Blockbusted! How Technology and Lack of Vision Took Down Blockbuster

Vid biz gets shaft from jolting techno-changes, quixotic consumers

The handwritten sign on the store at 85th Street and Lexington Avenue in New York City read: “To the community, We regret to inform you that this location is officially closed for business. — Blockbuster.”

It had been shuttered only a few days. Shelves were still stocked; there were Cokes in the freezer case and computer screens blinking. Amid the heavy foot traffic on a recent Sunday evening, passersby stopped to gape.

“Oh my god. Blockbuster’s closed. You can’t tell me that store didn’t do well!” said one woman.

Well, yes, we can.

Years of skepticism about Blockbuster’s future have finally come to a head in what can only be described as a mind-blowing shift in technology, retail trends, consumer taste and studio strategy.

The video rental market, embodied by 8,000-pound gorilla Blockbuster, has been a casualty, a metaphor really, of the shakeup, as consumers turn to the ‘Net, mass-market retailers and video-on-demand to rent or buy movies.

Dallas-based Blockbuster and its 9,100 stores, more than half in the U.S. — many with expensive leases in high-rent areas like 85th and Lex — has become a dinosaur almost overnight. The business itself risks becoming a vanishing species in its current form.

The crisis in a sense mirrors a similar slump in the box office this year, attributed to many of the same factors.

But Blockbuster’s also taken its own steps — some say missteps — that enhance a sense of turmoil.

Unlike its largest rivals, Blockbuster is simultaneously investing hundreds of millions of dollars in a new online service to compete with upstart Netflix, and losing hundreds of millions in revenue from a controversial no-late-fee policy launched early this year.

That’s created a massive cash crunch and fueled speculation of Chapter 11 — slicing the stock in half over the past six months alone.

We’re way beyond promises of better service and shorter checkout lines.

“Blockbuster will have to think of how it can reinvent itself. It’s already got popcorn, candy, and video games. But how do they move from being a video retailer to a broad entertainment retailer,” says one showbiz consultant.

If that’s indeed what they need to do. The company tried expanding its offerings a decade ago, soon retreating to its core biz.

Swapping and trading? Porn? Many insist adult entertainment, which it doesn’t stock, would perk up Blockbuster’s profits.

Even the most seasoned entertainment industry execs marvel at the speed of Blockbuster’s downturn.

It started when giant retailers like Wal-Mart started going after DVD sales, already thriving at Best Buy. Wal-Mart’s known for pricing a movie low, even below wholesale, in the first week to draw customers.

Wal-Mart now reps 30%-35% of the homevideo biz, Blockbuster about 10%.

“The shoe is so on the other foot from when I was at the studio,” agrees another referring to the vidtailer’s diminished marketplace clout.

The dramatic reversal gives studios more leverage in negotiating. But it’s a delicate balance. Despite an often-contentious relationship with Blockbuster and its CEO John Antioco, studios have no wish to see the vidtailer file for bankruptcy.

For one thing, Blockbuster is still a major customer of the studios and owes most of them money. And while it’s a much smaller revenue source that it was, cash is still cash and you don’t want to leave any on the table.

Blockbuster also a key place to studios look to monetize their B and C pics, which might not find shelf space at mass merchants as easily.

Plus, Wal-Mart’s muscle scares them.

“I think the studios would like a balance of power. They don’t want one delivery form to be dominant. They would prefer a healthy Blockbuster,” says Brian Mulligan, former co-chairman of Universal Studios.

20th Century Fox and Lions Gate are buying expensive insurance policies in case the vidtailer can’t pay them; others may be demanding cash upfront for big releases.

They know the vidtailer’s financial situation is serious: Blockbuster announced in August it had to renegotiate loan covenants with banks to avoid defaulting.

Compay said its third- quarter results will reflect compliance with the renegotiated debt covenants.

Studios would “be shooting themselves in the foot. They will have to give a helping hand at least until the holiday season so sales aren’t impaired or threatened. The real crunch will come in the spring,” says Hal Vogel of Vogel Capital Management.

Antioco, during a conference call in August to discuss second-quarter results, called the company’s new initiatives “necessary and correct” as Blockbuster faces online alternatives, cheap retail product and aggressive cable offerings, exacerbated, he says, by a poor box office and a slimmer release schedule.

