By Michael Moreton (UK)
August 2004 saw Blockbuster Inc. launch an online DVD rental
service in the United States, this paper will look at the
background behind that e-business initiative and will apply
an e-business model to analyse the implication it had for
Blockbuster1.
Footnote1.
This paper looks at Blockbuster Inc. in the US market because
(a) The US market is huge in volume, value and geographic
spread – over 80% of Blockbusters revenues came from
the US in 2003, (b) there are high barriers to entry for a
national service and (c) there are few competitors to Blockbuster
Inc.
Blockbuster Inc. was founded in 1985 in Texas in the United
States as a local video-rental store. Over the next thirty
years it grew to become the leading entertainment-related
rental store in the world, with 2005 sales of over $5.9 billion
in 26 countries (Blockbuster.com). Today
it has a combination of company owned and franchised stores
that rent and trade VHS, DVD and games, as well as sell snacks,
drinks and other linked services.
Early 2004 Blockbuster was in troubled times:
(1) The rental industry was shrinking in value, with prices
forced lower by the outright sales of DVD’s by retailers
such as Wal-Mart.
(2) The company faced increased competition from other entertainment
providers, Pay-Per-View films by cable channels – a
market Blockbuster had already captured its share of, and
from a successful start-up of an online rental service called
NetFlix.
Blockbuster expanded its sale of DVD’s business –
where it had just 3% of the market in 2003 (Forbes.com,
2003) - to combat the shrinking market value. The move
to combat the threat of competing services is the focus of
this paper and will be explored in more depth.
The largest competing service to Blockbuster was an internet-based
firm called NetFlix. Its internet-based model directly challenged
that of Blockbuster, with a different pricing and distribution
strategy. In response, Blockbuster experimented with several
business models, one resulted in Blockbuster announcing the
end of its late fees. However such a move destroyed an important
revenue stream - $250million for 2005 (Peers,
2005) - and not all the franchised stores operated the
new policy.
In the meantime Blockbuster faced severe criticism by analysts
who saw it slow to react to the new ‘NetFlix’
model, waiting for it to be proved and in the process allowing
its major rival to take 95% of the online rental market (Stern,
2004). The online rental market, however, made up only
a small percentage of the total industry - $280 million in
2003 (Arnfield, 2004). Blockbuster vice
president Shane Evangelist pointed out “The reason the
market is so small right now is that online movie rental is
a new kind of business, and the service providers need to
educate potential customers” (Newsfactor.com,
2004).
Following nine months of development with IT consultancy
firm Accenture, in August 2004 Blockbuster launched its online
service - Blockbuster Online. The service charged customers
a monthly fee, and then customers were able to create an online
list of DVD’s they wanted, whereby Blockbuster would
then mail them out to the customer’s home via the postal
service. When the customer finished with the DVD they popped
it back into a prepaid envelope and mailed it back, before
being sent the next DVD on their list. The new online service
had its own head office, albeit a short distance from the
main headquarters, so that operations were kept separate to
the local stores company.
The decision to launch the e-business initiative can be
analysed by using the ‘E-Business Opportunity Matrix’
by Tapscott.
E-Business Opportunity Matrix (Tapscott,
2000)
The online service would enhance the DVD rentals by adding
greater accessibility for the customer by means of a 24hour
website; it would also provide new e-Content for the customer,
such as personalised wanted lists and user reviews. In all,
the value added for the customer by the inter-networked technologies
would be a greater customer experience through personalisation,
convenience and greater access to DVD titles.
To critically analyse the move by Blockbuster, the E-Business
Model Ontology proposed by Osteralder and Pigneur
(2002) will be used. It uses four main components to create
a business model; product innovation, customer relationship,
infrastructure management, and financials.
E-Business Model Ontology (Osterwalder
& Pigneur, 2002)
Product Innovation
Blockbuster targets its online service to new DVD renters
as well as existing in-store customers. With 100% brand awareness
in the market (Gallup Organisation, Raven,
2002), Blockbuster has expanded its traditional brand
by pointing consumers to the website. The new DVD renters
have been reached through promotion by high traffic ‘content
providers’ (Weill & Vitale, 2001)
such as the AOL and MSN websites, the existing customers have
been attracted by in-store advertising.
Cannibalisation – where Blockbuster transfers revenues
from offline to online services rather than creating new revenues
– is something Blockbuster has tried to avoid, as nearly
half of the Blockbuster stores are owned by franchisees, not
Blockbuster Inc. The issue has been addressed by cross-branding
of the mortar and clicks operations through the use of coupons
offered to online customers for use in stores. Looking to
the future, as part of the e-business strategy and second
stage of the Blockbuster Online implementation, Blockbuster
intends to integrate its offline and online models completely.
A spokeswoman for the company outlined the strategy “we
think the real win-win will be a combination of an online
and in-store service" (Forbes.com, 2003).
At present a trial in San Francisco has combined the two models,
with the national roll-out due sometime this year.
