Case Study 1: The Movie Rental Market

The nature of a rental business is simple; customers want to use a product that they cannot – or do not want – to buy. In the fight for the customer’s movie-viewing dollar, the rental business competes with movie theaters and pay-per-view cable programs (also with fewer, fresher and more expensive titles).Since the 1990s, the market has been dominated by Blockbuster Inc., the company that successfully wiped out most of its franchised and independent competition.

The typical movie-rental process involves numerous steps. Customers take a trip to the store, browse the shelves, find what they like, check it out, return home, watch the movie, take another trip to the store to return the movie and return home again. There is a penalty if the movie is returned later than its due date.

The process is long, containing many redundant and no-value-adding steps such as multiple car rides, having to browse the available titles each trip and late fees. What this means is that there is definitely the opportunity for improvement in delivering a service of greater value to the customer. Netflix, Inc. was able to create a new business model that solved many problems associated with the original rental model.

The Netflix model has no due dates or late fees and no repetitive trips to the store. Movies are selected via the Internet and are then delivered and returned free of charge by mail. To make the model financially successful, there is a subscription fee and restriction on a number of movies a customer can possess at any given time, but no restriction on the number of movies the customer can request in a month. As soon as a subscriber returns a movie, the next title from his saved selection list is immediately sent. This saved selection list keeps the customer from having to browse inventory every time a movie is requested.

The customer is clearly receiving greater value from the Netflix model, which is why Netflix was rewarded generously with 2.6 millions customers by the end of 2004, each paying about $20.00 per month as a subscription fee. Where did these customers come from?

Blockbuster tried to ignore Netflix for many years, but the bottom-line prevailed. In the summer of 2004, Blockbuster opened an Internet-based rental unit. By this time, however, Netflix had already established itself as the Internet-based market leader. As always happens with any successful innovation, the Netflix model’s initial success immediately attracted a number of copycats. Not only did the existing players (such as Blockbuster) jump in, but also almost a dozen other companies joined the market, including Wal-Mart and Amazon.

Even at this early stage of development, the market became overcrowded with competitors that offered the same service for a similar fee. There was little clear differentiation between competitors. This led to service commoditization with subsequent price war, which only benefits the consumer. Since its inception in August, the price of Blockbuster’s subscription has gone down from $21.00 to $14.99 a month. It can be easily foreseen that the entire market could be captured (and competition eliminated) by a diversified competitor such as Amazon or Wal-Mart, who would provide the rental service free of charge as an incentive to buy other products or services that offer more value to the provider that the cost of the monthly service charge. Since people already buy products online from Amazon, such an incentive would be a logical and attractive proposition for both provider and customer.

What does the future hold for the movie rental industry? The Netflix model has a time delay between placement of an order and movie delivery (about one day). Based on the principle of time-to-value reduction, it can be predicted that movies will be delivered to a customer’s screen (via cable, Internet, satellite, etc.) at the moment they are requested; for the cost that she pays now for a movie rental, the Netflix model will become obsolete. At that time, all of the companies that have adopted the Netflix model will have to accept the new model, switch to a different market or go out of business.

Some might say that this was too obvious, too easy. But this simplicity is exactly why understanding of the predictable nature observable in the evolution of any product or service is such a valuable planning tool. Indeed, the concept of movies on-demand has been around for a number of years. Moreover, there are companies that already provide this service over the Internet. Certain technical challenges (such as minimization of download time and movie quality) still need to be addressed to make this model a viable reality, but it can be predicted that this will happen in the not too distant future.

The emergence and evolution of the movie-on-demand service raises additional problems, but in the application of GTI this is equated with more business opportunities. For example:

§ Since the Internet has a limited capacity and is often overloaded, what alternative methods are there for downloading movies? The answer leads in the direction of cable, satellite and wireless communication, and also clearly indicates who the future competitors will be. Major telecoms, including cable and satellite television service providers, telephone companies and ISPs all have the resources necessary for providing this service and can be expected to join the competition.

§ Stationary TV sets and computers will not be the only devices used to download and view movies – cell phones, PDAs, portable DVD players and even smart watches can be used. For this to work, these devices may need to periodically plug in and update their memory. This, in turn, will require a greater convergence of PDAs, cell phones and portable DVD players with computers, producing another new opportunity in this market. (Update: Verizon Wireless introduced movie on demand download to its customer base in 2005.)

