The Impact On The Video Rental Industry Marketing Essay

INTRODUCTION

Technology and innovative entry strategies have changed the way companies enter and compete in saturated, mature markets. Although there are many publications and studies on technology in the workplace, there are far less research studies in the strategic management community on technology’s role as the workplace, especially when it comes to specifically addressing the video rental industry and how it has dramatically been made-over by newcomers within the last decade. Blockbuster, once the dominant player in the video rental industry, is being challenged by Netflix, an online video rental company, and Redbox, a low-cost video rental kiosk found in several popular retail stores. In recent years we have even seen the closure of several Hollywood Video locations, Blockbuster’s former biggest rival (S&P, 2010). In this paper, journal publications on innovation, diversification, and strategy will be used, along with case studies and articles on the video rental industry, to provide insight to managers in all industries on how to prevent similar market penetration with new technologically savvy entry strategies. This study will examine not only the decline of Blockbuster, but the impact the new entrants are having on the economy as well.

Purpose of Study

This paper develops a conceptual framework to understand how technology has allowed new companies to break into the established video rental industry and dominate it. It will also explore how these new entry strategies are affecting the US economy and the importance the video rental industry example serves for management in other industries. This study seeks to answer the following three questions:

How has technological innovations changed the traditional (bricks-and-mortar) video rental industry?

What impact are the changes to the video rental industry having on the US economy?

Are the new strategies that video rental stores are employing likely to be duplicated in other industries?

Video Rental Industry Background

Technology has always been a prominent, and at times, a controversial component of the video rental industry. With the advent of the VCR (video cassette recorder) in the mid 1970’s came opposition from the Motion Picture industry and the war of Betamax versus VHS. However, by the 1980’s VHS, the prevailing video format, turned out to be incredibly lucrative for the film industry, generating over 50 percent of the industry’s $45 billion in revenues (Savitz, 2009). Revenue-sharing contracts between the movie studios and video rental chains came next and they helped to fulfill customer demand by supplying more copies of new releases at lower up-front costs in return for a shared percentage of every rental. These contracts required special computer technology to track and report each rental, which was too expensive for many smaller, independent video rental stores. Moreover, chains like Blockbuster and Hollywood Video were able to negotiate better revenue splits because of their store size, number of retail locations and order volume compared to independent video rental stores. This made it difficult for smaller stores to compete because even when they were able to invest in the technology to track their rentals, they could not afford enough copies of movies to prevent shortage, which caused customers to turn to the bigger chains to meet their rental demands (Cabral, 2009).

After the revenue-sharing contracts came the laser disc, then the DVD, then Blu-ray versus HD where Blu-ray triumphed, and who knows what other format changes are to come, especially with the recent release of 3D televisions. Clearly technology is no stranger to the video rental industry and this past decade technology has reinvented how movies are rented by consumers. Consumers can now have movies shipped straight to their mailbox or checkout a movie from vending machines strategically placed inside retail stores. These more convenient and lower cost rental methods have changed the industry completely and become extremely popular among consumers. These new entrants, specifically Netflix and Redbox, have transformed the competitive environment quickly leaving little reaction time for the traditional bricks-and-mortar video rental chains. They offer the same products as traditional video rental stores but at lower costs, because their business model has lower overhead (salaries, rent, etc.) associated with their operations. The appeal of lower cost movie rentals to consumers gained the new entrants market share in a heavily saturated, mature market, but it cost Blockbuster huge losses and even forced other chains to close their doors.

Although more convenient and cheaper movie rentals seem like they benefit the consumer, the costs may outweigh the benefits. The video rental industry may only be a small sector of the US economy, but the impact Netflix and Redbox are having on job loss and the economy should not be taken lightly by consumers. Consumer behaviors, preferences and demands dictate how managers innovate and strategize, and if consumers demand more convenience, faster delivery times and lower costs because they know technological advancements have made that entirely possible, that leaves managers no option but to employ new technologies and processes that may ultimately lead to reductions in their human capital.