Neither he nor the company has said boo since Antioco, who has a reputation as a loose cannon, knocked the shares down 3% in a day last month by telling the Wall Street Journal that “studios have a legitimate reason to be concerned about the entire video business.”

Blockbuster will report third-quarter numbers in early November. Company said in a statement Oct. 6 that its rental revenue for the quarter eased 1%, outperforming an 11.7% drop in the overall industry.

Yet Antioco isn’t seen as the savior who’s going to reinvent Blockbuster. He’s a tough negotiator, a strong manager. “But management and vision are two separate things,” says a former high-ranking Blockbuster exec, who recalls, “We had the option to buy Netflix for $50 million and we didn’t do it. They were losing money. They came around a few times.”

Instead, in 2000, Blockbuster inked a 20-year exclusive video-on-demand pact with Enron as the energy conglom launched into telecom. Blockbuster canned the pact after nine months.

Netflix is now worth $1.4 billion. Blockbuster’s market cap is about $850 million.

Sumner Redstone bought the vidtailer in 1994 for $8.4 billion. He spun off about 20% in 1999 and unloaded the rest a year ago. Just in time.

Antioco’s job seemed at risk when corporate raider Carl Icahn swept in this summer. But Icahn had Antioco restored to the board with CEO title after he was effectively bumped off at the latest shareholder meeting.

The move may have been aimed at avoiding a big severance payout the vidtailer can’t afford. Or, it may mean Icahn has no clue who else could, or would be willing to, shoulder the task of turning Blockbuster around.

Icahn’s presence usually fires up a stock. But in this case, his meddling has muddied the waters. Uncertainty at the top, and the fact that one of the world’s savviest investors has lost himself a bundle, makes investors even more jittery.

Meanwhile, Blockbuster pushes ahead online, where its efforts, while costly, are bearing fruit. The service, launched in August of ’04, had a million subs by end of June. It expects to hit 2 million sometime next year – although not by March as it had hoped.

Netflix had 3.2 million subs as of June and has said it expects 4 million by year end.

Blockbuster’s other key initiative, the no-late-fee program, has been likened to a step on the road to video rental suicide. Vidtailer said the move cost it $140 million in lost revenue in the second quarter.

Antioco insists the policy is drawing more business to the stores and says that by the first quarter of ’06, “overall rental revenue will be better than if we continued to charge extended viewing fees.”

Perhaps most importantly, Wall Streeters and industry players think the company needs to shutter more stores. They’re doing it selectively, but won’t publicly make it a centerpiece of the company’s turnaround.

“It’s hard to reinvent the business when you’ve got 9,1000 stores,” says one consultant.

Chapter 11, while highly unlikely, would at least allow the company to get out of underperforming leases, much like movie theater chains did in a round-robin of bankruptcies five years ago.

Blockbuster’s modus vivendi for y
ears has been rapid-fire store openings to drive top-line growth. That’s not necessarily ideal as ‘bricks and mortar’ gives way to new forms of distribution.

“John’s fault at the moment is that he’s still trying to make Blockbuster a growth company. Someone needs to rein him in if he can’t work in the environment he’s operating in and stop tilting at windmills,” says Dennis McAlpine of McAlpine & Associates.

And existing stores should cater to the markets they’re in — a strategy that has allowed some tiny competitors to survive, even thrive.

“It makes no sense that that the Blockbuster on 85th and Lex was the same as a Blockbuster in Nebraska,” says Peter Feingold, co-owner of Video Room, which has two locations in Manhattan that focus on foreign fare and kids films. A Park Avenue matron “doesn’t need a store with 90 copies of ‘Rambo 8.’ ”

“They need to expand the analysis of various locations. They look to see if they have competition, but don’t look to see who their customers are,” he adds.

But he and others still see a place for the video store on the corner in the culture.

“Frequently people want to see a movie now, or tomorrow,” he says, instead of waiting for their online order in the mail. They like to come in the store, check out the boxes.

For families discouraged by the high price of movie tickets, or parents with young kids, it’s still an outing.

Says one media consultant. “Retail formats go up and down. They change. Think about how different Banana Republic is from five years ago. It used to be a place to buy khakis, now it’s upscale clothing. The Gap used to be jeans, now it’s something else.”

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