The online service creates value by offering the customer
increased convenience so that they no longer need to visit
the physical store. They can now use any internet connection
to order titles and they pay no late fees. The redesigned
B2C website enables customers to personalise their visit,
allowing them to create their customised wanted list and prioritising
it – the list is on-going and can be changed at anytime.
Rare titles are able to be shipped in from other locations,
and searching for specific titles is made easier for the customer.
These add-on services to the core rental activity add value
for the customer - Shane Evangelist, Blockbuster
vice president “It's a matter of maximizing convenience
and choice” (Newsfactor.com, 2004)
- and the increased availability of the internet and the shorter
postage times have established the infrastructure needed to
operate the service.
Blockbuster has followed competitors into the market, and
as such the service it currently provides is very similar.
The e-business initiative behind the service has taken the
‘NetFlix’ model to start with, but Blockbuster
has plans to go further and with the integration of offline
and online services it offer greater convenience to the customer.
Future issues of stock management will become important as
the need for local stores to keep copies of titles for both
postal send-outs and customers coming into the store.
Blockbuster already has critical mass in the rental market
and holds the skills to be able to perform the core aspects
of the rental service. It has formed partnerships with firms,
as explained later, to learn the online side of the business
and to promote the service and provide the background systems
– stock management, website design and provide the logistics
of the online service.
Infrastructure Management
Blockbuster Online will offer a unique product offering of
integrated online rental service combined with the in-store
service in the near future. At present it has its strong brand
image and exposure in the market to attract consumers to its
online operation - however at the same time the Blockbuster
image of a physical rental store can also restrict the online
service.
The creation of the online service was outsourced to IT consultants
Accenture. Blockbuster internally did not have the essential
knowledge of how to create an online operation, including
a capable B2C website, however it did have IT employees that
worked with Accenture on the service. Prior to Accenture,
an undisclosed company was commissioned - it failed to bring
adequate results and was replaced. The failure was costly
to Blockbuster both in terms of cost, and of time-to-market
of its online service. Blockbuster also suffered at the hands
of investors, who saw little evidence that the company was
taking any action to combat the online threat of competitors.
After the humiliating failed partnership the Accenture one
proved to be more of a success, taking just nine months to
set-up the service with a team of 100 – drawn internally
and from Accenture (CioInsight.com, 2005).
Once established IT firm Infosys was contracted in to help
train internally to perform the online side of the business,
allowing Blockbuster to build up internal knowledge rather
than to subcontract.
The initial investment of Blockbuster Online was huge in
order to set-up new stock, warehousing and systems, including
the new B2C website. The online service was kept separate
to the offline service initially and 10 dedicated distribution
centres opened with the ability to serve half the market with
next day delivery. The figure hit 20 centres by January 2005,
and 30 by June 2005 (Blockbuster.com) -
in all $120 million was spent in 2005 building the online
business (Peers, 2005). The further expansion
plan to add the 4,500 local stores to the distribution network
will cause more investment in the infrastructure of Blockbuster
Online.
Another important partner for Blockbuster Online is the United
States Postal Service. It is one of the key elements of the
infrastructure, and thus is a venerable point for Blockbuster.
To mitigate risk, Blockbuster Online has worked in conjunction
with the USPS to develop a relationship, locating distribution
centres near major USPS sorting offices.
Customer Relationship
Blockbuster Online uses sign-up information to target promotion
to customers, such as TV advertising to certain age groups
where service uptake is low, but rental usage (taken from
in-store membership details) is high. Analysis is also completed
on the title popularity, seasonality and other trends so that
better forecasting can create better efficiency in the distribution
network. A help for this also comes from the user wanted lists,
as they give an indication of the films that need to be sent
out to the customer in the future so allow the organisation
of the distribution network to make that title available.
Aggregated together the stock keeping is very complex but
allows Blockbuster Online to better plan its stock and form
a more accurate customer relationship.
Personalisation to the user allows them to create their own
customer experience at the Blockbuster website. For Blockbuster
this proves an information gathering activity so that relevant
promotion or information can be sent back to the customer.
Blockbuster Online can create a ‘Blockbuster recommends’
and ‘other users that rented this item also rented’
customised message for customers similar to that operated
on the Amazon.com website.
Blockbuster Online uses the original Blockbuster brand, known
by the market, to gain trust from its potential customer.
An online community of customers is then created and the customers
can exchange reviews and interact with each other. This is
part of the Blockbuster Online brand extension to form a relationship
with the customer, and it also provides a space for Blockbuster
to promote its own products and services as well as external
advertising.
Financials
The revenue model for Blockbuster Online is subscription-based.
Each month payment is received regardless of the number of
DVD’s mailed out to the customer. With the integration
of in-store operations, there is a worry that revenue models
and pricing structures will clash because at present Blockbuster
stores operate a pay-as-you-go pricing structure. The diagram
below shows that the subscription model provides more revenue
up to a cross-over point where it is then better for Blockbuster
to charge a pay-as-you-go revenue model.
