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Classic Strategic Failures: Blockbuster

Disruptive innovation or incompetent leadership?

12Jun

Blockbuster is often held up as a poster child for companies left behind by disruptive innovation. They had the world at their feet, dominating the video rental market with thousands of outlets across the world. Then video streaming came along and it all fell apart. Netflix, the online subscription streaming service, now dominates the sector with more than 50 million subscribers. All that remains of Blockbuster is a few stores in Alaska, after the company declared bankruptcy in 2010.

When people talk about Blockbuster as having failed to keep up, however, they forget that Blockbuster was, until 2007, actually making strong headway in streaming, using its powerful position and tremendous resources to dominate Netflix. In fact, rather than a simple case of being left behind by its rival, the fall of Blockbuster was down to a series of massive strategic failures, an activist investor who thought they knew best, and one of the worst CEO appointments in history. It is a classic tale of a company that forgot its reason for being and thought it was the center of the world in its own right.

In 2004, Blockbuster was riding high. Since his arrival in 1997, CEO John Antioco had introduced some basic changes that had been tremendously successful, essentially focusing on making sure supply met demand. Too often customers were going to Blockbusters and coming away without their first choice because the store didn’t have enough copies. As Antioco wrote in Harvard Business Review, ‘Blockbuster’s biggest problem stemmed from its business model. Movie studios sold VHS cassettes to rental companies for about $65 apiece, so a store had to rent out each tape about 30 times to make back the money. That’s a big up-front investment for a product that most people want just during the few weeks after it first comes out. The whole industry was hurt by stores never having enough copies of new releases. We asked the movie studios to shift to a revenue-sharing system. We proposed that instead of buying the cassettes for $65 each, we would pay $1 a copy up front but give the studios 40% of rental revenues on their titles. Eventually they agreed. That allowed us to stock many more copies of hot titles and to advertise their availability.’

They backed up these changes with a new marketing campaign - ‘Go Home Happy’ — as well as ‘The Blockbuster Guarantee,’ which essentially said that if you come to a Blockbuster store for a really popular movie, it will be in stock, and if it’s not then you get to rent it for free as soon as copies become available.

These simple strategic changes saw revenues to $6 billion. But 2004 would prove to be the year that Blockbuster peaked. The advent of DVDs, which could be easily posted and would fit through a letter box, had opened up the market to DVD rental by mail. Netflix, and to a lesser extent Redbox, was making ground in the market. There was also increasing competition within the entertainment space from the internet, which was taking people away from their televisions, as well as more options from satellite television.

Antioco saw the way the industry was going. Perhaps not as fast as he could have but, given that Netflix was still in its infancy, it was certainly quickly enough to outflank them. Antioco began to push through two key policies that dealt with the issues Netflix created for them. Firstly, he got rid of the late fees. Although these brought in around $400 million in revenue, they were annoying for customers. Further, since Netflix was a subscription service, it had no need for late fees. Customers could watch a video for as long as they wanted or return it and get a new one. Blockbuster also invested heavily in their digital platform, Total Access, which launched in 2006.

Total Access was almost immediately successful. By March 2007, it already had 2 million subscribers - far fewer than Netflix’s 6 million at a time but the rate of growth suggests it would have easily outstripped them by the end of the year. Blockbuster began picking up Netflix customers who found the wait for their videos to arrive in the mail slow and cumbersome. With Total Access, you could take the DVDs back to a Blockbuster store, which allowed video junkies to get far more rentals for their money. Blockbuster had Netflix on the ropes, and Netflix CEO Reed Hastings was asking them to acquire his company. At a conference call with analysts in 2007, Netflix CEO Reed Hastings said Blockbuster had thrown everything at them but the kitchen sink. Blockbuster COO Nick Shepherd sent Hasting’s office a kitchen sink the next day with a note that read simply, ‘Here’s your sink.’

Then it all started to fall apart.

Despite his success, Antioco had problems. These came primarily from renowned activist investor Carl Icahn, who was challenging him at every turn. By 2007, Icahn had essentially gained control of the board, and did not like the direction Antioco was taking. This came to head when Icahn picked a fight over the CEO’s bonus, which he demanded be slashed from the $7.7 million promised down to $2.3 million. John Keyes, the retiring 7-eleven CEO (ironically, Antioco had also been 7-eleven CEO), was named as his replacement, and he immediately reversed Antioco’s changes in order to increase profitability. Keyes immediately cut spending on Total Access, and while subscribers remained stable at 3.1 million, there was no growth. Instead he focused on retail, choosing to turn Blockbuster into a one-stop entertainment shop selling everything you could need around watching a video in house. This was a strategy that Blockbuster had tried before. And it had failed before.

Ultimately, it was not simply that Blockbuster fell behind, it’s that it forgot why people used Blockbuster. You go to the Empire State Building for the view not to be inside the Empire State Building - if you black out the windows and start selling candy corn inside, people are going to stop coming. While many enjoyed the experience of going into a store on a Friday evening and browsing the shelves, the majority just wanted the video and to get hold of it in the most convenient way possible. Blockbuster Total Access was more convenient than Netflix as a mail order company, and would likely have outstripped it within the year. It is likely that as online streaming exploded, they would have largely remained with the platform. Having a large selection of movies to choose from was important, as Antioco realized - it wasn’t the act of walking into a store. Nobody likes going to stores, it’s exhausting.

Sources

Image credit: JLRphotography/Shutterstock.com

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