SUPPLY CHAIN MANAGEMENT 1. In what ways did Blockbuster achieve better strategic
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Question
SUPPLY CHAIN MANAGEMENT
1. In what ways did Blockbuster achieve better strategic fit than local stores?
2. How much implied uncertainty do Netflix and Redbox face? What levers do they use to deal with this uncertainty?
3. How did Netflix and Redbox achieve better strategic fit than Blockbuster?
The Demise of Blockbuster After struggling with debt and strong competition from Netflix and Redbox, Blockbuster, Inc. filed for bank- ruptcy in September 2010. This was a sad end for a com- pany that had dominated the movie rental business in the 1990s. Blockbuster Inc. was founded by David Cook in 1985 with its first rental outlet in Dallas. Cook planned to take advantage of a highly fragmented video rental market, in which most of the stores were relatively mod- est family operations that carried a small selection of former big hit movies mainly due to the high cost dis- tributors typically charged (about $65 per tape). With 8,000 tapes covering 6,500 titles, Blockbuster had a much broader and deeper inventory compared with that of its nearest competitor. The store operations were also greatly streamlined by a computerized system for inven- tory control and checkout. The store was a huge success, which prompted the addition of three more locations by mid-1986. In 1986, because of liquidity problems, Cook was forced to turn over the whole company to a group of investors led by Wayne Huizenga. Between 1987 and 1993, Huizenga grew Blockbuster into an enormous suc- cess. During this period, Blockbuster opened stores around the globe at the rate of about one every 24 hours. By 1993, Blockbuster was the leading global provider of in-home movie and game entertainment, with more than 3,400 stores throughout the Americas, Europe, Asia, and Australia. Blockbuster stores were a ubiquitous neigh- borhood feature that stayed open 365 days a year, gener- ally from 10 a.m. to midnight. Merchandise selection, quantity, and formats were customized at the store level to meet the needs and preferences of local customers. In the early 2000s, though, Blockbuster began to see real competition from the burgeoning online rental market as DVDs started to replace tapes. Its major com- petitor was Netflix, launched in 1997. In addition to being cheaper to purchase than tapes, DVDs were well suited for shipping by mail because they were less expensive to ship and less fragile than tapes. Netflix challenged Blockbuster on two key dimen- sions—variety and late fees. Whereas Blockbuster stores generally carried about 3,000 titles, Netflix initially offered more than ten times that amount. In addition, Netflix did not charge Blockbuster’s greatly disliked “late fees,” instead allowing customers to keep titles as long as they wanted. Netflix’s monthly subscription plan offered unlimited mail-order rentals for $9, the cost of two rentals at a Blockbuster store. Meanwhile, Redbox, a unit of Coinstar Inc., oper- ated vending machines that rented DVDs for as little as $1 a night. Despite its best efforts, Blockbuster’s brick- and-mortar stores could not match the low-cost operat- ing models of Netflix and Redbox, leading to its bankruptcy (see financial results in Table 2-5). Netflix Netflix was founded in 1997 by Reed Hastings as a pay- per-rental mail-order video rental company. After exper- imenting with both pay-per-rental and subscription, the company settled on a subscription-based strategy by the end of 1999. By 2010, Netflix had 13 million members and was the world’s largest subscription service, sending DVDs by mail and streaming movies and television epi- sodes over the Internet. For $8.99 a month, Netflix members could have any of more than 100,000 DVD titles delivered to their homes and could instantly watch a smaller set of television episodes and movies streamed to their televisions and computers. Netflix shipped some 2 million discs daily in the United States. Netflix focused its strategy around offering a large variety of titles, helping customers navigate titles with a sophisticated recommendation engine, and ensuring that titles reached customers quickly. Whereas a bricks-and- mortar rental store typically carried about 3,000 titles, in 2010 Netflix offered its customers a selection of more than 100,000 DVD titles, most of which were old releases. In 2009, about 70 percent of the DVDs shipped by Netflix were titles with release dates older than thirteen weeks. In 2010, Netflix had about 60 regional distribution centers across the United States, with sophisticated sys- tems to track customers’ DVD queues. As the distribu- tion center processes were linked to the recommendation software, movies that were likely to be in stock were rec- ommended to customers. When the distribution center received a watched DVD back from a customer, a new one from the customer’s rental queue was shipped out. These distribution centers were highly automated for rapid processing and were located within driving dis- tance of several U.S. Postal Service processing facilities. Netflix estimated that it would spend about $600 million in 2010 on shipping expenses.
Netflix’s ability to rent older titles was very appealing to studios that had historically seen little rev- enue from this content. Netflix bought older DVDs from studios at cost and, in turn, provided them a per- centage of the subscription revenue based on utilization for rentals over a specified period (typically 6–12 months). For newer content, Netflix did not attempt to serve the entire initial rush of rental demand. Given the higher initial cost of purchase, the company purchased only a limited number of new release DVDs, preferring instead to wait a few weeks and buy the bulk of its sup- ply at lower cost. Customers could put new titles into their queues and receive them when the DVDs became available in stock. Between 2005 and 2009, Netflix delivered excel- lent financial results and grew revenues by 150 percent and profits by about 175 percent. Despite the strong per- formance of its DVD rental business, however, the com- pany was focused on increasing the fraction of digital content it delivered. Its streaming service, launched in 2007, allowed customers to watch select movies and content on the Netflix website via their PCs.
