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You may have heard the argument that this company was meant to be what Netflix is today. But it may not be all that simple. So, let's talk about Blockbuster, the movie rental giant that dominated the market and delivered home entertainment to virtually everybody in the US during a couple of decades, reaching its pinnacle in the late 1990s; and then succumbed to the changes that the new millennium brought.
Yeah, let's remember the old days of physically going to a video store, walking around endless shelves loaded with VHS or DVD movie titles and video-games, that you would rent to take home, enjoy, and then head back to the store to return them. The younger ones may find all that to be ridiculous, but for those in your mid-late twenties or more, it certainly brings a few memories. That's right, what is now just "Netflix and chill," whatever that means to you… back in the 80s and 90s was the whole thrill of the family trip to Blockbuster to pick up the weekend movies and luckily some popcorn and goodies.
In this episode, we will go over what happened to Blockbuster, how it managed to become the most significant movie rental service globally. We'll review its business model and what happened to it when on-demand video and online streaming emerged. That, of course, will bring us to the competition and how Netflix ended up stealing the show, even after unsuccessfully having tried to partner up with Blockbuster, only to later surpass and kill it.
This is Company Forensics: Blockbuster.
You may think Blockbuster is a perfect example of a business left behind by technology and new consumer behavior, and that may be partially right, as video rental stores were just naturally replaced by on-demand video and online streaming. There is this idea that Blockbuster was stubborn and resisted change. However, they did make attempts to evolve its business, even developed their own membership streaming service and other efforts that we'll review in a minute.
But at the end of the day, the truth is that by 2004 they had more than 9000 stores in the US and around the globe, employing more than 80,00 people. Those would sound like good numbers for any business, if only the Internet wasn't just about to take over and revolutionize the market entirely, leaving all those thousands of stores pretty much obsolete.
So, let's remember history and go back to the golden age of video rental to review the raise of this company.
The first Blockbuster store was opened in 1985, in Dallas, Texas, by a local entrepreneur named David Cook, who worked as a software developer for oil and gas companies, mainly writing computer programs to run inventories. The oil industry wasn't doing good that year, and Cook started looking for new business streams. Along with his wife, they got interested in the video rental business, and thanks to his background, they realized that most video stores were mainly small, family businesses with a reduced inventory of their movie titles and therefore limited offer to the public. All this gave Cook the idea to create the first super brand for video rentals.
His background proved useful when they finally opened the first Blockbuster store with an inventory of 8,000 tapes and a brand new computer system to manage it, making the rest of the local stores look very modest. The store was a hit, and they realized there was a bigger appetite for video rental than they first expected, defeating the idea that rentals were mostly exclusive to movie hits and new releases.
Encouraged by this initial success, the Cooks set out to raise money for further expansion with an initial stock offering. They started franchising the brand and built a $6-million warehouse to help sustain and support future growth by allowing new stores to open quickly. Interestingly enough, Blockbuster stores reportedly had a custom-made inventory to their neighborhood, based on local demographics. Yeah, call that a handcrafted algorithm. Aha.
Among other things, the efficiency in inventory management allowed Blockbuster to be the only video rental to have the actual tapes and discs displayed on the shelves. With this, the public could just pick them up, checkout in the counter, and leave, as opposed to the traditional procedure where stores would showcase empty boxes and then have to go to the back and get the actual movies for the customer.
That somehow reminds me of how ToysR us changed the concept of toy stores by merely stacking up toys on shelves and hallways for the first time. Check that video here.
But after the initial investment, the Cooks had a hard time raising money for more expansion, and soon Blockbuster was facing significant debt. Cook was also starting to worry about the rise of cable TV and the threat that it could pose to video rental. So, less than two years later, he sold the majority of the company to a group of three investors who already owned some of the franchises. One of these investors was Wayne Huizenga, an accomplished American businessman that ended up becoming the head of the company.
As opposite to Cook's vision to expand through franchising, Huizenga went on a relentless expansion and instead bought back most of the franchised stores, further absorbing the market by acquiring most of the leading video rental chains of the country. By 1987, Blockbuster was operating 133 stores and had become one of the country's largest video chain in terms of revenue. Sales went from $7.4 million in 1986 to $43.2 million that year. By the end of the next year, there were already 400 Blockbuster stores.