Significance

This paper will examine these harmful consequences in detail. It will research the effects the Internet and kiosks are having on the video rental industry, as well as whether or not these strategic moves with technology as the workplace are likely to be used in other industries to penetrate market share. The findings will serve as a guide for managers of existing companies trying to keep or create a competitive edge and for entrepreneurs looking to start a company in markets with high barriers to entry. Lastly, and possibly the most important reason for this study is to take a look at how rapid technological advancements and consumer’s affinity for lower costs and convenience can have more negative effects than positive on their lives.

RESEARCH AND CONCEPTUAL FRAMEWORK

Blockbuster

Started in 1985 by David Cook, Blockbuster is today the leading video rental chain with stores worldwide. Blockbuster began expanding internationally in 1989 and was bought for $8.4 billion by Viacom in 1994. In 2001, Blockbuster opened its eight-thousandth store in Sao Paulo, Brazil (Cabral, 2009). However, Blockbuster has been experiencing losses since 2004 and in an attempt to stay competitive Blockbuster’s operations have expanded to include mail rentals, online streaming and kiosks (Gallaugher, 2008).

Blockbuster’s mail rental program is called Total Access and it allows customers to exchange movies by mail or in stores all for a flat monthly rate. Blockbuster Express kiosks are currently strategically placed in over 2,000 locations (Blockbuster Corporate). Unfortunately, this may be too little too late for Blockbuster because today the chain only has 6,000 stores operating worldwide and has more closures planned for this year. Additionally, Blockbuster only pulled in revenues of $1.08 billion in the fourth quarter of 2009, a loss of $435 million from the previous year. Blockbuster also began this year with debt of $984 million, which investors and analysts worry they will not be able to repay (Associated Press, 2010). As a result, Blockbuster’s stock on the NYSE is currently trading for around $0.40 (Yahoo! Finance, 2010). Despite sagging performance due to increased competition Blockbuster remains at the top of the industry.

Netflix

Select, Receive, Watch, Exchange. That is the Netflix video rental model. This innovative idea made it possible for people to rent movies without ever leaving their house. All you do is create an account online at Netflix.com, select if you want one, two or three movies at a time, queue the movies you want to see and wait for them to ship to your mailbox. When you’re done with the movie just ship it back in the pre-paid envelope and the best part is there are no late fees (Netflix.com).

Netflix was started by Reed Hastings in 1997 and has been extremely successful since. Not only as of 2009 did Netflix carry over 100,000 movie titles, a much larger selection than your average local video store, but its subscribers could also stream movies from their computers or game consoles (Netflix.com). As of the end of the first quarter of 2010, Netflix had almost 14 million subscribers and nearly $500 million in revenues (Crawford, 2010). For these reasons, Netflix posed the biggest threat to competition and ultimately redefined the movie rental industry. To stay competitive Blockbuster created its own online rental plan, but Netflix saw this as infringement on their patents and sued Blockbuster, however ended up settling, but did not disclose the details of the settlement to the public (Reuters, 2007).

Redbox

In 2002, the newest edition to the video rental chains hit the market. Redbox was its name and it was created by Mitch Lowe and McDonald’s Ventures, LLC. Redbox kiosks vend new releases of DVD’s using an uncomplicated business model: Watch it, enjoy it & return it. Redbox customers can reserve movies online and pick them up or they can go to one of the 22,400 kiosks strategically located in popular retail stores and rent DVD’s using the touch screen catalog and a credit card. Rentals are just $1 per night and customers can keep the rental as long as they want, when they are done they can return it to any Redbox location (Redbox.com).

In 2005, Coinstar, Inc. bought 47 percent of Redbox from McDonald’s to make it a separate company from the fast-food giant with the interest of purchasing 100 percent of the company in a few years. Redbox owns two patents which protect their vending and loading technology; this allows Redbox to get new movies every Tuesday in the most efficient and least labor intensive way currently known. Redbox is continuously enhancing its offering to meet customer’s needs (Redbox.com). The popularity of this model proves that consumers are not only looking for direct to their house rentals, they will still leave their house to rent a movie if the price is right.

