Blockbuster's Long, Long Run

Baldwin Louie — Mon, 16 Apr 2001 18:00:00 -0400

NEW YORK - Nothing at the Blockbuster (BBI) store in lower Manhattan on a recent drizzly Saturday night seemed out of the ordinary - not the crowd producing a low chatter in the fluorescent-lit aisles, the kids running around looking for PlayStation2 games, the long snake of people waiting to pay. But this routine scene was extraordinary in its own way, when you consider that Blockbuster was supposed to be extinct by now.

Predictions of the video-rental chain's death date back at least a decade. In 1991 a story in USA Today declared that the "the industry's demise [is] on fast-forward" because soon people would be dialing up movies with their phones. The paper went on to quote a money manager who dismissed Blockbuster as a "casket case" that wouldn't be around in three years. CEO John Antioco, who joined the company in 1997, got used to the strange drill of downplaying what everyone else was playing up. "Technology has been looming large since I got here," he sighs. "At that point, people had been talking about the demise of video for at least six or seven years."

It didn't help Blockbuster's image when, in March, its own foray into the future of home entertainment fell apart. It was in the middle of market trials with energy giant Enron (ENE) to provide video-on-demand, the generic name for a host of services widely predicted to signal the obsolescence of video stores. Like similar projects in the works, Blockbuster's would have let people order movies at home with the push of a button and view them with all the features of a VCR. But many of the big studios spurned Blockbuster's effort to hedge its bets and refused to license the digital rights to their films. The ultimate indignity was that not even Paramount, Blockbuster's corporate sibling (both are owned by Viacom (VIA)), wanted to strike a deal.

But premature death notices haven't killed Blockbuster. And its survival says a lot about how a much-heralded technology can get hung up on the way to your home entertainment center. Video-on-demand became technically possible before anyone figured out how to make money from it, and before the studios could resolve their own internal power struggles. Key agreements remain to be struck among movie makers, distributors and retailers; for Blockbuster, the challenge is to build alliances with partners that are resistant to granting it any more power than it already has. Complicating the dealmaking is the haziness over who will pipe video-on-demand into the nation's living rooms. Despite the abundant ink it has gotten in the business press, "no one really knows where it's going," one studio executive confesses.

Still, Blockbuster can't afford to assume that it can hold off the future forever. The chain says it will broker new deals and woo the studios - or play hardball, if it has to. "We look at technology and say, 'It's a business opportunity. It's not something to be scared of,'" says company spokeswoman Karen Raskopf. But the question remains: Will Blockbuster help forge the brave new world, or be devoured by it?

Not so long ago, Blockbuster itself was the newest thing in the movie business. Beginning with its first store in 1985, the company introduced a new polish and breadth to home-video retailing and rental, which had been dominated by local mom-and-pops, many of them cramped and poorly stocked. Blockbuster set its marketing sites on the family: It didn't carry X-rated movies and had plenty of room for kids to run up and down the clean, well-lit aisles. The company gained some sizzle in 1987 when Wayne Huizenga bought the chain. Huizenga was a flashy entrepreneur who made a fortune in trash-hauling and later owned the Florida Marlins (dossier) baseball team when it won the World Series.

Under Huizenga, who didn't even own a VCR when he took over, the chain flourished. By 1990, 1,500 stores had sprung up, forever altering cultural habits - and the economics of the movie business. "Nothing that happened in the 1980s compares to the videocassette revolution," hyperbolized New York Times critic Vincent Canby in 1990. "Movies will never be the same again." And consumers loved the change: In one survey, they ranked renting movies second for "best value for the money." (The winner: chicken.) In 1993, the company was already generating more revenue than its next 300 competitors combined, renting 10 million tapes a week to 30 million families. It now boasts that 75 percent of the U.S. population lives within 10 minutes of one of Blockbuster's 5,191 stores.

Still, naysayers kept predicting that Blockbuster would lose out to cable and, eventually, to video-on-demand. "We're not afraid of technology," Huizenga said in 1993, introducing the company line that has never gone out of style. One of its internal reports from the early '90s, devoted to the looming fight between tape rentals and video-on-demand, was called "the battle that isn't happening."