However, at that crazy growth pace, soon in the early 90s, the video rental market started looking saturated in the US, and it became evident that this expansion was eventually going to reach a top. Entering the new decade, the company's earnings came from an impressive 114% growth rate in 1988 to a still-great 93% in 1989 down to a good 48% in 1990, starting to show a concerning trend.
Besides this, the threat of cable TV companies was getting real. For reference, in 1991, Time Warner announced it would upgrade its cable system, and only three days after that, Blockbuster's shares dropped more than 10 percent.
So, the company soon started looking for expansion abroad and continued its strategy of acquiring more of the leading video store chains in countries like Japan or the United Kingdom, where they bought the largest one at the moment, Citivision PLC, for $135M. Expansion continued later to other European and South American countries, finally reaching a presence in 24 countries in the coming years.
In 1992 Blockbuster went on a series of agreements to diversify the company's operations beyond the core movie rental business. Soon came other incursions like Blockbuster Music, a merger of some music companies, and things like an agreement with the British conglomerate Virgin Group to set up megastores in the US, Europe, and Australia. Already in December that year, the first such store opened in Los Angeles. Huizenga envisioned these stores not only renting videos, but also selling and renting music, computer programs, games, and other in-store attractions like arcades and even live performances.
Yeah, he even dreamed of a full-blown amusement park, but as you know, that never happened.
By 1993, the multi-billion blue and yellow Blockbuster logo was in more than 3,400 video stores worldwide. With its ever-growing corporate activities, Blockbuster was committed to diversification as a means of ensuring its future, and its response to facing the advance of new formats like video-on-demand and satellite TV. This strategy reached a peak when the company went for a $4.7 billion valuated merger with media giant Viacom Inc. It was also Huizenga's sign off from the company, as he would leave just shortly after.
That merge deal was controversial, as it reportedly was an unprecedented move from Viacom in its plan to take Paramount out of QVC Network's hands, in the epic bid war they held to own Paramount. Viacom and Blockbuster valued their stock-swap merger at $8.4 billion, and Viacom said it would raise its bid to $105 a share, totaling $6.5 billion, for 50.1% of Paramount's stock.
But back to Blockbuster, this can be considered the beginning of the end. And we haven't even talked about Netflix, but we'll get there just now. So, under Viacom's tutelage, the company pretty much stopped growing and started the downhill. During the early years of the new millennium, Blockbuster's competitors included cable and satellite companies offering video-on-demand, online movie rentals offering mail-orders, and large retailers like Wal-Mart Stores that sold inexpensive movies and games.
All this left Blockbuster sort of besieged for the years to come, but there were also a series of questionable decisions they made. For example, they turned down deals that would later prove very successful, like rejecting an exclusivity deal from Warner Bros., to rent new DVD releases for some time before they went on sale to the general public. Blockbuster turned the offer down, and the studio responded by lowering its DVD wholesale price to compete with the rental industry. Walmart seized the opportunity and a few years later surpassed Blockbuster as the studios' single largest source of revenue.
Oh, and yeah, they also turned down not one, but to deals from Netflix. First, in 2000, they decided not to acquire the platform for $50M. Later they also turned down Netflix's offer to run Blockbuster's online video service. Right, it's hindsight to blame them for turning these deals down at the moment; after all, Blockbuster was still a giant trying to hold on to the top by then.
In 1999, Blockbuster went public and released an IPO at $15 a share, below the range analysts who follow the industry had anticipated. They didn't raise the money they had expected, making around $465M. Fast forward ten years, and in July 2010, Blockbuster was delisted from the New York Stock Exchange.
But back to the 2000'2, they went after other salvation-type operations like partnering up with Enron in 2004, to develop their late video-on-demand platform, in response to what Netflix had been successfully doing for years now. Doing most of the work, Enron built a robust video-on-demand platform that was developed and tested with customers. But soon, they faced the fact that Blockbuster was still so focused on keeping at bay the once-lucrative video stores, and doubted that they wouldn't supply enough titles and support for the video-on-demand business. As a result, the whole thing was just canceled, and Enron's stock plummeted afterward.
Within a few years, Netflix and other competitors began to eat into Blockbuster's profits, not by undercutting it, but by reinventing video rental in the digital age. So, let's take a quick look at business models and what Netflix was doing to innovate while Blockbuster moved through the new millennium with the clumsiness of an old giant.
