Nimble, Focused, Feisty. Sara Roberts
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that appear so formidable and solid by traditional measures become unexpectedly vulnerable to disruptive competition.
When we dig into the details of the innovation explanation, it’s easy to understand why it’s so compelling. Blockbuster was attacked on two fronts at once. One assault came on the ground when Redbox arrived in 2002 with a new retail strategy that was deceptively old-fashioned. Instead of stand-alone stores, Redbox put DVD vending machines in other retail outlets. To Blockbuster, a few hundred DVDs in a kiosk probably didn’t seem like much of a threat given the giant inventory of movies at a single Blockbuster retail store. Yet, with lower overhead, Redbox was able to slash DVD rental costs to one dollar and compete with Blockbuster on price and convenience. Within five years, Redbox had more US locations than Blockbuster.
The second and ultimately more significant assault came from the air. Netflix started as a subscription-based DVD mail-delivery service. What Netflix lacked in convenience, it made up for with a large catalogue of movies, an easy way to organize and order rentals online, and a lack of late fees. Famously, the idea for the business arose after co-founder and CEO Reed Hastings was forced to pay forty dollars in late fees to Blockbuster for a copy of Apollo 13. Hastings knew that the dissatisfaction he felt over that penalty was something just about every Blockbuster customer could relate to, so he came up with a revenue model that didn’t rely on making customers angry.
Capitalizing on pent-up customer frustration is a classic path to disruptive innovation, and Netflix made that impulse part of its core. In 2007, the same year Redbox surpassed Blockbuster in retail outlets, Netflix took pre-emptive steps to disrupt its own delivery model and introduced a streaming service. This, many believe, was the final nail in Blockbuster’s coffin. Blockbuster was not too big to fail; it was too big to respond.
Or so the story goes.
At a strategic level, the explanation that disruptive innovation from new competitors killed Blockbuster is a good lesson to absorb. Dominant companies rise and fall all the time, and Davids often slay Goliaths. To stay on top, companies need to aggressively reinvent themselves in line with changing customer needs. In the famous words of Andy Grove, “Only the paranoid survive.”
The problem, however, is that in Blockbuster’s case that narrative is wrong. It wasn’t innovation, change, or a pesky competitor that did Blockbuster in. That was just the tip of the iceberg. Below the surface of the water, Blockbuster collided with the culture that it had relied upon to become so dominant in the first place.
THE REST OF THE ICEBERG
Blockbuster came to rule the retail movie-rental market by improving customer experience and offering the kind of ubiquity, convenience, and access to movies that independent video stores couldn’t deliver. Its revenue model was strong, the brand was powerful, performance was excellent, and by the time John Antioco became CEO in 1997, just as the dot-com boom was beginning, the company was in an enviable position. Even so, Antioco knew that Blockbuster couldn’t stand pat. He wanted to change the company at its core by making it more responsive to customer needs and more agile with new technology, while continuing to innovate its business model. Blockbuster only had about 25 percent market share then and plenty of room to grow. Indeed, it would grow to about 40 percent before Antioco was done.
Antioco was an accomplished turnaround expert who’d been raised in the world of retail. He’d helped 7-Eleven achieve prominence and had been instrumental in returning Circle K and Taco Bell to profitability. When he was tapped to head Blockbuster, he was excited because it gave him the opportunity to give “customers what they want while still making money for the company.”1 Much of the success Antioco did achieve with Blockbuster came from this customer focus.
Indeed, one of the things customers wanted was newly released movies. At the time, however, movie studios charged rental companies sixty-five dollars per VHS tape, and that upfront investment was too large to stock enough titles to give customers easy access, especially when demand would drop off within a few weeks. So Antioco went to movie studios and persuaded them to flip that business model—take less up front for more on the back end—and Blockbuster began a policy of guaranteeing the availability of new releases, which helped sales and market share grow. Chalk up one big win for innovation.
Video-on-demand was a worry but not yet technically feasible to achieve at scale. Instead, it was the arrival of DVDs that proved to be the Trojan horse that allowed Redbox and Netflix to challenge the video-rental giant. Unlike VHS tapes, DVDs could be easily stocked in kiosks or delivered in inexpensive mailers. Nevertheless, though Blockbuster was a little slow to switch to DVDs, once it did respond, the company continued to thrive because of its market dominance. Daunted by his overwhelming foe, Netflix CEO Hastings proposed a partnership with Blockbuster in 2000 in which Netflix would leverage its internet-delivery prowess to manage Blockbuster’s online brand while Blockbuster would promote Netflix in its stores. Blockbuster refused in part because it had its own web strategy in mind.
Antioco didn’t see new technology as a threat to Blockbuster so much as an opportunity. He decided to build a fairly radical model for the time—called Blockbuster Total Access—in which customers could choose to do business in one of the company’s retail stores or online through Blockbuster.com. By the mid-2000s, Total Access dominated the video-rental market. Around the same time, Blockbuster also decided to eliminate late fees even though they accounted for 16 percent of total revenues. Antioco knew that penalizing customers was no way to thrive long-term.
Soon, Blockbuster was on the march again, stealing nearly a million customers from Netflix each year. By 2007, things were so bleak for Netflix that Hastings sought and obtained permission from his board to begin merger talks with Blockbuster.2
On the brink of total victory, however, everything changed for Blockbuster. The board put a full stop to the direction Blockbuster was engaged in and forced out Antioco because they disliked many of the changes he had made, such as cutting out 16 percent of revenue by rescinding late fees. In Antioco’s place, they hired James Keyes. Keyes had been the CEO of 7-Eleven from 2000 to 2005, presiding over a remarkable thirty-six consecutive quarters of same-store sales growth, which by 2004, had resulted in global revenues of $41 billion. To the board, Keyes seemed like the perfect candidate to lead the company into the future because he more closely resembled the Blockbuster of the past.3 He had the experience of scaling and stabilizing a highly successful retailer that seemed to be on every street corner throughout the United States. That was the Blockbuster the board knew and understood.
Keyes’ vision was to make Blockbuster the 7-Eleven of video stores. He believed that stable growth in retail locations and expanded products within those locations would make Blockbuster successful.
Keyes’ vision was to make Blockbuster the 7-Eleven of video stores. He believed that stable growth in retail locations and expanded products within those locations would make Blockbuster successful.
After being named CEO, he quickly restructured his team, ridding the company of Antioco’s lieutenants as though they were a virus and promptly naming a new CFO, CIO, general counsel, and vice president of merchandising, distribution, and logistics.4 Then he redirected Blockbuster’s online business strategy to an in-store, retail-oriented model because he couldn’t see the potential value of a DVD-by-mail service, nor the relevance and opportunities that Blockbuster.com may have presented. “The Internet is worthless, and we’re getting out of it,” he declared.5 “I’ve been frankly confused by this fascination that everybody has with Netflix . . . Netflix doesn’t really have or do anything that we can’t or don’t already do ourselves.”6
Antioco had compressed some of the hierarchy at Blockbuster as part of his approach to modernizing the company and given retail clerks a lot of freedom to solve customer problems and see to their needs. Keyes put that hierarchy back in, reestablishing many layers of management between the top team and the customer. As a result, decisions were increasingly made without any direct experience of customer needs or their frustrations with the Blockbuster experience.7 Thus, employees at the prized retail stores—who had briefly