Movie Gallery & Hollywood Video

In 2005, Movie Gallery, a popular video store in small rural cities (Grant, 2000), bought out Hollywood Video, Blockbuster’s biggest competition, to become the second largest video rental outlet with 4,500 stores (Watson, 2010). Since the 1990’s Hollywood Video was Blockbuster’s biggest competition. It was started in 1998 and went public just 5 years later with 16 stores. From there Hollywood Video acquired a Texas video rental chain called Video Central to own 100 stores. The chain continued to expand rapidly and in 1996 with 500 stores it was the second largest video rental chain just behind Blockbuster. Blockbuster had 25 percent of the market share, while Hollywood Video had a mere 5 percent. Although Hollywood video owner Mark Wattles did not see Blockbuster as a rival, but more as a friendly competitor with room for both companies in the industry, Hollywood Video stayed competitive by offering a wider selection than Blockbuster, guarantying availability of new releases and pricing their rentals competitively (Fujinaka, 2007).

Unfortunately, Movie Gallery has since filed for bankruptcy twice, had to close over 800 stores and been delinquent on rent payments at several locations (Watson, 2010). The company was hard hit when Netflix and Redbox type competitors entered the market. Their bricks-and-mortar style operations were just too costly to compete on the same level. While Movie Gallery was busy buying up market share through acquisitions, entrepreneurs were looking to enter the industry by reinventing it with technology.

WHY BRICKS-AND-MORTAR RETAILERS ARE CRUMBLING

Video rental stores from Blockbuster to Redbox all have one thing in common; they provide a service to their customers. These companies do not make the movies they rent they just supply them. This means that it a very simple concept to imitate and with the changes in technology and the introduction of the Internet the way businesses strategize and enter the market really depends on consumer behavior. To consumers, high-tech translates to higher efficiency, less overhead (labor, rent, etc.) and more customized, yet faster service on the supply side, which means more convenience and lower cost for consumers on the demand side causing consumer behavior to shift toward the Internet, which has opened the doors for consumers to price shop and compare products beyond just what is carried on the shelf of a bricks-and-mortar store (Brynjolfsson et al, 2006). This concept created a way into the video rental industry for Redbox and Netflix by modifying the existing service with innovation and offering lower-priced, more convenient rentals.

Typically Blockbuster charges $4.99 for a 5-day rental, Netflix’s plans start at $4.99 for two rentals per month and their unlimited rentals per month range from $8.99 for one movie out at a time to $23.99 for up to four rentals at a time (the latter all include unlimited instant watching of select movies online) (Nexflix.com), and Redbox charges $1 per night and after 25 nights the movie is yours to keep. It makes sense that consumers would be drawn to Netflix and Redbox over Blockbuster because they are getting the same products for less in most cases. Also, Netflix, Blockbuster’s fiercest competition, offers a much wider variety of movie titles, which Brynjolfsson, Hu and Smith see as an important added value for consumers. This theory builds on the idea of Chris Anderson, editor of Wired magazine, who believes consumers have a much broader tastes than typical bricks-and-mortar stores can fulfill with their offerings. Consumer’s wants go beyond the few “hits” carried in the stores and rather span into the many niches in “the long tail” of the demand curve (Anderson, 2004).

If this is true, it would explain why Blockbuster is losing so much market share to Netflix. It is much cheaper for Netflix to offer more variety because it does not cost them expensive self space to promote those more obscure titles, they just add it to their online catalog and house it in one of their warehouses, where cost per square foot is lower than Blockbuster’s shopping center real estate (Gallaugher, 2008). As the first mover, Netflix’s successful execution of an Internet to mailbox rental system was able to draw in market share before Blockbuster could even react. Blockbuster and Movie Gallery’s mistake was trying to acquire as many physical rental locations that they could, rather than consider gaining market share through new outlets that utilize the advancements in technology. Times have changed and traditional ways of expanding are not as relevant as they once were.

