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Blockbuster's 20-Year Odyssey

23 Jun, 2005 By: Thomas K. Arnold

It's not easy being Blockbuster Inc.

On the cusp of its 20th birthday this October, the world's biggest video rental chain is winding down its teen years with more aches and pains than anyone ever expected from a retail operation that was once so powerful it was accused in court of dictating terms to the Hollywood studios.

Here's what transpired in the last year:

  • Video rental, Blockbuster's core business, slipped an alarming 18 percent in 2004 and is expected to drop further as consumers continue to embrace buying instead of renting. DVDs.

  • An attempt to buy its top competitor, Hollywood Entertainment Corp., was met with a snide editorial in the Los Angeles Times headlined, “When Dinosaurs Mate.” When the deal fell through, irate shareholder Carl Icahn blasted CEO and chairman John Antioco and won a seat on the board for himself and two fellow dissidents.

  • For the third consecutive year, Big Blue bled red, posting a loss of $1.24 billion in fiscal 2004 after losing $978.7 million in 2003 and $1.62 billion in 2002. The losing streak continued into the first quarter of this year, with a loss of $57.5 million, compared with income of $114.4 million in Q1 2004.

  • A much-ballyhooed scrapping of late fees to boost business turned into a public relations nightmare. Fine print about a “restocking fee” was branded misleading and led to legal inquires and a $630,000 settlement.

  • On top of all that, according to one studio president who asked his name not be used, Blockbuster continued to slide down the home entertainment food chain. What was once every studio's top customer is down at No. 4, behind Wal-Mart, Target Stores and Best Buy.

  • Antioco concedes it's an uphill battle to maintain Blockbuster's longtime leadership position in the home entertainment industry. But he's convinced the company's controversial diversification strategy ultimately will pay off.

    “The rental business is clearly troubled,” he said. “The emergence of inexpensively priced and ubiquitously available DVD had a huge impact on the home entertainment business, and rather than denying this impact or refusing to change with the times, Blockbuster decided to evolve with the marketplace.”

    Since late 2003, Antioco said, Blockbuster has been transforming itself “from a brand where customers go to rent a movie into a brand where they can go to rent, buy or trade movies and games, in-store or online. Customers still love watching movies at home, and Blockbuster wants to be the first brand they think of to take care of their home entertainment needs.”

    Still a Blockbuster Chain

    Indeed, 20 years after Texas businessman David P. Cook exited the oil business and opened a video superstore in Dallas, Blockbuster is still here, now a worldwide giant with more than 9,000 stores and annual revenue of more than $6 billion. Blockbuster grew up with the video industry and in short order became its leader. With its bright, clean superstores, Blockbuster became a role model for the legions of mom-and-pops that had launched the industry but were floundering as the business matured.

    “Blockbuster as an institution was very important to the growth of the video business,” said Benjamin Feingold, president of Sony Pictures Home Entertainment. “They were the first company to professionalize video rental, and that helped grow out the revenue base for Hollywood studios under the rental formula.”

    When the novelty of renting videos began to wear off in the middle 1990s and the industry entered a slump, it was Blockbuster that reinvigorated the rental business through its revenue-sharing proposal with the studios. The chain — and, soon, other retailers — could bring in many more copies of hit movies, on the cheap, and thus satisfy growing demand for hot new releases. “Go Home Happy,” Blockbuster promised in its ad campaign, and not only did its own financials improve, but so did the health of the overall rental business. Rental revenue shot up 6.2 percent in 1998, the first year revenue-sharing was implemented, according to Paul Kagan Associates.

    “Blockbuster's embrace of revenue-sharing helped broaden customer satisfaction,” Feingold said. “And in the long run, that helped everyone.”

    At the time, not everyone agreed. Independent retailers, who had always regarded their larger competitor with suspicion, rallied and filed antitrust actions against Blockbuster and the studios, accusing them of conspiring to put the smaller stores out of business. Many of them did go out of business, but ultimately the suits were dismissed.

