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Blockbuster's Keyes Has Big Plans to Transform Chain

24 Jun, 2008 By: Erik Gruenwedel

Jim Keyes

Blockbuster Inc. CEO Jim Keyes sat down with Home Media Magazine to discuss the future of his company following his appearance on the panel during EMA's Home Media Expo opening business session.

  • HM: Many studios, especially those that own cable TV operations, want to bury traditional DVD rental with same-day VOD. How do you deal with your suppliers trying to eliminate you at the same time?

  • Keyes: I understand their position. The approach we have had in the past as we were pressured economically is we did two things: We pulled back on our inventory, which put more pressure on us economically, and we pushed hard on studio suppliers, which put pressure on them economically. As a result, we had sizable gross profit percentages, but we didn't have inventory.

    If the studio looks at VOD versus physical rental, and they say they can make 70% margin on VOD and 30% on physical, my response is: Would you rather make 70% on 3% of the demand or would you rather make 50% on 40% of the demand? So let's talk. If they can help me satisfy the customer, I can pay more margin. That's not the problem because we are both going to increase our gross dollars by avoiding opportunity costs.

    We can provide [the studios] a much better share of a much bigger pie that in the next five years will be much easier to mine that consumer opportunity than try to build a new one. We're both going to miss opportunities if we push too hard on the VOD consumer who perhaps isn't yet ready. We're still going to go down the VOD path, and I'm not concerned in the long term for the VOD side of the equation because we'll be there.

  • HM: How important is Blu-ray to Blockbuster?

  • Keyes: It is very important. There are very few opportunities to extend the life cycle of any product. And since physical DVDs have been such huge portion of our product assortment, obviously an enhancement that extends the lifecycle of that product is huge for us. So it is important for us to jump on that bandwagon and increase adoption as quickly as possible.

    Blu-ray has two opportunities for Blockbuster. We are trying to transform our business more into a retail model, and that is for the long term self preservation. The more we use what are excellent retail locations to sell things, as opposed to just rent things, [the more] there is life beyond physical distribution of content. So Blu-ray, when it comes to retail, gives us a big advantage. Now, it is a new reason for the customer to buy in our store as opposed to just rent in our store.

    On the rental life cycle, the opportunity is huge. When DVD came in, we missed the retail opportunity and ceded that to our mass merchandizing competitors. We adhered rigidly to our rental model. And at a $20-$25 price point, that was a missed opportunity because many customers found they could buy versus rent, and it was a better use occasion, especially if you had small children.

    Blu-ray is whole different proposition because in today's world, $20 is still more or less an impulse purchase. But $30 crosses a consumer barrier, especially in today's economy. Even though I can afford a $30-$34 disc, I'm going to think twice about buying versus renting. We think this gives new life to the rental model and can stimulate increased consumer adoption of the format.

    And the numbers bear that out. It surprised me with a title like National Treasure: Book of Secrets that we would have so much rental versus retail. Our challenges with Blu-ray are significant because the industry, in some cases, is clinging to the traditional wholesale price model.

    The challenge is that there's a demand curve and there's an inventory cost. We're left managing that balance between having enough inventory to satisfy increasing demand and having too much inventory where we consume the profits just to stay in stock.

  • HM: What's wrong with the wholesale price and Blu-ray?

  • Keyes: The wholesale cost is inconsistent with the desires of the traditional consumer product approach to a new product or format adoption. With any introduction of new product, you have to oversupply. You have to put more inventory in the early days to meet a growing demand curve.

    We've introduced Blu-ray with a traditional wholesale price that actually puts more burden on the retailer to have that inventory risk. Therefore the retailer holds back on inventory, and the customer doesn't get what they want (lower price) and they hesitate in their adoption.

    The ideal store shelf would stock the same number of titles in standard DVD as Blu-ray. The current economic model from the supply chain does not facilitate that, and yet, the physical cost to put that product on the shelf is about $2. The intellectual property value brings it up to about $24. The retail is $34. But if I don't have it for sale it is worth nothing. So I'm trying to get to that price, and if there was way to recognize that revenue when the consumer wants it, I would never be out of stock.

