21 May 2009 • 1:32 pm

Blockbuster vs. Netflix: A Case of Technology-Driven Strategy

For a few years now, I’ve been doing a riff on Blockbuster and Netflix in some of my speaking engagements. It’s been a useful case for sharing many of my insights about strategic management and the role of technology in strategy (disclaimer: neither of these firms has been a client of mine, and my impressions have been formed only from publicly-available information).

The essence of the riff is this: Blockbuster built a very successful business model and then had its lunch eaten by Netflix. The key lessons we can learn from this case are:

  • Don’t underestimate the power of technology to change your competitive environment.
  • Constantly be looking for ways to challenge and reinvent your value proposition, or your competitors will do it for you.
  • Recognize and overcome the forces that will resist change in your own organization.

Let’s look at the history. Blockbuster opened its first store in Dallas in 1985. It grew rapidly through franchising, company-owned stores, and acquisition and consolidation of the thousands of independent “mom and pop” video rental retailers around the country. The value proposition was easy to see: convenient, economical, and reliable rental access to video and game entertainment, in a clean and family-safe (with no X-rated movies) environment. Viacom acquired Blockbuster in 1994 for $8.4 billion.

But Blockbuster’s fortunes have been on a long decline. Viacom floated shares in Blockbuster with plans for a full divestiture. The separation was completed in 2004, with Viacom taking a $1.3 billion charge for its trouble. Blockbuster stock, which traded above $29 a share in 2002, has recently been trading below $1.00 per share. Blockbuster’s market capitalization is less than $150 million, and trading was halted briefly in March 2009 on rumors of bankruptcy.

Billions of dollars in shareholder value lost. What happened? Netflix happened (although other, less significant forces contributed). Netflix was established in 1997 and has its headquarters in Los Gatos, California. Although it started with a conventional pay-per-rental model, it introduced its monthly subscription concept in 1999, and dropped pay-per rental soon after. Capitalizing on the shift from tape to disk media for video, Netflix’s business model exists entirely without a bricks and mortar retail presence.

The basic value proposition of Netflix has been to capture its customers’ DVD choices on its website (heavily driven by customized recommendations), and ship the chosen DVD to and from customers via U.S. Mail. Compared with bricks and mortar video rental stores, Netflix offers the convenience of website ordering and door to door service at the sacrifice of same-day service. In most cases, DVDs arrive in the mail the day after an order is initiated (either by request on the website or returning a previously rented DVD). Netflix’s success has certainly been due in part to reliable execution of its order capture and delivery processes. Netflix went public in 2002 selling over 5 million shares at a (split-adjusted) $7.50. After having incurred losses for a few years, it posted its first profit of $6.5 million on $272 million in revenue in 2003. Netflix recently traded around $40 per share, and has a market capitalization over $2.2 billion.

Don’t underestimate the power of technology to change your competitive environment

Netflix’s business strategy was entirely built on the basis of then-available technology. Environmental changes, such as higher penetration of internet access and broad availability of DVD players changed the landscape, and created opportunity. Of course, the technology was available to Blockbuster, which was certainly aware of environmental change. But Blockbuster was slow to respond.

Compared with Blockbuster’s retail video rental model, Netflix offered the value proposition of convenience, choice, essentially unlimited inventory, and of course low cost; all because the consumer interacts with Netflix using her computer, rather than having to physically visit a Blockbuster. Think about the layout of a typical Blockbuster store; nearly all the space is occupied by air. This air creates aisles that allows consumers to walk and see (often with some difficulty) the cover art and titles of perspective DVD rentals. The actual space necessary to store the DVDs is a small fraction of the space needed for an effective browsing environment. So Blockbuster incurs a huge overhead in real estate, as well as the relatively modest salaries of the clerks and store manager who probably aren’t offering you a lot of advice about what movie to see.

Although Blockbuster finally entered the online market in 2004, it hasn’t enjoyed the same success as Netflix. It was sued by Netflix in 2006 for patent infringement on the design of its online rental program (the case was settled with undisclosed terms). Recent measures of online traffic show that outdraws by a factor of about 5 to 1.

Constantly be looking for ways to challenge and reinvent your value proposition, or your competitors will do it for you

Despite competition from self-service rental kiosks from such firms as Redbox, Netflix seems unlikely to be overtaken soon by a competitor. Despite its current success, Netflix is in the process of reinventing itself. Netflix has added a “Watch Instantly” feature to its web site. At no additional cost, eligible subscribers are able to stream near-DVD quality movies and recorded television shows instantly over the internet. While the number of titles available now is limited, the inventory of Watch Instantly titles is growing rapidly. Netflix is now forming partnerships with electronics manufacturers to instantly stream movies directly to their devices. In May 2008 they released a set-top-box to stream Netflix’s Watch Instantly movies. While Blockbuster may have been competing with Netflix, Netflix today seems to be gearing up to compete with cable and satellite video distributors, as well as such studio-sponsored streaming sites as Hulu.

Recognize and overcome the forces that will resist change in your own organization

Without insider knowledge, we can only imagine what kinds of leadership meetings took place at Blockbuster when rentals began to decline in favor of Netflix and other competitors. What seems clear is that Blockbuster was unable to muster the courage and the tenacity to reinvent itself in the face of technology and environmental change. Netflix seems to be embracing the inevitability of change in its future.

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