Wednesday, January 03, 2007

The Death of Blockbuster

Interesting piece from Edward Jay Epstein about the last days of Blockbuster:

In 1998, at the dawn of the age of the DVD, Blockbuster made a decision that would change the future of Hollywood. Warren Lieberfarb, who then headed the home-video division of Warner Bros., offered Blockbuster CEO John Antioco a deal that would have made the DVD the same kind of rental business as that of the VHS tape, which, at the time, provided the studios with $10 billion in revenue. Lieberfarb proposed that Warner Bros. (which, along with Sony, was launching the DVD) create a rental window for DVDs during which sell-through DVDs would not be available for new movies.

With this window, Blockbuster, which then accounted for nearly half of the studios' rental income from new movies, would have had the opportunity to rent out DVD releases before they went on sale to the general public. In return, the studios would receive 40 percent of the rental revenues that Blockbuster earned from DVDs, which was exactly the same percentage they received for VHS rentals. In fact, it was Sumner Redstone, whose Viacom conglomerate then owned Blockbuster, who personally pioneered the revenue-sharing arrangement for video. Only a few years earlier, Redstone had told Lieberfarb, "The studios can't live without a video rental business—we [Blockbuster] are your profit." Yet, even though Lieberfarb was only asking that the same deal be extended to DVD, Blockbuster, perhaps not realizing the speed with which the digital revolution would spread, turned him down.

Nevertheless, Lieberfarb, determined to make the DVD a success, went to Plan B: pricing the DVD low enough so that it could be sold to the public in direct competition with video rentals. Wal-Mart, seizing the opportunity for an enormous traffic-builder for its stores, began selling DVDs like hot cakes. By 2003, the studios were taking in three times as much money from DVDs as they were from VHS videos (click here for the actual numbers). In this reversal of fortune, Wal-Mart replaced Blockbuster as the studios' single largest source of revenue. Other mass retailers followed suit, often pricing newly released movies on DVD below their own wholesale price to draw in customers who might buy products with higher profit margins, such as plasma TVs. Blockbuster, with no other products to sell, became a casualty of this cutthroat competition for traffic. Not able to match these low prices, its rental business was decimated.

The other shoe dropped with the emergence of Netflix as a major online competitor for what remained of the rental market. (Blockbuster turned down the opportunity to buy Netflix for a mere $50 million, instead entering a disastrous home-delivery deal with Enron.) Netflix signed up over 3 million subscribers by 2005 by offering DVDs that could be kept as long as renters liked for a monthly fee. To compete, Blockbuster had to do away with its single biggest profit-earner: charging late fees to customers who kept videos past the due date. It also had to invest millions of dollars in a copycat online plan.

Of course, WalMart and Netflix may have killed Blockbuster, but won't online downloads soon do the same to Netflix?

Read the whole thing, and appreciate how Joseph Schumpeter would have loved it.

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