Competition in the Movie Rental Industry: Netflix and Blockbuster battle for Market Leadership - Research Paper Example

? Competition in the Movie Rental Industry: Netflix and Blockbuster battle for Market Leadership Table of Contents Table of Contents 1 Introduction 2 How Netflix Outmaneuvered Blockbuster in DVD Rentals 3 How Netflix Surpassed Blockbuster in Online Video Streaming 4 How Netflix Competition forced Blockbuster into Bankruptcy 5 Current Challenges to Netflix Business Model 7 Blockbuster’s Future as a Consumer Brand and Business 9 Conclusion 10 References 11 Introduction Blockbuster Inc. built an international franchise business around the video tape rental industry based primarily in VHS technologies in the early 1980’s, starting with a single store opened in Texas by founder David Cook and his wife Sandy. The pair secured additional financing and investment to expand operations by the managing partners of the Waste Management company. (FundingUniverse, 2011) Blockbuster went public in 1986, and management was taken over by Wayne Huizenga, one of the founders and chief investors in Waste Management (NYSE: WM). Huizenga enacted an aggressive expansion policy, purchasing a number of independent video rental chain stores and franchises, and converting these stores into Blockbuster video rental shops under the national brand. Huizenga brought in investors from the entertainment industry, electronics manufacturers, and other multinational companies in order to scale the company to become an international franchise. By 1993, Blockbuster operated “more than 3,400 video stores worldwide, about one-third of them overseas”. (FundingUniverse, 2011) Huizenga then negotiated a merger with the media company Viacom that valued Blockbuster at over $4.6 billion USD. (FundingUniverse, 2011) By 1999, Viacom spun off Blockbuster from its corporate structure in a second IPO that was motivated by the losses incurred in the video rental and retail operations of the company. Netflix was founded in 1997 by Reed Hastings and Marc Randolph in California, and proceeded to swiftly outmaneuver Blockbuster in the rapidly changing video, DVD, and online streaming video markets in the U.S. and internationally, ultimately forcing Blockbuster to declare bankruptcy in 2010. Blockbuster’s inability to transform its legacy operations to meet the consumer dynamics and demand of the digital media industry left it unable to meet the challenges to its business model offered by Netflix. How Netflix Outmaneuvered Blockbuster in DVD Rentals Netflix offered a low-cost video rental service that is widely regarded as changing the industry and undermining Blockbuster’s “bricks and mortar” strategy of operating thousands of retail stores with a large number of sales staff and other employees. Netflix’s innovation was to offer DVD rentals by mail, to allow flexible rental policies that did away with the “late fees” that Blockbuster customers had come to abhor, and utilized the growing internet and web technologies to streamline operations as well as make services available to a wide segment of the population. With Netflix, customers could rent video titles that they selected from an online catalog and receive them often within one day through the U.S. Postal Service. Netflix provided the users a postage-paid return envelope that could be used to return the DVDs at the customer’s leisure. In this manner, Netflix created a decentralized national network in the U.S. with over 50 distribution centers that provided unlimited video rentals for a flat monthly fee and used the government-subsidized costs of U.S. Post Office services for a competitive advantage over the “video store” model operated by Blockbuster. (Thompson, 2008) While Blockbuster was paying retail employees to staff physical store operations in major mall and min-mall locations across America and internationally, with rent, utility, staffing, training, and other overhead costs, Netflix was able to offer its services through warehouse shipping and delivery centers operating on the Amazon.com model at a reduced cost in comparison to Blockbuster. While Netflix’s operations likely would not have succeeded with VHS videotapes due to the size of the shipping requirements, the new DVD technology was perfect for mail-order rentals in its light, compact size. What is critical to understanding the success of Netflix in outperforming Blockbuster was the fact that it had invented an entirely new model for video-rentals using the online and postal delivery system, that this model under-cut Blockbuster’s margin and advantages through a lower cost of operations, and Blockbuster’s management team failed