The battle that was happening had more to do more with Blockbuster's own missteps. Huizenga sold the company in 1994 to Viacom, which used Blockbuster's healthy cash flow to buy Paramount. But the business began struggling: The chain started selling things like T-shirts and potato chips that quickly turned into flops. It also sparked massive staff turnover when it moved its corporate headquarters from Florida to Dallas, hiring three CEOs in the space of a year. Antioco came on board in June '97 with a mandate to turn the business around.

Credited with reviving Circle K convenience stores, Antioco is far more animated talking about customer service than fiber-optic lines. When he came to Blockbuster, he says, one fundamental aspect of its customer service was "a joke": The chain was so incapable of meeting demand on hit movies that it didn't even market them for weeks. Antioco's solution was to overhaul Blockbuster's deals with the studios. Forget having to pay big fees up front for the tapes. Antioco pushed for Blockbuster to buy the movies at a steep discount and then share its rental revenues with Hollywood. After more than a year of negotiations, the studios finally signed on.

Blockbuster didn't invent this revenue-sharing arrangement, but institutionalized it on a large scale. (Says one Hollywood insider on whether studios get their fair share from the deals: "How much is ever enough?") Consumers now find endless rows of top-10 movies, and Blockbuster's clout has only increased. Today, the studios make nearly $10 billion, or 55 percent of their domestic revenue, from home-video rentals and sales. Blockbuster now dominates 36 percent of the video-rental market. "It's like Wal-Mart," says one studio insider of Blockbuster's mass-market muscle. "It's creepy."

If the last few years have shown anything, it's that revolutions require more than talk. Video-on-demand is yet another of those ideas that was supposed to change the world, but is off schedule. "Less than a year ago, people were projecting the demise of retailing, that the world would be e-commerce. What happened?" asks Antioco, who can't conceal his satisfaction. Today, industry players circle video-on-demand as if it were a pinata: eager for the treats they know are there, but blind and clumsy in their approach. No one wants to cede any ground or strike the wrong deal. The agreement between Blockbuster and Enron, which has been building a broadband business, was supposed to be exclusive and last 20 years; it didn't last 10 months.

The present, so it seems, is still where the money is. Just ask one of Blockbuster's newest competitors, a company that bet, in a sense, against the future. The business model for 3-year-old NetFlix rests on ordering DVDs online that are then delivered and returned through the mail. By eliminating those annoying late fees - which account for a full 15 percent of Blockbuster's $4.96 billion in revenues - NetFlix appeals to customers who "love movies and hate Blockbuster," says the company's CEO, Reed Hastings.

Video-on-demand won't become a significant business for at least five years, Hastings predicts (by which time he figures to be in that business, too). Sure, the technology is there, but "they also have helicopters so you can commute," he says. "Video-on-demand is a really compelling vision, but it's just not economical to deliver it."

While video-on-demand isn't exactly Topic A in most living rooms, it certainly is in some executive suites, where people like Antioco are busy plotting the future. In Antioco's case, his chain's muscle complicates his plans. For video-on-demand to work, it has to feature the same broad selection of movies as one of his video stores. That means striking deals with the studios, which are loath to let Blockbuster dominate another potential multibillion-dollar business.

Antioco uses soft corporate-speak to describe Blockbuster's "negative leverage," or what might be described as its ability to extort what it wants from the studios. Some suggest Blockbuster already employed such tactics with Universal when it negotiated digital-film rights for the Enron deal. Blockbuster's revenue-sharing video-rental contract with Universal expired last October, and Blockbuster made clear that it wouldn't renew without securing digital rights for the Enron experiment. (Blockbuster and Enron test-marketed the arrangement in the Pacific Northwest.) When Universal balked, Blockbuster applied pressure. It refused to stock tapes for Bring It On and Rocky & Bullwinkle, two of the studio's new releases. Universal cried uncle and signed over the rights.

"This is not us bullying," says Blockbuster's Raskopf, who adds that the company will not renew any revenue-sharing deals without new provisions allowing for video-on-demand. "This is saying, 'We're in this to make money for all of us.'"