Berry, Shankar, Parish, Cadwallader and Dotzel coined a new term they refer to as “market-creating service innovation” and define it as a company’s idea to improve a current service by adding a new component that customers see as an added benefit. They argue this new value that is created for customers often causes the competition to react. This was seen when Blockbuster tried to mimic Netflix’s revolutionary concept. Mimicking however does not create a new value and it is hard to entice consumers to switch brands for the same service and/or product. Blockbuster offered the option to return videos through the mail or stores, but people switched to Netflix initially because they wanted to return movies in the mail so Blockbuster’s service was not any more valuable to them. Netflix was able to hold on to market share and even gain more by continuously improving their new service and adding features of value such as search features and personalized recommendations. It is hard to try and catch a first mover that is always innovating and improving their offering and Netflix’s video rental model revolutionized the industry by offering a new delivery system for an ordinary product. They didn’t create a new market, but rather made enjoying a familiar product easier than ever before by redefining the markets total offering. Instead of using technology in the workplace as Blockbuster had done with the revenue-sharing software, Netflix made technology the actual workplace. They created a superior customer benefit by saving customers money, time and effort when renting videos (Berry, 2006).

The key factors that made Netflix successful in a saturated, mature market were the combination of an extensive selection of easy to browse and search titles, reasonable pricing, convenience and a dependable, customer-friendly delivery system. These factors created a never before offered customer experience and consumers were very pleased with the service. E-commerce companies are held to a higher standard than chain stores with multiple locations because one bad experience with the website can lose a customer forever, while with chain stores customers may have a bad experience at one location, but may be willing to try another location in the future (Gallaugher, 2008).

IMPACT ON THE ECONOMY

The exact effects on the economy since the changes to the video rental industry from the entrance of Netflix and Redbox are hard to assess. The economy has been hard hit in the last few years and regardless of the new competition in the industry, video rentals would have likely decreased due to people having less disposable income, which unfortunately erodes retail revenues overall. It may even be said that low-cost rentals and subscription rental plans saved the video rental market from suffering even bigger loses. Therefore, both the positives and the negatives that Netflix and Redbox have had on the economy as a whole will be explored, focusing specifically on how consumer behavior has dictated these changes in the economy.

Positives

Netflix is actually helping movie studios by offering a wider selection of movies to rent. With Netflix’s cost structure the movie studios are actually earning a percentage of subscription fees based on the movies that are rented. So movies that typically are not popular enough to be on the shelves in Blockbuster do not usually continue to earn profits for the movie studios. However, now that older movies can be rented through Netflix, especially because Netflix suggests rentals based on the subscriber’s prior rentals, the movie studios are experiencing revenues they otherwise wouldn’t with the bricks-and-mortar stores. All without even having to invest in any additional marketing (Gallaugher, 2008).

E-commerce companies like Netflix have an advantage over bricks-and-mortar stores and that is they can reach a national or even international customer base without a lot of additional spending (Brynjolfsson et al, 2006). Netflix serves the United State and Puerto Rico at a fraction of the cost it takes Blockbuster to serve the same market. This may actually prove an advantage to the economy because it reaches a much larger demand and in turn brings in revenues from consumers that otherwise may not have a local video rental store or that may have a store but not the selection they are looking for. The larger your market the better your chances of finding more customers with that are looking for those non-mainstream movies. On average, Netflix mails out 45,000 different movie titles in one day (Gallaugher, 2008). This ultimately means increased consumer spending on video rentals assuming that consumers are not give up some other retail item to rent movies.

According to the S&P Movies and Entertainment Industry Report from March 2010, Rentrak Corp. found that consumers actually spent $6.5 billion on video rentals in 2009, an increase of more than 4 percent (S&P, 2010). Netflix and Redbox can rent their DVD’s at a lower price than Blockbuster because their marketing and overhead costs are much lower. This means a lower return to the movie studios because 50 percent of $1 is only 50 cents, but the industry shows an increase in rental revenue which would indicate that the studios are actually getting a higher rent from low-cost rentals and subscription rentals. This is most likely due to renters keeping rentals more than one night or renting movies more frequently due to more affordable prices.

It also must be noted that Netflix and Redbox both pay a flat fee for movies on top of revenue sharing and with the number of DVDs Netflix offers, the studios are making more than they ever were because their old films are being purchased again. With Blockbuster’s 5-day rentals at an average price of $4.99 it also should be considered that consumers may share their rentals with their friends and family to get more value out of these higher cost rentals, which lowers the cost per night if held for 5 days to about $1, the same as Redbox, so it is hard to argue low-cost rentals like Redbox are hurting the industry. The average rate of return for Blockbuster movies is 5.23 days, which is actually less than $1 per night, since Blockbuster has eliminated its late fees to remain competitive (LAEDC Consulting Practice, 2009).

