A business sparked from late fees on Apollo 13 has gone on to completely recast the DVD rental market

By Jim Harris

Once upon a time, Blockbuster dominated the video rental business. It was big and powerful and Hollywood trembled during annual negotiations with the company.

Then one day in 2000, a tiny start-up company met with the Blockbuster execs. It offered to sell a majority of the company for a US$50 million investment. And the Blockbuster execs looked at the little company’s business model and decided it was deeply flawed. Instead, the wise Blockbuster execs signed an exclusive 20-year video on demand (VOD) deal with Enron.

The little rejected company was Netflix, and it soon grew up: as of May 2008, it was worth US$1.9 billion. Blockbuster is valued at US$345 million.

Supplanted by subscriptions 
Netflix — an online movie rental service with 8.2 million subscribers who can access more than 100,000 movie and TV titles — radically changed the video market. Its most popular subscription plan allows for three titles out at the same time, with no due dates, late fees or shipping charges on an unlimited number of rentals, all for $16.99 monthly. Subscribers select movies online and DVDs are delivered by first class mail, each with a postage-paid return envelope. This disruptive business model came to founder Reed Hastings when he had to pay $40 in Blockbuster late fees for Apollo 13.

Blockbusted profits
As Netflix grew, Blockbuster decided to “drop” its late fees, but its profitability took a huge hit: late fees accounted for 16 per cent of its earnings. Today Blockbuster renters have a seven-day grace period beyond the return date; they are then charged the DVD’s full value. Netflix, by contrast, truly has no late fees: members can have a video out for as long as they wish.

Also flattening Blockbuster’s profits is the weight of its brick-and-mortar stores. Instead of having thousands of stores in expensive retail locations like Blockbuster, Netflix’s 50-plus distribution centres in relatively inexpensive industrial locations guarantee one-day delivery to 95 per cent of U.S. residents. So what was once Blockbuster’s strength — dominant retail presence — is now its greatest weakness, because of huge overhead costs.

As a result, Blockbuster has been busy closing stores, shrinking from 9,100 locations in 2005 to 7,800 today.

In 2007, Netflix’s 1,300 employees generated US$1.25 billion in sales — almost US$1 million per employee — while Blockbuster’s 67,300 employees generated US$5.54 billion of sales, or approximately 90 per cent less per employee. It’s clear: Blockbuster can’t survive in its current form.

Digital to dominate
With YouTube doing 200 million video downloads per day, no on can ignore this is the way the market is moving.

Netflix is diversifying its business to gain market share in the video digital download market. In January 2008, it began offering most subscribers unlimited streaming of movies and TV episodes on their PCs. As Apple’s iTunes and Netflix rapidly expand their paid video download offerings, the death knell will toll more loudly for Blockbuster.

Other trends hitting Blockbuster:
> Wal-Mart’s muscle: 37 per cent of all U.S. DVD sales are through Wal-Mart, and sales dampen the rental market
> Cable companies are pushing Personal Video Recorders, and time shifting movies and shows also decreases rental demand
> Video on Demand’s growing popularity: why rent, when you can pay your cable or satellite company to watch on demand?
> File-sharing services such as Limewire allow the transfer of millions of movies a day

Canadian success
None of this is lost on us Canadians. Zip.ca, founded in 2004, is the Canadian equivalent of Netflix. It has 72,000 individual titles, 35,000 members and distribution centres in Ottawa, Calgary, Vancouver and Toronto. The most popular subscription is three DVDs at a time for $24.95 a month with no monthly limit. Sound familiar? Zip.ca will ship its 10 millionth DVD in 2008.

And we have just seen the launch of the Bell Video Store, a new download service with more than 1,500 movies and TV titles available. Bell is offering both rentals and movies to own. 
 

Jim Harris is the author of the international bestseller Blindsided, published in 80 countries worldwide, and The Learning Paradox, nominated for the national business book award. E-mail him at jimh@jimharris.com