9/10/2011

Blockbuster vs. Netflix

The battle between Blockbuster and Netflix continues. From 2006 – 2007, Blockbuster closed over 500 stores trying to compete with Netflix. As Blockbuster tried to increase their over-all membership, Netflix was increasing in domination because of their “total access” to movies. (Say Goodbye to Blockbuster) In 2010, Netflix gained market power and received revenue of over $2.14 billion. (Netflix Press Release) One would think Blockbuster would just give up. But in 2011, Hollywood put their foot down against Netflix, and the light began to shine for Blockbuster. Because of Netflix market power, Hollywood demanded additional compensation. Netflix agreed not to rent out new releases from Warner Brothers Studio for 28 days. Thus, allowing Hollywood to see more growth in their DVD sales. (Netflix Gains Market Power) With market power, Netflix also decided to raise their prices. Blockbuster saw this as an opportunity to take away Netflix’s unhappy customers and came up with a “total access” plan which provided customers with a 30-day free trial and only $9.99 per month (renting one disc at a time). (Blockbuster Rescues Furious Netflix Customers) Both companies are not giving up! This battle is continuing…who will come up with the next great idea to win over unhappy customers and regain market power?

8 comments:

Dr. Tufte said...

What I find really interesting about this, is that retail video rental was just the sort of industry that D.C. likes to regulate: obvious market concentration, and lots of cash flow (profits don't hurt either, but it's been my experience that regulators are more attracted to cash flow).

Managerial economists emphasize that industries are not static. On the other hand, regulators assume static industries as a basic tenet. Here we have an obvious case of an industry that was not static, and where the signals that Blockbuster and Hollywood Video were sending out attracted competition that just about killed them, and may yet.

Jessica said...

I was looking at Netflix the other day and read two articles that portend tough times ahead for the streaming entertainment company.

An article on seekingalpha.com claims, "As we wrote in previous pieces, Netflix (NFLX) doesn’t have a sustainable competitive advantage. It doesn’t have barriers to entry. It does sell somebody else content with a technology that isn’t proprietary. It is a matter of time before its business is squeezed from all directions; and eventually becomes a commodity."

An article on streetauthority.com cites a high p/e ratio of over 50, customer defection due to membership price restructuring, and potential market saturation as areas of worry for Netflix.

It will be interesting if Netflix will be able to maintain its market share given these challenges and plenty of competition nipping at their heels.

Dr. Tufte said...

With a p/e over 50, Netfilx is definitely overpriced.

But I'm not so sure that they are ripe for competition. It seems to me there are huge economies of scale in their delivery business, and at least some in their streaming business. I would tend to be more worried about how much they'll lose as they scale their shipping business back down as more people shift to streaming.

Gunny said...

This is an age old debate as to who is the best. I think it needs to be noted that both of these are also competing with Redbox, who plans on entering the streaming market (http://money.cnn.com/2011/02/17/technology/redbox_streaming/index.htm). As to which is better, right now it depends on consumers preferences ("Netflix vs. Redbox vs. Blockbuster: What’s the Best Movie Rental Deal?" moneyland.time.com). If Redbox can become competitive in streaming then it will depend on price. I am a Netflix subscriber and was disappointed with their recent price increase. I for one switched out of getting DVDs from Netflix and now use the service strictly for streaming. I was always disappointed that Redbox got new releases before Netflix anyway. I think that is the hope of Netflix. They want to be in streaming. It was a good move overall for Netflix to change their pricing. If you can’t be the best at DVD’s, eliminate that product and focus on your competitive advantage, which is streaming. If Netflix can continue to improve their streaming content than they will remain dominate in the industry. Everyone else will be playing catch up. Competition is good for consumers. I am glad that we are seeing heavier competition in these markets. I hope that it forces Netflix, Redbox, and Blockbuster to keep prices down at an affordable level.

Dr. Tufte said...

Gunny, it would be great if you got rid of those bare URL's and put in hyperlinks.

