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Blockbuster Busted

Blockbuster Busted Part 2: A Business Model Analysis

Most people attribute success or failure to a product, service, or even technology. However, one of the most common thieves of a successful business is the business model. A business model is not just how you make money, or reach a customer, but everything in between—it is the entire value chain of how you develop the good or service and deliver it to the targeted customer segment.

In Blockbuster Busted Part 1: An S-Curve Analysis, it was evident that Blockbuster failed for multiple reasons—everything from strategic decisions to underestimating Netflix. Business models are often another reason a business suffers, and unfortunately it’s sometimes the last place leaders look to innovate. In Blockbuster’s case, the business model didn’t change fast enough and by the time it did, it was too late.

In a recent post, we looked at the Business Model Architecture, its 11 components and how they can be mined for innovation opportunities; the architecture and its components are key to staying relevant to your customers and to financial well-being. In this post, we’ll revisit our story of Blockbuster Busted, specifically in the context of how its business model didn’t keep up with customers’ needs or the competition.

Over a 30-year period Blockbuster went from a dominate force in the movie industry to nothing more than a brand name. Netflix was a reason for that, but not the only one. Blockbuster’s business model not only attributed tremendously to its initial success, but also to its demise in 2013. The Blockbuster and Netflix business models are dissected here over four stages, each at a chunk of time where each company developed, modified, or innovated their model to become that much more competitive.

Stage 1: Blockbuster Rules the Roost

Back in its heyday, Blockbuster was a formidable force, owning much of the movie and entertainment market. Once a movie left the theater or new video game was released, Blockbuster was the first to have it, in stock and ready to provide hours of entertainment in the comfort of your home. At its peak, Blockbuster had over 9,000 stores and millions of customers.

Not only did Blockbuster provide the entertainment, but also the rest that completed the experience, including beverages, candy, popcorn, movie posters, video players and game consoles. Blockbuster was a one-stop shop that had it all, at thousands of locations just minutes away from home. Things were looking green, and Blockbuster felt no reason to think otherwise.

At the core, Blockbuster’s success was focused by three business model patterns: brick-and-mortar stores with thousands of titles, cross-selling other merchandise, such as beverages and candy, and rent over buy. Many other patterns emerged that enhanced the experience, but without stores, merchandise, and rental programs, the Blockbuster experience wouldn’t have been the same.

At the time, Blockbuster’s business model was pretty standard, yet incredibly robust. It delivered a strong core offering—renting movies—with an even stronger complementary offering—all the stuff: candy, pop and popcorn. You could even say this was part of the customer experience; for many it became tradition to rent a movie and popcorn on Friday night.

We have all been into a Blockbuster at some point and most likely rented there. I know I did, everything from movies to games to game consoles (my parents wouldn’t let me have one growing up so I rented one). The Blockbuster experience wasn’t complete, however, without one thing—late fees. Truth be told, late fees was a huge revenue stream (at one point Blockbuster eliminated late fees, and later reinstated them because it lost too much money!). Between rentals, the concessions and late fees, Blockbuster made good money, and the back of the business, processes and resources, allowed it to keep operations fairly low-cost.

However, as the saying goes, don’t bite the hand that feeds you. In this case, late fees bit hard. It was a ridiculously expensive late fee on Apollo 13 that made Reed Hastings, just a customer at the time, ask one simple question: Why is renting a movie, late fees…the whole model just a hassle? There has to be a better way to give people access to movies without this. Thus, Netflix was born.

Stage 2: Blockbuster On Top, But Not for Long

Netflix was simple: a flat fee, subscription-based service that allowed customers to select movies online and have them delivered to their door. Each movie came with a pre-paid envelope. Just order online, watch at home, return from home, and receive the next one in just a couple days.

Netflix, no matter how creative the idea was, struggled mightily to stay afloat in the beginning. It was just a blip on Blockbuster’s radar, seen as a small movie rental company with a new, crazy idea to ship movies to customers at home. Netflix developed a unique business model, but it didn’t catch on right away, as most things take time, which the diffusion of innovation will tell you.

While Netflix provided movies directly to your home, there was something that Netflix did not provide, the one thing that had made every Blockbuster customer, at one time or another, angry: dreaded late fees. There was a logical reason Blockbuster didn’t want to lose the late fees. In 2000 alone, Blockbuster’s revenue was just shy of $5 billion, with $800 million, or roughly 16 percent of revenue, due to late fees. In 2004, Blockbuster finally established a “no late fees” program in many markets, but rescinded the program six years later citing significant revenue losses, some estimating $300 million a year. Late fees were just a part of Blockbuster’s DNA.

Leading up to 2007 proved to be the defining years for Blockbuster; its grave was being dug by both Netflix and a small rental kiosk outfit called Redbox. Redbox, started by just a handful of locations in 2002, didn’t have all the accessories and candy, but it did do a much better job satisfying the true customer’s Job-To-Be-Done—renting a movie. By 2007, Redbox had more locations around town than Blockbuster, but the real estate was quite different. Redbox was a 20-square foot kiosk while Blockbuster still ran massive video supermarkets.

For Netflix, 2007 was a turning point; it had tried to sell out to Blockbuster in the early 2000s. Luckily for Netflix, Blockbuster had wanted nothing to do with it. Soon after, however, Netflix started to cash in, and big. Customers were leaving Blockbuster in droves to the new movie rental delivery companies that promised so much more for less.

Netflix’s core business model hinged on delivering rental movies to homes with a tasteful promise: no late fees, ever, and very quick delivery turnaround. Customers could keep the movie as long as they wanted and just send it back. Customers could simply keep a profile online, update their “queue” and keep getting movies delivered as long as they kept paying the flat rate subscription service. For $6 to $15 a month at the time, you could have as many discs as you wanted with no late fees. I remember watching 10 plus movies a month. At Blockbuster, that would cost over $40, not even including late fees, which were just inevitable. With Netflix and Redbox, the world just didn’t need Blockbuster’s old school brick-and-mortar solution.