to react decisively to counter this competitive threat or to introduce services in the same sector that were received popularly by consumers. Blockbuster assumed that its VHS video rental business model could be updated and repeated by simply converting stores to offer DVDs, but the inherent economic inefficiencies in this model gradually allowed Netflix to outmaneuver Blockbuster by reinventing the DVD rental industry. How Netflix Surpassed Blockbuster in Online Video Streaming The second way in which Netflix outmaneuvered Blockbuster in the video rental industry is by quickly innovating in the online space related to “streaming digital video”. While the VHS technology that Blockbuster built its video rental business on is related to analog technologies, the DVD and Blueray formats relate to the transformation of video, cinema, and movies to the digital format. In the early days of the internet, the computing devices lacked sufficient memory, storage, and bandwidth in internet connections to be able to offer digital video competitively online. However, after the year 2000 and the advent of YouTube thereafter as an online digital video distribution network, the advances in personal computers and broadband data-transfer speeds on the internet gradually enabled more and more consumers to consider an online “streaming” option for their video rental needs in entertainment. Streaming video is related to “video on demand” that is offered by various pay-per-view cable networks through subscription services and also by satellite TV operators. Both streaming video and video-on-demand services generally leverage the digital conversion of media titles, using a network of servers, databases, and the internet to deliver media titles to consumers directly. Analysts felt that streaming online video and video-on-demand services could prove disruptive not only to DVD rentals, which displaced VHS in the consumer market based on changing technological standards, but also the traditional mainstream cable, theatre, and television markets. Therefore, Netflix’s early entry, organization, and operation of digital streaming services coupled with its DVD-by-mail rental services was seen as challenging not only to Blockbuster, but also to Hollywood and network TV business models. Many analysts saw online streaming video on demand as the future of the entertainment industry as a whole. How Netflix Competition forced Blockbuster into Bankruptcy At the time of Blockbuster’s bankruptcy in 2010, the company had still over 25,000 employees in its organization, due primarily to its continued focus on operating the legacy retail store operations. (Humer, 2010) In contrast, in 2011, Netflix still has just over 2,000 total employees in its organization, and this critical difference in business structure and operating models can be seen as providing a huge advantage in cost-savings over Blockbuster. Before its bankruptcy, Blockbuster had been repeatedly closing its franchise and company operated retail store locations across America and internationally. (Thompson, 2008) With the “bricks and mortar” strategy of operating retail video rental stores, which worked so well for Blockbuster in the VHS era, the Netflix model easily outperformed due to the decentralized and online nature of its business model. Consider the salary costs of the Blockbuster employees required to staff retail locations, the cost differences between management and retail staff, the turn-over of employees, the provision of benefits, insurance, decoration, distribution, marketing, advertising, and other costs for each store, it became quickly clear to Blockbuster, its shareholders, and analysts that the company would lose money in operations when challenged by Netflix’s rapidly expanding web-based operations. This can be seen on one hand as a failure of Blockbuster management to understand the changing technological environment and its effects on consumer buying patterns, as well as an inability to adapt quickly and innovatively enough in developing new corporate strategies to take on Netflix in new media. Netflix grew its base of subscribers quickly at Blockbuster’s expense, scaling from 107,000 total users in 2000 to over 6 million subscribers in 2007. (Thompson, 2008) “In 2008, Netflix had more than 2 billion movie ratings from customers in its database, and the average subscriber had rated more than 200 movies.” (Thompson, 2008) This fact shows how Netflix managed to leverage the transformation in web technologies such as social networking, dynamic user content, algorithms for content suggestion, and streaming online video to take away Blockbuster’s core business customers. In