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Shrinking Stores, Staff Seen As Cure for Blockbuster Woes

25 Nov, 2005 By: Erik Gruenwedel

How should Blockbuster Inc. retool itself?

Observers say the No. 1 video rental chain can emerge from its dire state by slashing dated business practices. Overstaffing and the chain's reluctance to ditch the “superstore” concept, among other missteps, have resulted in bloated stores with significantly higher-than-needed operating expenses.

Blockbuster may enjoy a healthy 60 percent gross margin (70 percent rental, 20 percent merchandise), which puts it in the same league as Starbucks.

But Blockbuster's overhead — officially known as sales, general and administrative (SG&A) expenses — tops 51 percent of revenue (59 percent for Movie Gallery) compared to 43 percent and 35 percent for Starbucks and McDonald's, respectively, analysts and observers note. That's not good.

The idea is to get maximum revenue from retail space. If store-operating expenses (rent, personnel, utility costs, etc.) are relatively fixed, the more sales generated with those costs result in a lower SG&A as a percentage of sales.

Analysts and observers contend that if Blockbuster gets its SG&A expenses below 40 percent, even with the current contraction in the industry, its market capitalization could increase dramatically.

“You have to visit Tiffany's to get store operating expenses anywhere close to those of video stores,” said Bill Fischer, VP of corporate development for DVD Station, a San Francisco-based operator of proprietary kiosks. “And Blockbuster has neither Carrera marble nor chandeliers.”

Blockbuster spokesperson Randy Hargrove reiterated the company intends to lower its cost structure through a combination of reduced marketing spending, overhead reductions (above the store level) and the elimination of operational costs associated with non-Blockbuster-branded assets. “Our plan is to lower SG&A by more than $100 million in 2006 and by an incremental $50 million in 2007,” Hargrove said, adding this is in addition to cost reductions announced earlier this year.

Analysts and observers say the average Blockbuster store occupies about 6,000 square feet and is staffed by 11 full-time employees during a 12-hour business day. The central retail space of Blockbuster stores (about 60 percent) is not particularly productive. Only about 11 percent of rentals come from this area, compared to 89 percent from primarily new releases on the back wall.

“You have 5,000 square feet of real estate that is dedicated to 11 percent of the business,” Fischer said. “It just doesn't make sense.”

Analysts and observers say Blockbuster should adjust staffing to reflect key peak periods. Big Blue also should eliminate large-format stores and raise the a la carte rental price 25 cents.

“I don't know why they don't do that,” said Michael Pachter, media analyst with Wedbush Morgan Securities in Los Angeles. “People who rent do so out of habit and wouldn't say anything about a price increase.”

Fischer said DVD Station contacted Blockbuster and Gallery about implementing automated cash transactions and kiosk-style library shelf storage. He said the switch could reduce Blockbuster's staffing 50 percent.

Pachter likes DVD Station's 500-to-700-square-foot kiosk business model and believes Blockbuster could begin implementing kiosks as present stores come off lease.

“I think that concept only makes sense in high-traffic, expensive real estate like in New York,” Pachter said. He said Blockbuster could enter traditionally cost-prohibitive areas such as office buildings by emulating Starbucks' business model and strength of brand by establishing rental and sellthrough kiosks in major downtown lobbies and walkways for impulse consumption.

Pachter also said Blockbuster could sublet unproductive retail space to third-party businesses, including cell phone providers, coffee shops and fast food eateries. “Those are the kind of things they should be talking about,” he said.

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