Redbox The concept of Redbox originated in 2002 within McDonald’s Ventures, LLC, which was working to iden- tify new ways to drive traffic to its restaurants and pro- vide added convenience and relevance to customers. Redbox’s first kiosk was launched in 2004 in Denver. Coinstar, Inc. purchased Redbox in early 2009. Redbox’s strategy was based on targeting the bud- get-conscious movie renter who wanted to quickly rent a DVD for immediate use. Redbox met this need by plac- ing its automated red kiosks at easily accessible loca- tions, where customers could rent movies for $1 per night. Movies could be returned to any Redbox machine and no membership was required.
By early 2010, Redbox had approximately 23,000 kiosks nationwide, including in select McDonald’s res- taurants, leading grocery stores, and Walmart, Wal- greens, and 7-Eleven stores. Redbox had expanded to over 40,000 kiosks by 2012. Retailers, who were strug- gling to keep people shopping, realized that having a DVD kiosk in a store created foot traffic. In some cases, retailers even offered discounts that essentially made it free for Redbox to install a kiosk. Each Redbox kiosk carried about 630 discs, com- prising 200 of the newest movie titles. A Redbox kiosk rented its average DVD 15 times at an average of $2 per transaction. After that, the used DVDs were made avail- able for sale to customers for $7. By mid-2010, Redbox accounted for 25 percent of DVD rental volume, more than Blockbuster. The company was on course to generate more than $1 bil- lion in annual sales, faster than Netflix was able to achieve that milestone.
Study Questions 1. In what ways did Blockbuster achieve better strategic fit than local stores? 2. How much implied uncertainty do Netflix and Redbox face? What levers do they use to deal with this uncertainty? 3. How did Netflix and Redbox achieve better strategic fit than Blockbuster?
Explanation / Answer
Ans 1:
Blockbuster started with the business model of having large physical storefronts in high-traffic neighbourhood locations. By building stores that were larger than existing mom-and-pop rental stores, Blockbuster offered customers a wider choice of movies and better product availability. Movies were typically rented out for about $5 for five nights.
Given that mom-and-pop stores were much smaller, even though they carried only a few hundred titles, it was very difficult for them to provide availability of these movies given the high cost of inventory (VHS tapes sold for $60-$80 each at that time) and space. Blockbuster built larger stores that aggregated demand across a wider area than a typical mom-and-pop store. The larger store allowed Blockbuster to provide greater variety and better availability at a lower cost than mom-and-pop stores. The aggregation of inventory and physical space allowed Blockbuster to fill demand from its customers better than mom-and-pop stores.
Ans 2:
Netflix used a centralized supply chain structure to provide variety in the form of old movies (high uncertainty) to its customers at low cost. Redbox used a decentralized supply chain structure to provide predictability in the form of new releases (low uncertainty) close to its customers at low cost.
Ans 3:
Netflix and Redbox achieved a better strategic fit than Blockbuster by targeting different segments of movie rentals. Whereas Blockbuster attempted to provide its customers with both new releases as well as older movies, Netflix and Redbox divided the market among themselves. Netflix primarily targeted a wide variety of older movies while Redbox primarily targeted a much smaller variety of new releases. Blockbuster’s attempt to serve both markets increased its cost for both new releases and older movies. In contrast, Netflix was able to provide variety to its customers more effectively (100,000 titles rather than 5,000 at Blockbuster) and at lower cost through its aggregate model of shipping from DCs. Redbox was able to provide new releases at a lower cost than Blockbuster by using vending machines.
Whereas a Blockbuster store carried around 3,000 titles that were not recent releases, this represented a very small fraction of old movies. In contrast, Netflix carried a very wide variety of titles but in centralized distribution centres. Netflix had about sixty distribution centres (at its peak of mailing DVDs), where DVDs were processed and shipped all over the United States. Thus, Netflix had much lower facility costs than Blockbuster while providing a much higher variety of movies.
Only a single wall at a Blockbuster store was dedicated to new releases (which constituted a significant fraction of the rentals). Given that Blockbuster was paying for the whole store, this increased the facility cost per rental because most of the space was used by other movies that rented at a much lower rate than the new releases. Redbox, in contrast, used very low-cost vending machines (with low fixed installation costs of $15,000) in high-trafficked locations such as grocery stores, supermarkets, and malls to rent the same recent releases (much lower PP&E/SG&A) compared to Blockbuster. As a result, the facility cost per rental was much lower at Redbox compared to Blockbuster.
Inventories at Blockbuster were high (relative to revenues) because of the decentralized nature of its operations. In particular, carrying many low-volume rental titles (after all, there were perhaps only about thirty movies at any given time that were renting in large quantities) exacerbated the inventory requirements. This increased the cost of both inventory and space for Blockbuster. Netflix carried a wider selection of titles in its distribution centres but was able to carry lower inventories because of aggregation at its DCs. Redbox stocked newly released DVDs, which rented in large volumes with relatively predictable demand. As a result, there was much less inventory sitting around. Each Redbox kiosk carried close to 630 DVDs comprising 200 of the newest movie titles. Each DVD was rented out on average fifteen times, after which it was sold to the customer.
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