this contest, Netflix led the industry in innovation while Blockbuster merely prepared imitations of Netflix services in response. Netflix grew gross corporate revenues from $35 million USD in 2000 to over $1.2 billion USD in 2007. (Thompson, 2008) In contrast, Blockbuster posted “losses of $1.1 billion” in 2010 and filed for corporate bankruptcy, with legacy operations including the brand valued at only $24 million. (Carr, 2010) While Netflix is experiencing its own problems relating to its streaming video catalog of titles, Blockbuster was purchased by the Dish Network out of bankruptcy for a total of $324 million USD in 2011 delivered to its debt-holders. The Dish Network announced that “the deal covers ‘substantially all’ of the rental chain's business, and likely gives Dish the rights Blockbuster had to stream movies over the Internet, the Blockbuster brand name and customer lists.” (Hals & Baler, 2011) Thus, the Dish Network will attempt to resurrect and revive Blockbuster to challenge Netflix again in streaming online video, digital content, and use its retail outlets to additionally sell and market its satellite TV services. Current Challenges to Netflix Business Model Netflix has become a victim in some ways of its own success, as the popularity of its digital video on demand streaming services that are operated online are very popular with consumers, and subsequently threaten the business models of old media companies such as TV stations, film studios, and cable companies that provide the content and distribution for Hollywood and American television broadcasts while receiving significant advertising revenue in association with these operations. Netflix is an online, internet based video channel that potentially includes over 12,500 different movies that consumers can watch at any time, from any place, commercial free if they have a computer and broadband connection. This means that consumers may prefer to “watch what the feel like in the moment” via Netflix from the internet rather than tune into the scheduled TV channels through cable, satellite TV, or broadcast stations. The current state of American corporate organization is such that many of the Hollywood film studios, television production studios, and cable companies have merged into giant conglomerate and shell companies that manage these services in competition with each other on an international basis. As such, these companies have billions of capital available for investment and significant resources in infrastructure, media, and management teams that are eager to introduce services similar to what Netflix has developed from their own studio offerings. The networks, studios, and cable companies are not interested in having the online offerings “cannibalize” their own TV ratings and consequential advertising sales, however. Therefore, in the early days of operation, Netflix was able to work with film studios by offering them large payments for the rights to stream new and old media titles in digital format online. As Netflix was also making large payments to the same studios for films in DVD format, they were able to negotiate preferential terms that other start-ups in the same sector could not. Blockbuster as the industry leader in video rentals should have out-produced Netflix in streaming video from the start, and in doing so leveraged its long-standing partnerships in the entertainment industry. But instead it produced weak and late attempts to imitate Netflix after suffering serious losses to its store-based video rentals from Netflix’s online DVD rental and streaming services. Blockbuster, in fact, attempted to introduce web based video rentals by mail, but refused to give up its limited time policy and late fees, essentially offering an inferior product in comparison to Netflix, and being rejected by consumers. Netflix faces threats by Amazon.com, Google, Apple via iTunes, and the major studios with their cable, TV, and mass-media partnerships that may create an increasing threat to its services as they compete for consumer popularity. As these companies launch their own online sale of digital video titles from database-driven or “cloud” websites, tie up exclusive licensing and marketing deals with studios, and force up the costs for Netflix’s own access to titles for its DVD and streaming options, it could see consumer support migrate to other services, increased business costs, and the inability to maintain its historical growth rates. Netflix stock (Nasdaq: NFLX) has already dropped from over $304 USD per share in 2011, to as low as $103 per share. Nevertheless, Netflix still has the potential to be bought or taken over by any of the