§ A great business opportunity is associated with providing movies on-demand to travelers. This is especially attractive in that you have a large, captive audience looking to add value to their under utilized travel time (again, the principle of time reduction is applied).The car market is especially big and, therefore, tempting. Related but somewhat different from this travelers’ market are people waiting in restaurants, hospitals and hotels.Here a customer base of organizations instead of individuals can be developed.

Will these inevitable developments in the movie on-demand industry completely replace the traditional retail rental industry? No, it is an unlikely development. The market for traditional rental service will survive as a niche, but in a modified and shrunk form. It will be defined by circumstances where download service is impossible, inconvenient, prohibited, etc.

For example, if downloaded movies are prohibited during flights due to safety concerns, a new business opportunity emerges. A network of retail rental kiosks located in airports could rent movies, DVD players or both to customers about to board a plane, and returns would be made at the destination point. This service could also be ordered through an airline while booking a flight, with movies delivered directly to your seat after boarding. (Update: In 2004, one billion people worldwide flew. If only 10 percent of them (i.e., 100 million) had given an innovative entity $10.00 per rental event, it would have added one billion dollars to the bottom line.)

Another similar opportunity would be to provide a service for people who forget to download movies prior to their car trips. They could stop by a store and rent a movie, DVD player or both. However, this market will be small. Therefore, stand-alone rental stores will again give way to the travelers’ kiosk, this time in gas stations and convenience stores such as 7/11. Perhaps this type of rental will include DVD with timed, self-destruct mechanism so that returns are not an issue.

Another opportunity can be again identified by using the time-to-value reduction principle. If today’s business model requires a dedicated trip to a store, then bringing movies to the locations where people (customers) will be represents an interesting opportunity. For example, locating rental stores at malls, supermarkets or office buildings would provide a major value for the customers. Imagine positioning a few stores at a large technical center where tens of thousands of people work and delivering movies to their desks by the end of a working day.

In the meantime, due to the strength and direction of the competition for retail customers in the market, Blockbuster dropped its late fees; this is probably too little too late. Emergence of the on-demand movie model, along with excessive competition and service commoditization in the Internet-based niche, have created a situation in which the entire industry stands on the brink of major change and the outcome for any particular competitor is unclear. The financial markets seem to be in agreement with this conclusion. While the general market trend rose in 2004, the movie rental industry was depressed, as shown in Figure 4. Of course, the investment community does not like uncertainty, and it is uncertain whether future developments in the movie rental market will become opportunities or threats for the current competitors. This solely depends on the strategic decisions made by the leadership of each company.

Figure 4: Market Punished by Movie Rental Companies in 2004

All of the above clearly indicates that for any traditional rental company gaining advantage lies through significant change, requiring capital expenditures leading to a change in valuation. If such a company continues its business as usual, it is surely poised to continue sliding and losing to savvier rivals until the change prescribed by the law of an increasing degree of freedom is introduced; the sooner it happens, the better and more advantageous it will be for this entity.

Update: The forecast played well with the client who decided to pass on the opportunity. The chart in Figure 5 illustrates what happened to Blockbuster, the company that did not change and stuck to the old business model in 2005. Its stock dropped from $9.30 to $3.75, a huge loss for investors. This slump continued until the summer of 2007 when the company CEO’s, John Antioco, was replaced. His successor, James Keyes, quickly realized the need for a change. Blockbuster entered the movie download-on-demand niche by purchasing Movielink LLC. The same move made earlier in 2007 by Netflix complying with the forecast. Meanwhile, Netflix truly enjoyed its online pioneer status. By 2007, its customer base grew to 6,613,000; Netflix still dominates the online market.

Figure 5: 2005 Performance of Blockbuster Inc. Stock

On October 11, 2007, Movie Gallery, the company that purchased Hollywood Entertainment in 2004, announced bankruptcy, again validating the forecast. The last strategic move was made by drug store chain Walgreen. On October 28, 2007, it announced that customers will be able to buy movie DVDs that will be burned in stores. Entering the movie rental market is the next logical move, which means that brick-and-mortar stores are threatened, as predicted.

Date: 2016-04-22; view: 683