    Some people will say that at retail you have the opportunity to return; well you can, but only up to a certain limit — and the cost of returns can consume the whole margin. I'm challenging my suppliers to help me to figure that out.

    Right now, we are treating the retailer as the ultimate customer, when it should be the consumer.

  • HM: Are you still pursuing Circuit City?

  • Keyes: We are still in our due diligence process. I hope all of our stake holders will recognize that this represents opportunity, and it is in everyone's best interest to check the books.

  • HM: Are most analysts vocal in their disdain for the deal?

  • Keyes: Citibank came out with an alternative opinion. It comes down to three opportunities: The cost synergies purely because you have overlapping retail organizations. Your infrastructure synergies because as we transform into a retailer ourselves, that chain would help us with logistics with retail point-of-sale systems they have developed better than we have … many of the things that are fundamental to being a better retailer.

    The third part is an entertainment retail destination doesn't exist. There are people that sell boxes, and there are people who sell content. But in other countries, there are retailers that bring these two together. The closest we have come here to a true entertainment retail destination would be Apple, who have brought together hardware, software and service. And yet, theirs is a closed-loop system.

  • HM: Would you change your acquisition offer since Circuit City's stock has declined?

  • Keyes: Can't comment, that's what due diligence is.

  • HM: What role do CE stores play in entertainment retail?

  • Keyes: When people think of retail, they tend to look backward. CE products have traditionally been sold next to the refrigerators and washing machines. Best Buy still sells washing machines.

    As a retailer, I have a forward look. In five or 10 years how, as consumers, are we going to consume our entertainment? In 10 years, it will predominantly be digital and how will I buy that digital content to get it into that device, which is an enabler for entertainment. Do I buy a box and put it on my wall and then figure out how to get stuff in it? Or will I be buying a service more than a device? That's where we are looking at Blockbuster into a digital content provider. Are we still going to be competing with Netflix with banner ads or are we going to get to that consumer at the best possible place: when they make that CE acquisition?

    I think that's the appropriate place to sell. That's what we're building. Today we sell a PlayStation 3; in the future I want to sell it with a Blockbuster Online subscription. That's consistent with our core mission to provide convenient access to entertainment.

  • HM: What are you doing about the burgeoning DVD rental kiosk industry? Why isn't there a Blockbuster kiosk?

  • Keyes: If you think about why kiosks are popular, it is the same reason why Blockbuster became popular. It is about convenience. We had at one point 2,000 more stores than we do today. When we close a store, we open an opportunity for someone else to come in and soak up that need for convenience. And vending has done just that.

    We recognize we need to be more convenient, and we are looking at vending ourselves. Our vending we want to build with an eye towards the future. Putting a credit card into a device and being able to access content will be ubiquitous. That's where we are headed, toward a combo deal where you can do both physical and digital in the same device. We want to do it with partners. We want to do it right.

    We're testing kiosks in Dallas. We just launched a few digital kiosks that we'll begin testing in 30 days. We've partnered with [portable CE device manufacturer] Archos, which will allow for a 30-second download of feature-length film onto an Archos device. We sell the devices next to the kiosks. You dock the device just like an iPod and either rent or buy the movie. It either will burn to an internal hard drive or you rent it for $3.99 over a 30-day period.

  • HM: Are you glad Movie Gallery is back?

  • Keyes: When Movie Gallery and Hollywood Video ran into problems, that was bad for the industry because it hurt consumer availability and it put a blanket over the investment community and their perception of the industry. I'm hopeful they will be successful, and I'm pulling for them because I think good competitors are a sign of a healthy industry.

  • HM: How does a 1980s brand keep itself relevant?

  • Keyes: Retailers often have a tendency to use historical research rather than live testing. With focus groups and panels, the customer will always tell you what they think, but they won't always tell you what they will do. With 5,000 stores you have a unique opportunity. In a very low cost way we can test everything from new pricing plans, Blu-ray adoption, inventory copy depth and breadth, etc. So what we are doing is trying to employ a practice of letting the customer tell us what they want. How do they want to see us in terms of relevance to them? If we listen, then we'll be successful.

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