other media conglomerates or an IT giant like Google, Apple, or Amazon. Blockbuster’s future will in turn be in managing legacy operations as part of the Dish Network and attempting to compete with Netflix in regaining its market-share and consumer support. However, Blockbuster must also compete with the other competitors in IT, Film, TV, Cable, Satellite, and Mobile-Telecom who are also beginning to introduce competitive offerings in digital video streaming and on-demand services. Blockbuster’s Future as a Consumer Brand and Business Blockbuster’s future will be as part of the Dish Network, owned by the EchoStar Corporation and headed by CEO Charlie Ergen. (Hals & Baker, 2011) The Dish Network will continue the re-organization of Blockbuster’s retail store locations as outlets to sell satellite TV which includes video-streaming, on-demand, and pay-per-view services. This partnership may be beneficial for the Blockbuster retail chain, as the company had sought to re-invent its retail outlets by offering video game rentals, video console sales, Blueray disks, and also high-end consumer DVD & Blueray players for the consumer market. When combining the possibility of using the online DVD and video game rentals with streaming video offerings, Blockbuster could continue as part of this network for many years, though undoubtedly the number of retail store locations will be reduced. Conclusion The entertainment industry operates in tandem with information technology in the 21st century, as companies such as Google and Apple are “reinventing” television and film distribution with YouTube, iTunes, and the popularity of the iPhone, iPad, and Android devices. Netflix tapped into the wider popularity, growth, and change in the internet community in a manner that simultaneously reflected new patterns in the consumer lifestyle. Netflix enjoys popularity such as Facebook, Amazon, Google, and Apple find with consumers, and represents an important change to the industry in offering streaming digital video catalogs over the internet. Netflix’s core DVD rental by mail through its web interface, and its low cost model vs. Blockbuster’s “brick and mortar” approach based around retails stores and employees allowed it to maintain a competitive advantage. The result of this was the rapid growth and expansion of Netflix’s revenue and subscribers, while this primarily occurred at the expense of Blockbuster’s core video rental operations. Redbox has also entered the kiosk DVD rental market in partnership with fast-food locations like McDonalds, and represents another rising threat to both companies. Similarly, media industry consolidation between studios, TV, Hollywood, cable, and mobile telecommunications companies suggests increased competition in this sector in the future. Following the Blockbuster bankruptcy, Netflix faces a number of strategic challenges and industry headwinds that will force it to adapt or become a take-over target for one of the larger media conglomerates or IT companies. References Carr, Austin (2010). Blockbuster Bankruptcy: A Decade of Decline. FastCompany, Sep 22, 2010. Retrieved from http://www.fastcompany.com/1690654/blockbuster-to-file-for-bankruptcy-a-decade-of-decline Cheng, Roger (2011). Blockbuster Movie Pass no Netflix killer. CNET News Digital Media, September 23, 2011. Retrieved from http://news.cnet.com/8301-1023_3-20110846-93/blockbuster-movie-pass-no-netflix-killer/ FundingUniverse (2011). Blockbuster Inc.. FundingUniverse.com, 2011. Retrieved from http://www.fundinguniverse.com/company-histories/Blockbuster-Inc-Company-History.html Hals, Tom and Baker, Liana B. (2011). Dish expands its scope with Blockbuster win. Reuters, Apr 6, 2011. Retrieved from http://www.reuters.com/article/2011/04/06/us-blockbuster-dishnetwork-idUSTRE7351VA20110406 Humer, Caroline. (2011). Blockbuster seeks turnaround in bankruptcy. Reuters, Sep 23, 2010. Retrieved from http://www.reuters.com/article/2010/09/23/us-blockbuster-idUSTRE68M10320100923 Sandoval, Greg (2011). Will Netflix comeback start tomorrow? CNET News Media, October 23, 2011. Retrieved from http://news.cnet.com/8301-31001_3-20124349-261/will-netflix-comeback-start-tomorrow/ Thompson, Arthur (2008). Competition in the Movie Rental Industry in 2008: Netflix and Blockbuster battle for Market Leadership. In 'Essentials of Strategic Management (2nd Edition),' edited by Thomas L. Wheelen and J. David Hunger, pp. 318-336. Retrieved from http://online.vitalsource.com/#/books/9781121078116/pages/32021859 Wasserman, Todd (2011). Blockbuster to Announce Netflix Rival on Friday [REPORT]. Mashable, September 23, 2011. 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