Negatives

Even though the video rental industry may be seeing higher spending on video rentals, this does not mean the Movie and Entertainment industry as a whole is experiencing these same increases. Actually the Movie and Entertainment industry overall is losing. 2009 marked the fifth consecutive year of loses for the industry since its peak of $21.8 billion in 2004 (S&P, 2010). According to the Los Angeles County Economic Development Corporation (LAEDC) report titled The Economic Implications of Low-Cost DVD Rentals, $1 billion in revenues will be lost in 2010 for the entire industry through the loss of over 9,000 jobs, $30 million in tax revenues, and $1.5 million in economic output. This is likely a very accurate figure because Netflix’s technology allows it to serve more people than Blockbuster with fewer employees. Also, the S&P Industry Survey reports Hollywood Video plans to close 2,400 more stores this year and that Blockbuster will be following suit. Blockbuster lost $400 million alone from dropping its late fees, which was essential to staying competitive, but unfortunate for the industry’s profitability (Mullaney, 2006).

The LAEDC’s report projects loss for the Movies and Entertainment industry as a whole, but the movie rental industry seems to be gaining revenues. The video rental industry’s bricks-and-mortar stores are definitely losing revenues, but the success of Netflix and Redbox seem to indicate that the revenues are just switching to new players in the industry not actually leaving the industry. The LAEDC is correct however in indicating that many jobs are being lost due to the changes in the industry. The economic recession that has hit the United States in the past few years plays a big factor in the changes in consumer behavior and affinity for lower-cost rentals in favor of Blockbuster rentals or even going to see movie in the theaters. The question that remains is whether the public is really benefiting from saving a few dollars by using these new video rental models or actually hurting themselves through the economic repercussions of job loss. This a question that economists will have to analyze in the future because if consumers are really doing more harm than good for themselves a cheaper video rental really isn’t worth the increase in unemployment, especially in smaller towns where replacement jobs are few and far between.

As consumers demand lower prices and more convenience, all things technological advances provide, they typically do not realize the impact their demands have on the economy, job loss and the decisions managers have to make to remain competitive and to keep their brands alive in an ever changing and globalizing market. As the world gets more advanced, it is important to consider the effect computers and technology are having on the economy as they transform from an element of the workplace into the workplace itself, as with e-commerce stores like Netflix.

OTHER INDUSTRIES FEELING THE PRESSURES

The video rental industry is certainly not the first industry to experience revolutionary changes in business models and strategic entry strategies, and it will not be the last. Amazon.com changed the bookstore industry by adding numerous selections of book titles not typically carried on store shelves. Approximately 35 percent of Amazon’s sales of books are of titles not typically offered in bricks-and-mortar bookstores and account for nearly $1 billion in sales annually. Amazon carries around 3 million different titles, while your average Barnes and Noble carries about 70,000 titles on average (Brynjolfsson et al, 2006). The music industry has seen similar changes, first with the emergence of Napster and now with iTunes and Rhapsody, which sell both individual songs and whole albums. Rhapsody actually sells more copies of songs not on the top billboard charts, which goes to support the long tail theory Anderson developed (Gallaugher, 2008). This has greatly changed the music industry and today with social networking and new distribution outlets, smaller, more obscure artists have the opportunity to get their work known, something that was not possible with major record labels and traditional distribution channels which were extremely expensive. Another industry facing the same challenges are newspapers, which are becoming less popular because of free online news websites, publiscations, podcasts and blogs. People can be informed 24/7 something which was not possible in the past (Brynjolfsson et al, 2006).

