Why Netflix is Kicking Blockbuster's e-Butt

While I’ve always liked Netflix, I’ve remained dubious as to their potential for long term success.  Even when they hit their first million subscribers I thought little of it.  From my perspective, with tens of millions of customers, I figured sooner or later Blockbuster would just wipe out Netflix’s market share and opportunity. Instead, Netflix is en route to 9 million subscribers, and I’m more than a little surprised.  A conversation last night with a good friend of mine helped me understand why this is happening.  It’s a few parts Innovator’s Dilemma, and a few parts just plain bad business.  It’s a Cinderella story.  Outta nowhere.

In looking back on Blockbuster, their major rise to success happened during the VCR boom.  New movies were priced prohibitively for purchase ($80+ for a movie was not uncommon), so rentals dominated.  Blockbuster utterly mastered the art of creating a retail facility to rent video tapes.  In doing so, I believe they set the groundwork for their failure to convert to a successful Internet business.

First, it’s important to look at Blockbuster for what it truly is: an excellent Retail Business, whose product is Renting Movies.  Initially the format was VHS tapes, then as the shift to DVD occurred, the company adjusted.  If the next step was Blu-Ray (which it isn’t), and the primary market was consumers needing to rent content, Blockbuster would, hypothetically, be poised for a rosy future.  But that’s clearly not the case.

The DVD market saw a major change in pricing strategy for the content industry, with movies averaging $19.99-$24.99, and often much less.  This meant the movie rental business saw its first shift to the movie sales business.

Next up, due to the form factor, sending DVDs in the mail was a viable option, enabling Netflix to exist.  While Blockbuster has “toyed around” in the area of mailing DVDs, it’s a fundamentally different business than the Retail operations the company mastered.  In fact, when considering Netflix it’s very important to recognize their core strategy of distributing content based around personal recommendations.  Netflix is actually an excellent Movie Distribution Business, whose product was primarily Mailing DVDs.

As we look at the present, the world of Retail Businesses have seen enormous change, mostly due to e-commerce.  Additionally, the world of Movie Distribution Businesses have faced not just format changes, but also the massive decay of physical media formats.  Which is why Blockbuster has responded so poorly, and is so poorly poised for the future.  In a nutshell, Blockbuster isn’t about movies, it’s about retail movies, a world whose time has come.  Whereas Netflix isn’t about retails or formats, it’s about movies, and as the variables in that world change, Netflix can more easily change with them.

So even as we see Blockbuster dabble in the digital distribution world, the company needs a fundamental sea change in order to survive.  Interestingly, I don’t think there is anything that would prevent Blockbuster from digital success.  Per the NY Times article, there are plenty of other collaborative filtering tools to give them a great recommendations system.  They already have all the relationships and licenses in place in order to be able to offer literally identical services to Netflix.  They also have an incredibly strong brand to leverage, not to mention a massive customer database and distribution facility.

All they need to do is choose to operate a Movie Distribution Business, instead of running a Retail Business.  I think the simplest solution for the company is to create a spinoff entity, one not hampered by the P&L necessities of the retail organization.  This new entity should be run like a startup, be well funded, and given a couple of years to succeed.  They should have full access to the marketing vehicle that is Blockbuster, but none of the constraints or burdens of that organization.

Until then, I’ll enjoy getting my Netflix movies by mail.  I’ll watch it streaming on my Macbook, Xbox 360, or boxee setups.  If there’s a new release I can’t find within this setup, I’ll buy it through iTunes or through my HDTV cable box on demand system (something Comcast does extremely well, btw).  In the digital age, there can be many more than only one, but only time will tell if Blockbuster will be one of them.