Blockbuster insists that the studios need it as a middleman. Consumers already think of the blue-and-gold stores as a repository of films. After all, people don't shop for movies by studio; most have no idea who produced Erin Brockovich (Universal.) And Blockbuster's ability to influence viewing habits with promotions and other marketing could help keep video-on-demand from eating into the rental business. When it started selling subscriptions to DirecTV, for example, Blockbuster gave away a 52-week free rental card - and Blockbuster claims it rented more movies than ever.

To help it devise effective ways to boost the rental business, Blockbuster has a potent marketing tool: a database of the viewing habits of its 50 million customers. That data can help Blockbuster target suspense movie fans, for instance, when the latest John Grisham movie becomes available on broadband. "I think they have a lot to offer," says one studio executive who calls Blockbuster a "good partner." Though he acknowledges Hollywood's love-hate relationship with the chain, he adds, "There's probably a deal to be had [on video-on-demand]. But it's got to be on terms that work for both sides."

Inking those deals could take a while. The studios are still considering doing video-on-demand on their own, perhaps by working with the phone companies. Furthest along are Sony (SNE) and Disney. (In fact, one Disney exec told Business Week, "We intend to be Blockbuster.") The cable companies are also starting to offer "movies-on-demand" through their digital cable lines, but they haven't cut the deals they want with the studios, either. Then there are the startups, like Intertainer, a service that has deals with Universal and Warner Brothers, along with cable networks such as A&E.

But any attempts to shut out Blockbuster will be tricky. If the studios band together, they're likely to trigger antitrust questions - and Blockbuster won't be shy about pressing complaints with regulators. The studios have said they will not form any exclusive alliances, but they still have to tread lightly, lest they subject themselves to more so-called negative leverage. "If they really push video-on-demand," says Blockbuster's Raskopf of the studios, "they know video retailers won't just sit by. We'll promote the heck out of rental."

No question, the video-rental business' future is uncertain. Even Antioco says he has no idea what Blockbuster stores will look like in 10 years, but he's sure they'll still be around. Some people, he and his colleagues reason, won't want to pay for broadband and other tech services needed for video-on-demand. And many folks are perfectly happy with their VCRs and DVD players.

Still, the chain is planning for the day when it needs to hawk more than movies. Blockbuster already sells satellite dishes; this summer, it will start stocking RadioShack (RSH) products like DVD players. In the next few years, it's likely to announce more deals with players that would have been seen as enemies in the past: A movie downloading service with TiVo (TIVO), for instance, is a possibility. Because it doesn't know who will dominate video-on-demand, Blockbuster claims it is open to everyone. "[We] stand for watching movies at home," says Antioco. "Regardless of how the movie is delivered to the house, Blockbuster can play a role."

So just when will people get to spend even more time at home? For the last decade, Tom Adams, who heads Adams Media Research, has been skeptical about video-on-demand; recently he concluded that the new technology really is on the way. The costs are coming down, he says, though he predicts it will be five to 10 years before a significant business emerges. Adams also believes Blockbuster's eulogists have ignored "the whole history of media." Video rentals didn't eliminate movie theaters. And the studios can protect rentals by releasing movies for video-on-demand only after they are released in theaters and video outlets. Until the timing of these "windows" changes, the rental business is unlikely to take a serious hit.

Indeed, Blockbuster is looking healthier. Its stock has gone up this year, to a high of about $15 in February, compared with $8 at the end of 2000. Viacom announced a few weeks ago that it is dropping plans to spin off the chain because its business has picked up. (It's worth noting that this is hardly the climate to spin off Blockbuster anyway, and Viacom never planned to do it before the chain's stock topped $20.) Blockbuster should watch out for complacency, though. As its own experience shows, predicting the future course of technology is a loser's game. Blockbuster has a hairy relationship with the studios to manage and, in NetFlix, an aggressive competitor in DVD rentals.

If some of Blockbuster's customers on a Saturday night are any guide, video-on-demand has some appeal. When told what the future might bring, they were only too happy to think that going to a Blockbuster store would become a thing of the past. "That would be fabulous," said one woman as she complained about not finding a copy of The Philadelphia Story. "We'd never leave our house." Blockbuster needs to make sure that, somehow, it's right there with her, on the couch.

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Blockbuster's Long, Long Run