    Today, with traditional rental declining, Blockbuster is once again doing what smart money says all rental retailers need to do: diversify. With an eye toward successful subscription rental pioneer Netflix, Blockbuster offers consumers the opportunity to rent videos by the month, either in stores or online. Blockbuster has made a heavy commitment to renting and selling video games, and it is aggressively selling and trading used DVDs as an entry into the all-important sellthrough market.

    “Retail is where the growth is, and that's been the case for 15 years,” said veteran home entertainment industry analyst Tom Adams, president of Adams Media Research in Carmel, Calif. “Blockbuster could ignore that fact while it was rolling up market share in rental, but now that it has 40 percent of the rental market, any future growth depends on capturing more of the sales business.”

    Starting Out in Dallas, 1985

    The first Blockbuster Video store was opened in Dallas in October 1985 by David P. Cook, who had made his money in the petroleum industry and became a self-made computer whiz. When the oil business went bust, Cook went looking for a new venture, and after studying a video store franchise for a friend, he told Fortune magazine in 2003,

    “I determined there might be a bigger industry there.” The store, with more than 10,000 titles, was so mobbed on opening night that Cook had to lock the doors to prevent more people from coming in.

    Envisioning a chain that could one day number 1,500 stores, Cook began selling licenses to investors to open multiple stores in populous

    urban areas “in the same way that Coca-Cola would license a distributorship,” he told Video Store Magazine at the time. Gearing up for rapid expansion — he envisioned being able to open three stores every 24 hours — Cook built a $6 million distribution center in Dallas. An early visitor was analyst Adams, at the time an editor at Video Store Magazine.

    “David and I decided we should get a picture of his wife, Sandy, stocking the shelves,” Adams recalls. “Even though she wasn't really involved in the company, in those days — when husband-and-wife teams ran a big percentage of video stores — it just didn't seem right to portray the company as anything but one of the ‘mom-and-pops.’

    That philosophy would soon change. In need of cash to fund further growth, Cook turned to Wall Street. A planned meeting with Ross Perot failed to materialize, but in February 1987, Cook struck gold in the form of H. Wayne Huizenga, a Florida industrialist who had made a fortune in the waste management business. Huizenga bought a 60 percent stake in Blockbuster Entertainment Corp. for $18 million and soon took control of the company's 19 stores. Two months later, Cook walked after clashing with Huizenga over the best route toward future growth. Cook was a firm believer in franchising; Huizenga, however, wanted to build and acquire stores.

    “Jaw-Dropping Growth”

    With Cook out of the way, Huizenga put his plan into action, beginning with the June 1987 acquisition of 28-store Movies to Go of St. Louis. The deal put Blockbuster's store count at 67 and made the chain among the 10 biggest in the country.

    Under Huizenga's watch, Blockbuster experienced what the Miami New Times called “jaw-dropping growth.” By the end of 1988, Blockbuster was the nation's No. 1 video chain, with 289 stores and $200 million in annual revenue. In June 1990, Huizenga told stockholders that the chain's 1989 revenue of $663 million “exceeded that of our next 16 largest competitors combined.”

    It wasn't all business for Huizenga. Ron Castell, a senior Blockbuster executive, recalls accompanying his boss to the Paramount Pictures studio lot in 1989, Huizenga's first visit to Hollywood. “Our hosts, [video division executives] Eric Doctorow and Bob Klingensmith, graciously took us on two sets: The Hunt for Red October and “Star Trek.” Wayne was fascinated with the October submarine set, especially the fact that all the instructions on the sub were in Russian. And on the “Star Trek” set, he sat in Capt. Kirk's chair. He was amazed at the details.”