Other industries that have redefined the norm with technology include online marketplaces like EBay which brings buyers and sellers from all over the world together around the clock, or Craigslist which consists of local community forums for people to post jobs and other ads for free. Even the retail giant Wal-Mart has been extremely successful because of its inventory and distribution technologies which allow it to better meet customers’ needs and wants by tracking their purchase patterns and frequencies. Dell computers made it possible to buy customized personal computers online at affordable prices. While Starbucks redefined coffee shops by making coffee an experience and by creating a list of products that create a sense of comfort for consumer because they always know exactly what they are getting, just like McDonald’s did decades earlier with fast food. Travel agencies have also been influenced by technological advances and now people can plan trips from the comfort of their own home with Orbitz, Travelocity and Priceline. Even more incredible, students can now get their college degrees from solely online universities like the University of Phoenix. The world is changing and managers need to recognize this change as something permanent and something that they need to consider employing in their own business models and strategic operations before someone else beats them to it, as with Netflix and Blockbuster.

With so many industries already innovating to meet consumer demands there is no doubt that the future will mean more changes for several different industries. Not only high-tech industries have to constantly innovate to stay one step ahead of the competition, but now every industry needs to be changing its operations and business models to incorporate technological advancements and meet consumers need for more convenience in this fast-paced world. The future of video rentals is actually already beginning to transform again, this time into web based on-demand video rentals. Google’s YouTube is already in the process of testing a service that delivers videos online and if successful this could be Netflix’s biggest competition yet (S&P, 2010). Movie studios are actually researching video-on-demand outlets in an urgent response to changing consumption patterns and as a precaution to piracy threats.

MANAGERIAL IMPLICATIONS

Computers, the Internet, and other technological advancements have vastly changed the way companies are conducting their businesses. Technology has improved the way products are manufactured, marketed and distributed all in a short time period (Brynjolfsson et al, 2006). That means that managers have to be constantly innovating and looking for ways that technology can improve their product, service and delivery offerings. Consumers want more for less, that is nothing new, but the value they now seek is convenience. Consumers can now practically order anything online, with the exception of some hands-on services like healthcare or haircuts, but even those services now offer access to records or the ability to schedule appointments online. For this reason, managers now more than ever need to make sure they develop a strategy that keeps their offering current, convenient and cost competitive.

An effective manager must be able to recognize when it is time to implement a new strategy, even in saturated, mature markets. That is the biggest mistake managers make. They think just because they are the market leader that nothing can change that, but in an ever-changing, fast-paced world the competition can change overnight. Sustainability and competitive advantage can be lost in the blink of an eye. Technology and not harnessing its power before the existing competition or new entrants is the biggest threat companies face right now. It will be costly to implement these new technologies initially, but in the long run it will pay for itself and become increasing less expensive to operate over time. For managers that decide to switch from bricks-and-mortar stores to e-commerce operations, marketing costs will go down because consumer’s word-of-mouth through product reviews and referrals will dramatically increase. Satisfied customers refer friends and in the case of Netflix over 90 percent of subscribers recommend the service to their friends and over 70 percent of new subscribers report that they were encouraged to do so by their friends (Gallaugher, 2008). Word-of-mouth marketing is actually proven to be more trusted by consumers than other forms of advertisement and both positive and negative endorsements from friends, co-workers, peers and acquaintances have a very strong impact on product and service consumption. The failure of managers to realize the direction their operations should be going in can lead to devastating lost growth opportunities, some of which may even mean the end of the company or brand (Berry et al, 2006).

The most important thing for managers is to understand the innovations that can transform markets or even lead to new ones. Managers need to constantly research technologies available to them and hire or collaborate with people that understand these technologies to help them innovate before it’s too late. The drivers of success in the current environment are technologies that add value to products and services for customers by making the delivery more effortless, the price lower, and overall more convenient to consume, or a combination of any or all of the above. This will position companies for sustainable growth and profitability if executed in a timely and well supported manner. Company’s cannot execute new innovations without a solid team in place to deliver superb customer service and supporting features such as customized recommendations, advanced search options and user-friendly interfaces. First impressions are key and managers cannot half implement an idea, it must be fully formed and executed to be successful in the competitive, technologically savvy world we now live in. Managers need to separate their services from their products or tangible goods and develop ways to improve the service side of the offering by adding a new core benefit that is different from the actual use of the product. If managers can figure out how to out-innovate the competition and at the same