You may have heard the cheesy story that Netflix was created after its founder, Reed Hastings, was upset for having to pay $40 on late fees for returning a movie to Blockbuster, allegedly, Apollo 13. It is probably just an adorned anecdote, but it certainly reflects how stubborn Blockbuster was, holding on to obsolete business models and practices like those hated late fees, while others like Hastings, were working towards reinventing the industry.
Yeah, late fees, we all hated them, but they were kind of a necessary evil to the rental business model, and Blockbuster stuck to them until very late in the mid-2000s. Of course, the profits from those late fees were fat, accounting for an essential percentage of the company's earnings, reportedly generating incomes of up to $800M at one point. Yeah, that sounds greedy. And even when they tried to get rid of them, they didn't. In 2005, they implemented a new policy that charged you the full price of the movie or game after eight days, which you could cancel by returning the product in question and paying a restocking fee. The move backfired, and more than 40 states filed suit against the company for false advertising. Ouch.
On the other hand, already in the late '90s, Netflix was experimenting with new ways to rent movies, non-dependant on brick and mortar stores, and started their DVD mailing system. Let's make a quick comparison of both models.
You already know the traditional Blockbuster way. It had physical stores where you would go, pick up movies, take them home for three days and then head back to the store to return them. With time, this concept was enriched with in-store attractions and related sales, making it an enjoyable experience. Remember the excitement of going after the new movie releases or picking up the latest video games after having walked around the store, laying your eyes on all the titles. It was undoubtedly a weekend plan for families and friends.
But then, of course, was the pain of going back to return them after only three days, or assuming the punishment of paying those hatred late fees. There was certainly a lot of mobilization there and the collateral pains of it.
On the other hand, Netflix was looking for ways to simplify the process and even get rid of late fees, despite they also had them in the very beginning. So, they came up with the DVD mailing system, where you would sign up for a membership and be able to choose movie titles to be directly mailed to your home, so you didn't have to move. Once you were done, just sent them back, with prepaid return envelopes that were also provided. This felt new and fresh at the time, but they only had around 300,000 members, as opposed to the millions in Blockbuster. Later on, with this system, you would only get new movies after you had returned the ones you got, allowing you to get rid of late fees.
But this mailing system relied on the postal service and implied waiting one day or more to get your movies when in Blockbuster you could just go and pick it up. Also, the movie catalog Netflix offered at first was just ridiculously smaller than Blockbusters.
However, this placed Netflix as a fresh face in the market and made manifest their will to innovate and provide different, better solutions to movie rentals. But in the process, they realized Blockbuster's competition was still just smashing in terms of magnitude, and it was then when they proposed to sell them the company. For Blockbuster, turning down the offer ended up being bitter, very bitter… but for Netflix, it ended up being a good thing, as it probably urged them to push harder towards innovation and competition.
For some time, Netflix had considered offering movies online, but it was only in the mid-2000s that data speeds and bandwidth costs had improved sufficiently to allow customers to download their films. The original idea was a "Netflix box" that could download videos overnight, and be ready to watch the next day. By February 2007, they had delivered its billionth DVD and began to move away from that original core business, by introducing video on demand via the Internet. And we all know the rest of the story.
In January 2013, Netflix reported that it had added 2M US customers during the fourth quarter of 2012, reaching 27.1 million streaming customers in that country and a total of 29.4 million total customers globally. Already in September that same year, Netflix reported its total of global streaming subscribers at 40.4 million. Four years later, by October 2018, Netflix's customer base more than tripled, reaching 137 million worldwide and confirming its rank as by far the world's largest online subscription video service.
So, yeah, at the end of the day, maybe Blockbuster was meant to be what Netflix is today, considering they were the single most prominent brand in movie rentals and had the business muscle to lead an industry revolution. And yeah, they were stubborn about sticking to brick and mortar stores and those lucrative late fees from the old business model. Clearly, they failed to evolve the business alongside technology and new consumer behavior.
It's arguable, and maybe a bit unfair, to say that their biggest mistake was to turn down on Netflix. In hindsight, we know that closing that deal would've provided them with the new blood required to innovate their already large business, and if that had happened, maybe the color of online streaming wouldn't be red as it is today, but blue and yellow instead.