How Blockbuster Failed at Failing

Yes, the movie-rental firm was doomed. But the ending could have been a lot better

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Brian Ulrich

Blockbuster may have to close two-thirds of its 3,500 stores

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"We had a saying at Blockbuster," said Huizenga. "If you don't come in on Saturday, don't bother coming in on Sunday. We worked hard." Blockbuster's share price soared during its rapid expansion. By '94, there were nearly 3,000 locations generating close to half a billion in annual cash flow.

One of the keys was something Huizenga and his team called "managed dissatisfaction." On weekend nights, the most popular movies disappeared fast. But Blockbuster had more movie titles than many of its rivals. So most customers would leave with something, if not their first choice, and would have an enjoyable evening anyway. The tactic kept customers happy and boosted profit. Studios charged less for the nonhits, and older titles were often paid for already. In those days, nearly 70% of Blockbuster's sales came from less-popular fare.

Huizenga said he knew technology was going to hurt the brick-and-mortar business at some point. He hired a team to research new ways to deliver movies. "We discussed it a lot and thought about buying a cable company," he said. "But there were so many ways it could go, and none of us wanted to get into an area where we had no expertise." Having failed to conquer the tech risk, Huizenga devised a brilliant tactical retreat: he made Blockbuster somebody else's problem. He sold it in '94 to Viacom for nearly $8 billion.

Without Huizenga, Blockbuster faltered. Viacom tried to turn the stores into outlets for its Paramount and MTV merchandise, selling T-shirts, toys and books. Sales fell. Within two years, Blockbuster lost half its value. Jim Antioco, a former Taco Bell boss who took over as CEO in '97, refocused on movies. Profits rose again, for a time.

Then Huizenga's fears were realized: Netflix launched the year after Antioco took over, and within a few years the company started to eat into Blockbuster's sales. Rather than charge $5 per movie like Blockbuster, Netflix uses a subscription model. For $16.99 a month, Netflix customers can rent three movies at a time, choosing from its 100,000 films via the website. There are no late fees, which always turned off even Blockbuster's most loyal customers. Keep the movies as long as you like. Send one back, and Netflix sends you another.

At first Antioco didn't seem to take the Web or the Netflix threat seriously. Blockbuster introduced a flat monthly-rental fee, but unlike Netflix, it continued to charge late fees. It wasn't until 2004 that Blockbuster launched a competing by-mail service. By then, Netflix had nearly 3 million customers. In a bid to slow the competition, Antioco finally eliminated late fees. Subscriptions increased, but not enough to compensate for the $300 million the company had been getting from tardy renters. Blockbuster's frustrated board, led by activist investor Carl Icahn, sent Antioco packing in '07. Keyes took over.

Blockbuster got some things right. It must have, because these days it's Netflix that's taking a page from Huizenga's playbook. About 70% of Netflix's sales come from less-popular titles. And that's more profitable. That's because Netflix has to pay the studios significantly higher fees for new releases rather than, say, foreign flicks or art-house movies. That and the fact that Netflix doesn't have stores has made it much more profitable than Blockbuster. Last year, Netflix earned $116 million. Blockbuster lost $518 million.

Still, Netflix will have to watch out; its own business model is quickly becoming outdated. Increasingly, consumers are streaming movies over the Internet, cutting out the middleman. And Netflix has a growing number of well-financed competitors, including Redbox. Amazon already sells movies. You can stream movies from Apple, through its AppleTV device, and at Microsoft's Zune, through its game console xBox. Scarier still, Walmart recently bought the video-streaming website Vudu. Google's YouTube, movie studios and cable companies are also measuring the market.

Blockbuster is now in the streaming game, and Keyes thinks he can compete there. For new movies, Blockbuster has negotiated a 28-day exclusive period with four of the biggest studios. Keyes says the new-movie advantage matters when customers can quickly switch from Netflix to Blockbuster with one click from their couch. They'll pay a premium. Blockbuster charges $3.99 a rental — though for $8.99 a month Netflix lets you watch all the movies you want. What's more, Netflix has 20,000 films available through its "Watch Instantly" streaming service. Blockbuster's service carries mostly recent releases. Netflix, for its part, seems to be adapting to oncoming technology, recently launching a streaming-only subscription service in Canada — dumping its original business model. What's clear is that whether Netflix, Blockbuster or someone else dominates this new world of rentals, a huge market is resetting.

There are few aneurysms in American business. Few companies drop dead. Instead, most endure a long slide into the grave. Harvard professor Clayton Christensen, who has studied technological change and its effect on large companies, says many of the decisions that led Blockbuster to bankruptcy might have appeared rational at the time. "But when faced with a threat by disruptive competitors like Netflix, the circumstances were different," says Christensen. "Decisions that in other circumstances would have made sense, instead drove the company into the ground." Into the ground Blockbuster went. In 2002 it had 8,000 stores and a market value of $3 billion. Today, movie-by-mail Netflix is worth nearly three times that much. And Blockbuster is broke.

This is an updated version of an article that originally appeared in the Oct. 11, 2010, issue of TIME magazine.

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