Blockbuster Revenue Models
The worry of integration is that if not careful, Blockbuster
may isolate one of the separate customer groups and risk losing
them - not all customers will want to pay monthly to rent
a DVD. Along with this the subscription-based model relies
on card payments, and is inflexible to cash payments –
something that the pay-as-you-go model is ideal for. Blockbuster
could have offered one-off rentals to customers by using the
pay-as-you-go model and card payments, but its other services
– local stores and Pay-Per-View films – are better
suited to that market. The subscription model is used for
ease of use and to recover the vast sums of investment in
the online infrastructure.
Since the start of Blockbuster Online in August 2004 the
pricing strategies have changed several times. The service
started at $19.99 but was lowered to $14.99 in December 2004
to increase service uptake. The price was then raised to $17.95
in August 2005, due to “enhanced value and service levels
for consumers” (Blockbuster.com).
Blockbuster has at all times, however, tried to undercut rival
NetFlix. The fluctuating price has angered many customers,
take for example comments on the DVD Rental Review website
(dvdrr.com) that rate a satisfaction level
of just 30% for the Blockbuster Online service.
A growth area for Blockbuster is selling advertising space
on the envelopes for returning DVD’s. At present Blockbuster
is experimenting with the idea, looking at using the space
to promote its own services and selling it as advertising
space. The space may be used by partners in exchange for promotion
of the Blockbuster Online service – at no extra cost
to Blockbuster.
The initial costs to set-up Blockbuster Online were substantial
($250million (Reuters.com)), with new systems,
warehousing, personnel and extra (separate to offline) stock.
The ongoing costs are reasonable – at $120 million for
year 2005 – and once fully integrated Blockbuster will
experience some economies of scale.
Unlike the revenue model, the cost model for the online service
is dependant on the rate that customers change their rented
DVD’s. The large part of the cost is postage, hence
the more a customer returns back and requests a new DVD, the
more postage costs incurred. Through the development with
Accenture, Blockbuster was able to design a return envelope
that accompanies the DVD title sent out to the customer so
that it weighs in the lowest postage category - rival NetFlix
patented its envelope but Blockbuster was able to develop
its own separate design. With more sign-ups, the costs will,
while the service is young, rise over-proportionally as more
stock is needed and more distributions centres are built.
In the long-run, however, the cost per sign-up will fall as
the infrastructure is in place and there is only minimal extra
cost attributed to extra customers.
The integration of offline and online cost models will be
important, as the majority of cost for the offline operation
is rent (as stores tend to be in prime locations), compared
to postage for the online operation. Combined, the online
operation has stock closer to the market – in local
stores, therefore postage is at a reduced rate and some customers
will come into the store to drop-off and pick-up.
Profits made by Blockbuster Online, are reinvested back into
the service to increase the market coverage, increase the
number of distribution centres and to invest in stock to satisfy
demand. As part of increasing the distribution centres, profits
are invested into the integration of the online system with
Blockbuster stores, to offer customers greater convenience.
In conclusion the Blockbuster Online lost the first mover
advantage in the online DVD market. Rival firms who started
out as small niche businesses, like NetFlix, were able to
expand into the mass market and take the dominating market
share. In an industry with high barriers to entry –
warehouses, systems, stock – this left Blockbuster many
years behind.
Source: (Reuters.com, 2006)
However when in August 2004, Blockbuster entered the market,
its e-business initiative went beyond that of rivals, using
the model on a stages basis to merge with its offline model.
With its established brand Blockbuster was able to aggressively
attack the market, investing heavily in the infrastructure
behind the service. However the size of the business, its
image and resources were not necessarily a recipe for success
as proved by the entry of Wal-Mart – the largest retailer
in the world. It entered the online DVD rental market but
several months later was forced to abandon its operations
in favour of promoting NetFlix.
Solid revenue, cost and profit models showed that Blockbuster
Online was able to claw back market share from competitors.
However being behind, Blockbuster was yet to hit the trade-off
period - as customer satisfaction improves (faster delivery
times, quicker turn-around times, more stock) the profit margin
decreases because of higher costs (new distribution centres,
new systems and personnel and more DVD titles). Also because
of the fixed revenue model yet variable cost model, there
is a risk of negative profits. The fixed revenue model works
on the basis that some customers will rent only a few DVD
titles per month and yet will pay the monthly amount, thus
Blockbuster will make a profit. On the other hand, some customers
will rent many DVD titles per month, thus Blockbuster will
lose money. The revenue model works on the basis that more
customers will fall into the first category than the second.
However a fall in the revenue model or an increase in the
cost model will have the result of flipping this balance and
hence the Blockbuster Online service may make a loss.
At a time when the rental market is becoming saturated, a
time where the internet is becoming a more important part
of life Blockbuster Online and the e-business initiative behind
it is indeed satisfying its aim of increasing the convenience
for the customer. The provision of added-on services has opened
market channel opportunities for Blockbuster to expand its
revenue streams.
As part of the overall corporate strategy, the e-business
initiative has expanded the Blockbuster service level and
revenue streams. The extent to which it succeeds will be seen
in the future, when both offline and online operations are
fully integrated, but Blockbuster Online is a solid base to
start from. |