    In January 1991, Blockbuster made its biggest acquisition to date, snapping up the nation's No. 2 rental chain, Erol's Video Club, for $40 million. A year later, the acquisition of two big music chains led to the creation of Blockbuster Music. In February 1993, Blockbuster bought into Spelling Entertainment as the step toward fulfilling Huizenga's goal of becoming a content provider as well as a distributor. Less than a year later, however, Huizenga stunned the industry when he sold out to cable giant Viacom in an $8.4 billion deal. By then, Blockbuster had grown into an international powerhouse, with more than 3,500 video stores in the United States and nine other countries generating upwards of $4 billion in annual revenue.

    Analyst Adams still marvels at the house that Wayne built — and the way it was built. “Huizenga's strategy of buying up smaller chains for five times cash flow with stock that Wall Street was willing to value at 10 times cash flow, and then selling out for 12 times cash flow just as the industry's growth trajectory flattened out, is simply one of the greatest displays of business strategy and execution ever seen,” he said.

    The Viacom Era

    Under Viacom, Blockbuster's growth soon flattened. By March 1995 the chain began asking studios for lower prices in return for a share of rental revenue. Bill Fields, the former No. 2 man at Wal-Mart, was hired as CEO of Blockbuster in January 1996. He promptly began a disastrous diversification program that saw Blockbuster drop the word “video” from its stores — and ad campaign — and venture into books, magazines, CDs, toys and other licensed merchandise, all with significantly lower margins than video rentals. Stung by a staggering decline in earnings, Fields abruptly left in April 1997 and was replaced two months later by turnaround-whiz John Antioco, whose latest assignment had been to fix faltering fast-food chain Taco Bell.

    Antioco immediately refocused Blockbuster's energies on its core video rental business and set out, with Viacom chairman Sumner Redstone, to resurrect the revenue-sharing strategy first proposed two years earlier. The studios bought off on the plan, and to placate other retailers offered similar revenue-sharing deals, along with various “copy depth” incentives, to everyone, with the common goal of boosting the supply of hot new releases in the market.

    The video industry recovered from its slump, and Blockbuster was once again the leader of the pack, claiming a 26 percent share of the rental market in December 1998 and a 32 percent share in February 2000. By then, the chain had dumped its money-losing Blockbuster Music division (in a fire sale to Wherehouse) and had gone public, pricing 31 million shares at $15 each in an August 1999 IPO. In the meantime, Antioco was keeping careful watch on new technologies. He began selling DirecTV systems and service in Blockbuster stores and cut a deal with Enron to launch a video-on-demand service, although that deal soon crumbled on the eve of Enron's notorious implosion.

    The troubles at Blockbuster began with the new millennium. DVD caught on faster than anyone had expected. With new releases priced low out of the gate, instead of after a six-month rental window, the home entertainment economy changed from a rental model to a buying model. DVDs were embraced by big discount chains like Wal-Mart, Target Stores and Costco. At first, the rental business held flat, but last year, as the majority of U.S. households had switched to DVD, rental revenue began to decline.

    At the same time, traditional rental found itself having to compete for dwindling rental dollars with online subscription services like Netflix, which offered consumers all the benefits of renting videos without the hassle of having to bring them back — and the risk of incurring late fees.

    Blockbuster's Future

    Don't prepare the eulogies for Blockbuster just yet. Most observers agree Blockbuster has plenty of life left in it — as long as the chain fully embraces sellthrough and successfully establishes itself in the public mind as the place to buy, and not just rent, movies and other types of packaged home entertainment.

    “You have to look at where the business is going,” said Sony's Feingold. “I think Blockbuster is well positioned to participate in the growth businesses over the next 10 years, which are subscription rental and all sorts of sellthrough — DVD, PSP, high-definition discs and games. To me, that's the road map.”

    If he were in charge of Blockbuster, analyst Adams said, he'd do “what management is already doing — diversifying the product and service offering. This company has some of the best retail real estate in the country under lease and as good a brand as exists in the entertainment industry. The combination should make for a launching pad into the second 20 years.”

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