visible trend can be defined to describe which business model and company the market is
favoring.
Holding Period Return
An element closely related to the price of a stock is the return obtained for investing on it.
This case is another clear example of how the Internet model affected Blockbuster. In
2002, before Netflix’s stocks were traded, Blockbuster offered, on average, around a 3%
return, but since the new competitor appeared, that amount has decreased considerably. A
person who held Blockbuster stock since 1999, would receive, on average a negative
2.3% rate of return, which incidentally is the rate of return offered by Netflix, with a
positive sign, of course.
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Figure 2 –Blockbuster and Netflix average expected return comparison before and after June 2002
Sales
Sales are a key factor for the success of any business. Although by 2006 Blockbuster’s
sales were considerably higher than those of Netflix and still remained as an important
contender, an inflexion point was created in 2004 where it is clearly divisible how the
Internet model starts an increasing trend, taking sales revenues from Blockbuster. As you
can see in the following graph, a forecast can be made predicting that at some point both
sales will converge:
Figure 3 –Blockbuster and Netflix Sales from 1998 to 2006
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Net income
Taking into consideration the wide difference between the sales of each company, it
could be expected that the incomes would follow a similar pattern, but the reality is
different. Unlike Netflix that has generally had positive net income (it only had negative
net income from 2000 to 2002), Blockbuster has always had high levels of different types
of expenses that decrease their revenues, reducing their income. In addition, it is only
recently that Blockbuster has been able to achieve a similar level of income to Netflix,
proving that a fast growing company, with a business model based on the Internet can
manage their expenses very efficiently.
Figure 4 –Blockbuster and Netflix Net Incomes from 1998 to 2006
Current Ratio
The current ratio is an indicator of the ability of any company to pay back its short-term
liabilities with its short-term assets like cash or inventory. As we can see in the following
graph the appearance of Netflix did not influence the liquidity capacity of Blockbuster:
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Figure 5 –Blockbuster and Netflix Current ratio from 1998 to 2006
But it is also very clear that the model based on the Internet gives higher liquidity
capabilities to Netflix, which in turn reduces its necessity to incur debt, pay interests and
finance operations. Also, the current ratio indicates that Netflix has a much more efficient
operating cycle, turning its operations into cash faster.
Profit Margin
Although the profit margin ratio it is not a good indicator for comparing different
companies because different types of organizations are bound to different levels of
expenditures, we can observe in the following graph that the internal margin of
Blockbuster decreased from an average of -4% to -13.4% in the following years after the
appearance of Netflix. This indicates that Blockbuster would have to assume higher risk
if sales decline, erasing the possible profits.
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Figure 6 –Blockbuster and Netflix average profit margin comparison before and after 2000
Asset turnover
Even though Blockbuster has been able to increase the asset turnover ratio, it has never
achieved in its history such high level as Netflix in its comparable shorter life. This fact
demonstrates that the Internet based business model can be considered more efficient at
using assets to generate revenues.
Figure 7 –Blockbuster and Netflix asset turnover ratio comparison from 1998 to 2006
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The Future of the Video Rental Industry
1. Regularly downloading movies over the Internet to watch on wide-screen
TVs at home:
Movie buffs can download flicks from sites such as Movielink or CinemaNow for
$2-$5, and watch them on their computers. Movielink offers about 400 movies,
which take a half hour to 90 minutes to download, but you have the option of
starting the movie about 10 minutes into the download (Brush). iTunes also
offers movies for download for about the same price that customers can put on
their iPhones and iPods. The file lasts 24 hours but makes the movie rental
portable. Blockbuster customers can now also download rental movies on their
site.
2. Paying $20 monthly fees to rent "unlimited" movies that arrive and return
by mail:
Netflix customers pay $20 a month for up to four movies ordered online and
delivered by mail. Customers can rent more, once they return discs in pre-paid
mailers from Netflix. Blockbuster now offers a similar service that allows
customers to return movies both my mail and in the store. If movies are returned
in stores, customers can also check out replacement movies for free.
3. Selecting from large film menus offered by cable companies in viewing
formats that are just as convenient as DVDs and VHS tapes:
Cable subscribers pay $5 to $10 dollars on top of their normal cable bills to get
VOD and then pay $3.95 for recent releases, and $2-$3 for older films (Brush).
VOD is not yet a real threat because of little marketing initiatives and limited
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offerings. But current improvements in storage and file-compression technology
could prove favorable for VOD and a big problem for Blockbuster.
4. Buying DVD movie discs that "self-destruct" 48 hours after they're opened:
Buena Vista Home Entertainment, a Walt Disney division, began test marketing
these discs earlier this summer, with technical help from Flexplay Technologies,
at a suggested retail price of $6.99 (Brush). There are still some problems with
this technology, but once kinks are figured out returning movies could become a
thing of the past.
Conclusion
The Internet based business model used by Netflix has undoubtedly affected the
leadership position of Blockbuster. The use of the Internet, combined with other key
elements, naturally generates more efficiency in the operations of any company,
specifically the video rental market. The strength and the success of the new competitors
have completely changed the way the industry is approached. Blockbuster realizes this
evolution, which is the reason why the old leader has been striving to integrate their old
business model with the new technological trends to adapt to the force of the Internet and
its advantages. Netflix has been facing different challenges, but technology is once again
their main issue of concern. Netflix keeps looking for alliances to integrate with other
players to keep current with the latest industry trends. Nevertheless, only time will tell if,
in modern times, the media rental business can survive the challenges of technology and
whether the brick and mortar model will remain alive.
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