I found this comment a bit confused. Shorter can be better. :)

Remember, that criticism of the economics here is constructive. Here's what I found troubling:

1) "As to which is better, right now it depends on consumers preferences". Doesn't it always? 2) "If Redbox can become competitive in streaming then it will depend on price." Fair enough. But later you say that Redbox has already competed on features other that price: "I was always disappointed that Redbox got new releases before Netflix anyway."
3) You say "I am a Netflix subscriber and was disappointed with their recent price increase." You follow that with "It was a good move overall for Netflix to change their pricing." How was it good if you weren't satisfied?
4) "If Netflix can continue to improve their streaming content than they will remain dominate in the industry. Everyone else will be playing catch up." Unless they do catch up, which sounds like what Redbox is trying to do.

In sum, what you think is important Gunny, so write it up so that it comes across that way.

Sam said...
This comment has been removed by the author.
Sam said...

The announcement by Netflix that they will separate their DVD-by mail service into an entirely new website called Qwikster has me baffled. I think by splitting their streaming service from their DVD-by mail service Netflix has introduced a large element of customer confusion into their business. If Netflix customers must go to two separate websites to manage their streaming and DVD-by mail accounts then I think Blockbuster may have a great opportunity to step in and gain some market share.

The factors of ease of use and customer confusion must be taken into consideration as we look at where the market power is heading. If Blockbuster starts offering the same content and prices as Netflix with an easier rental platform then I think we will see an increase in the market power of Blockbuster. As the services become similar in terms of offering and price it may come down to customer experience that may turn the tide of customers from one company to the other.

Dr. Tufte said...

I think this move has baffled everyone, not just Sam.

Netflix has been behaving bizarrely for a few months: have you noticed that movies now disappear from your streaming list? This is because they have stopped paying the royalty fees on some films because they aren't generating enough revenue to cover them.

Netflix has clearly blown it in a big way, and may be on the way to bankruptcy. They clearly have created a division that is cannibalizing another division, and not spun it off early enough. Now that they want to spin it off, it isn't clear either daughter company is viable: 1) can the DVD business compete with Redbox, and 2) can the streaming business make positive economic profits at all?

I think what we're seeing here is the problems that arise from bean counting (no offense intended at accounting majors, lots of offense intended at managers who focus too much on accounting and not economic). My guess is that managers saw the shift to streaming as a way to reduce direct costs and increase net income, and it probably did in the short-run. But the accountants direct costs are closer to average variable costs than to marginal costs in economics.

But think about what average variable costs (AVC) tell us in economics. They tell us where to shut down, but not whether you are making money. When price falls to AVC, you shut down, but there is a range above AVC (and below ATC) where you are losing money but staying open. What Netflix has done with streaming is shift their AVC (and ATC and MC) downwards by eliminating shipping and warehousing charges. This only works as a business strategy if your demand stays high. But why would you expect that to happen when you are making it easier for other firms to compete with you (through streaming) when they were having a tough time matching up against your supply chain.

You see this a lot when we try to do forensics on why a business failed. Managers sometimes fall for their own BS; one way this happens is that they don't understand what business they're in. Consumers think Netflix is in the business of providing movies. Managers believed this. But no one is really in the business of providing movies: they are in the business of providing movies in a particular format through a supply chain. It's the supply chain that makes the business model work. Netflix didn't make any money by providing movies, they made money by developing a supply chain that video store chains couldn't compete with. That was clearly a tough thing to compete against. How is streaming a tough thing to compete against?

Having said all this, Netflix is in a tough position. Perhaps this is a business we never should have expected to last in the long-term. Think about it: would a company that had a mail order distribution business for renting audio cassettes still be in business? Don't laugh, there were businesses like that 20 years ago for audio books.

And, having made that point, what exactly is an owner or manager of Netflix to have done? Give up? Abandon their business? Not try something new? It's not clear to me, but I'm sure there are a lot of investors who are glad they sold out of Netflix.