There were many reasons for Blockbuster’s demise, including CEO leadership and strategic decisions but a huge factor was the mind-set of retail brick-and-mortar video warehouses scattered across the world. This was a huge sunk cost that Redbox and Netflix just didn’t need to worry about. Everything for them was either digital or central fulfilment centers that serviced millions of customers. The multi-millions of real estate that Blockbuster had in the balance sheet didn’t exist for the new solutions, and it never would.

Stage 3: Netflix on Top

Netflix was on a tear. From 2004 to 2013, Netflix grew, on average, 31 percent a year, revenues were up 16 fold while subscribers, Netflix’s core revenue generator, grew from 1 million to 36 million. Blockbuster was feeling the opposite. Blockbuster peaked in 2004 with 9,000 stores, and then declined from 2004 to 2013 at a rate of -59 percent. By the end of 2013, Blockbuster had revenues around $120 million and declared bankruptcy. The difference in business models was primarily responsible.

In 2007, Blockbuster ousted the current CEO and brought on Jim Keyes. He believed Blockbuster’s focus should not be in the digital space, but focusing on the brick-and-mortar model of physical stores with a core offering of renting movies and games.

Prior to this strategic shift, Blockbuster was positioned, at least on paper, to compete with Netflix. It had established a kiosk presence, Blockbuster Express, to compete with Redbox and an online rental portal similar to Netflix. Blockbuster at the time even had a unique value proposition that Netflix or Redbox couldn’t have competed with—the ability to rent online, at a kiosk or at a store, and then be able to bring the movie or game back to a store. For many customers, this was valuable; instead of having to wait two days to receive the next movie in the mail, a customer could simply take an online rental to the store and get another right then and there—instant gratification. However, customers didn’t really care, and it was a little too late. People had attached to the new shiny world of Netflix, being able to rent for a flat fee, watch whatever whenever, and return at will with no worry of late fees. Blockbuster’s fate was sealed, and Netflix was the new king.

Netflix’s core focus was on improving technology—more movies, better service and faster delivery. The only change between Netflix then to Netflix now: streaming content. People obviously loved Netflix for the ease and cost of rentals, but when streaming made its debut, droves of new and existing customers signed up. Content and options were limited, but it was another layer Netflix could use to penetrate new customers and markets, and to find new ways to stretch the value proposition even farther.

All of this was still driven around one revenue stream at the time: rentals. The difference between Netflix and other providers was that Netflix innovated a new way to put the pieces together that in the end created more value for customers. It had reached the level of critical mass and adoption; now it was up to Netflix to build on the model customers fell in love with.

One critical piece that made this possible was the dramatic improvements in broadband infrastructure. Without it, streaming wouldn’t exist. Could you even imagine trying to stream Avatar or House of Cards over dial-up? Painful.

Stage 4: Netflix Stands King of the Mountain

With Blockbuster out of the picture, the competitive landscape had changed. The war wasn’t fought on physical ground anymore, but in a digital space that was even less forgiving and harder to compete in. Netflix, and any other new entrant, would have to be smart, fast and innovate repeatedly to stay alive. And Netflix continued to do just that.

Streaming continued to grow and Netflix became not only a distributor of content, but also a creator. Original programming has become a strong keystone of success. Netflix and Amazon have both started to deliver original content, but even to date, Netflix is ahead of the game. Series such as House of Cards, Marco Polo, and Orange Is the New Black all became hits. Streaming, both licensed and original programming, became the core offering, and rentals became a complement.

To support this change, Netflix’s business model had to change dramatically. The existing rental piece stayed the same, but distributing and creating digital content came with different needs. Starting with the customer, Netflix innovated distribution channels by partnering with equipment manufacturers to integrate Netflix as part of the Smart TV experience and ISP providers to increase broadband speed and reliability. With streaming increasing, infrastructure has been key in enabling customers to watch shows and movies on demand. Digital content has also meant new resources, new talent and logistics knowledge, all of which were critical pieces to delivering value to millions at the end of the line.

The Takeaway: Don’t Overlook Your Business Model for Innovation

So what does all this mean for your business? Just count your blessings now because soon another younger, stronger, riskier you will make you suffer and eventually put you under? No! What it means is this: Nothing is sustainable; you can only improve your business so much; how you do things now most likely will not be relevant in the future; the world changes, and so should you.

It comes down to reinventing yourself. If you don’t, someone else will do it for you, and that probably won’t end well. Business model innovation is not the silver bullet, but it is one of those things that most overlook and can have the biggest impact.

Think about the following: Would these businesses still be around today if…?

  • If Amazon still only sold books
  • If Netflix only rented movies
  • If IBM only sold hardware
  • If (insert your favorite company here) only (did this one thing)

A few questions to consider here:

  • How does my business model create, deliver and capture value now?
  • How will my model need to change in the future?
  • How can I do more with less?
  • When do I need to start thinking about innovating my model instead of simply improving it?
  • How do my competitors do it?
  • Where in the model do most of the innovations within my industry occur?
  • Where can I innovate and receive the greatest impact?

The point is, every great company innovates in multiple areas, but one thing in common within all of them is the business model, and for one simple reason—business models are the foundation of how a business creates, delivers and captures value. If your business model cannot do that, what do you think your odds are of survival?

Derek Bennington is an associate at BMGI, supporting research and development of strategy and operational initiatives. He is an Advanced Kirton-Adaption-Innovation (KAI) certified practitioner and holds a TRIZ Associate certification from the Altshuller Institute. He is also the managing director of The TRIZ Journal.

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