The immediate cause of Blockbuster’s death, as my colleague Mike Wolf noted yesterday, was the same phenomenon that has been killing off brick-and-mortar video rental stores for years now: the general shift in consumer behavior toward digital delivery of content over physical media, complicated by the rise of low-cost DVD kiosks such as Redbox. But Blockbuster’s story should also serve as a reminder that non-technological factors can also contribute powerfully to disruption and displacement of a business.
Long before streaming became widely available, Blockbuster suffered two major blows that had little to do with technology per se but left the company severely weakened, both strategically and financially.
One was the introduction of the DVD format in 1997, at a a time when Blockbuster was at the peak of its power in the industry. The Hollywood studios’ adoption of DVD, spearheaded by then-Warner Home Video president Warren Lieberfarb, was in large part an deliberate effort to shift consumer behavior away from renting, where Blockbuster to dominant, to purchasing videos, where it was not.
The VHS business was highly profitable to the studios on a per-cassette basis, but it ultimately limited the studios’ share of consumer spending on video. Prerecorded cassettes were expensive to manufacture because they needed to be duplicated in real time: a two-hour movie took two hours to duplicate. The only way to achieve scale was to wire a bunch of VCRs together at press record — an expensive proposition. High costs meant high retail prices for cassettes, which encouraged renting over purchasing.
In the U.S., however, rental stores are not required to share revenue with rights owners. Thus, the studios made money only on the initial sale of cassettes to a retailer. All the upside in consumer spending on those cassettes belonged to the retailer.
One of the main goals in developing the DVD format was to change the cost characteristics of physical media to allow for lower retail prices. Unlike VHS cassettes, DVDs could be stamped out at high speed and in bulk, like LPs and CDs, greatly lowering the per-unit cost. Lower costs meant lower retail prices, which allowed DVDs to be sold in a wide range of retail outlets that would never have gone into the video rental business. That meant more consumer spending on video overall, and a bigger share of the consumer dollar going to the studios.
The lower cost of DVDs also lowered Blockbuster’s cost of goods, of course, improving its margins in the short term. But the new format also brought Blockbuster new competition for consumer spending on video, from the likes of Walmart, Target and Best Buy. That massive loss of market share, as much as anything, set Blockbuster on a downward course from which it never really recovered.
As problematic as the introduction of DVDs was for Blockbuster it suffered another major blow in 2004, when it was spun off by Viacom.
Viacom bought Blockbuster for $8.4 billion in 1994 as a cash cow to help fund its acquisition of Paramount Pictures, among other things. When the DVD-driven shift from rentals to sales kicked in, however, Blockbuster’s cash flow took a serious hit, leaving Viacom with a mounting debt load and no cash cow to pay for it. When it finally spun the retailer off Viacom took a big chunk of that debt and parked it on Blockbuster’s new standalone balance sheet, making it Blockbuster shareholders’ problem.
Shackled with a debt-heavy balance sheet, Blockbuster was severely constrained in responding to new competitive challenges, such as the rise of Netflix’s DVD-by-mail business. It came up with a Rube Goldberg-like scheme to try to eliminate late fees without undermining its own cash flow, and got into a price war with Netflix, but any move it made that undercut its ability to meet its huge, Viacom-imposed debt obligations caused investors to hammer the stock. It eventually tried to bulk up by acquiring its largest brick-and-mortar competitor, Hollywood Video, only to have the Justice Department put the kibosh on the deal.
Even without those constraints, of course, Blockbuster would not, by itself, have been able to stop the general shift to digital delivery of movies, and its brick-and-mortar rental business would have suffered in any case. But Blockbuster the company might have been better able to respond to the challenges and perhaps weathered the difficult transition, such as by buying Netflix when it had the chance, or gobbling up Redbox.
The point is: business decisions matter, even where technology change seems to determine the course.