Sun, Sep 19, 2010 page12

• Netflix is beating Blockbuster with clicks, not bricks

  • By Randall Stross / NY Times News Service, SILICON VALLEY, California
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  Not so long ago, in 2005, Blockbuster seemed invincible. However you preferred to rent movies — in stores or online — the company was ready to accommodate you.

  At the time, Netflix could offer only one way of obtaining a movie (the mail) and one way of returning it (the mail). It was clicks, with no bricks.

  Of course, we now know that Netflix has done just fine. In January 2005, its shares traded in the US$11 range. On Friday, they closed at US$140.46, giving the company a market capitalization of US$7.35 billion.

  As for Blockbuster, which was spun off from Viacom in 2004, it’s now a penny stock, and its woes are as visible as the “Closing” banner in the window of a store in your neighborhood. The company recently warned that it might file for Chapter 11 bankruptcy protection. Last week, its chief financial officer resigned.

  Blockbuster’s experience shows that executing a bricks-and-clicks strategy entails a high degree of difficulty, managing not just two very different kinds of businesses, with dissimilar domains of expertise, but also a third challenge: Integrating two separate systems. An online-only service can remain a best-in-class operation because its executives focus, focus, focus on just the online business.

  In the handicapping of likely winners and losers in 2005, Netflix seemed unlikely to survive, let alone thrive. Netflix is “not a sustainable business,” Michael Pachter, an analyst at Wedbush Morgan Securities, told SmartMoney that year. In his view, successful Internet businesses tended to “have a bricks-and-mortar component.” That is, retail stores.

  Pachter made an eminently reasonable point: That adding an online store to the market-­leading retail chain should make for a strategically unassailable position of strength, at least on paper.

  I called Pachter, who is now managing director of equity research at Wedbush Securities.

  “Blockbuster should have won — and didn’t. I was wrong,” he said. “I honestly believe most consumers would like a bricks-and-clicks solution. The reality is, they do have it. It’s just two different companies: Netflix and Redbox.”

  With video rental vending machines that sit within grocery stores, drugstores and other retail hosts, Redbox uses the bricks of its partners.

  Steve Swasey, vice president for corporate communications at Netflix, joined the company in March 2005, and he recalls that in his job interview he voiced concerns about Netflix trying to compete head-on with Blockbuster. There were plenty of other concerns, too: Wal-Mart, which also offered video subscriptions by mail (and would later abandon the service); rumors that Amazon.com would enter the business at any moment; and cable companies’ video on demand.

  Yet from Netflix’s vantage point, he says, Blockbuster’s decision to delay its entry into mail delivery put the giant at an enormous competitive disadvantage. Doing so postponed learning how to bring operating costs down.

  It took Blockbuster almost three years after introducing its online store to get around to integrating its bricks with its clicks, with its “Total Access” program which started in 2006.

  The plan initially delighted Blockbuster’s most profitable customers — its high-volume renters, who now could rent and return as many movies as they wanted for one low, flat rate. But it would be a financial disaster for the company. Subscription prices for unlimited-exchange plans had to be raised sharply, alienating many of those same high-volume users.

  Today, with broadband widely available, Netflix offers a streaming option to its members for many titles and now has that second distribution channel it was lacking.

  While Netflix has added digital distribution channels, so, too, have rivals, and it’s not clear that the subscription model will always do as well against the a la carte offerings of video on demand. Amazon never introduced a mail subscription service for video, as was once expected, but instead offers video on demand. And Redbox’s ever-spreading machines are another version of a la carte rentals.

  The allure of bricks and clicks has misled industry watchers in other cases. When Barnes & Noble started its online store in 1997, it, too, seemed a giant capable of sweeping aside an online-only company like Amazon with an effortless swat. But that giant had to compete against the world’s most highly evolved, ­easiest-to-use e-commerce Web site, with the most abundant customer reviews and all the other features Amazon had developed early because its executives were focused on nothing but that Web site.

  I bet that the author of an article titled “Why Barnes & Noble may crush Amazon,” which appeared in Fortune magazine in September 1997, now feels no small embarrassment about underestimating Amazon.com’s chances at the time.

  Actually, I’m certain that the author feels embarrassed: He was I.

  Randall Stross is an author based in Silicon Valley and a professor of business at San Jose State University.
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