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Flaws in Blockbuster's Revival

Kevin Kelleher

Blockbuster's plan to knock off competitor Netflix seems to be working. The game is over.

Or is it?

Blockbuster's stock closed Monday at $7.14, up more than 85% since late October. That's not bad at all for a company that only a year or so looked like wide-eyed roadkill with a Mack truck bearing a Netflix logo headed straight for it.

At its darkest hour, Blockbuster turned the tables admirably, launching Total Access. The program aimed straight at Netflix' weakness: Blockbuster subscribers who rented a DVD through the mail could return it to a bricks-and-mortar store and get a free DVD there while the next DVD in their online queue was popped into the U.S. mail.

The strategy played on Netflix's tendency to "throttle" DVDs -- that is, find some excuse to delay shipping a DVD to a hyper-loyal customer addicted to DVDs. Throttling, which helps hold up Netflix's bottom line, does a mean thing to addicts: It denies them their addiction.

But with Total Access, a movie-lover jonesing for a new DVD could drive down to a Blockbuster store and get a quick fix.

It was a brilliant move. Investors loved it so much they kept driving up Blockbuster's stock, despite a couple of quarters of earnings depressed by higher marketing and other costs needed to get the program off the ground.

To send the ultimate all-is-forgiven message, they've granted Blockbuster a forward price-to-earnings ratio (19.1) on par with that of Netflix (19.8).

And Blockbuster rewarded investors for that faith. In its fourth quarter, it not only posted its first profit in three quarters, that profit was 4 cents above the 5 cents a share that the Street had forecasted.

Total Access, it seemed, was now behind of the wheel of the truck -- with Netflix in its sights.

But this month brought evidence that Total Access may not be the slam-dunk that Blockbuster investors hoped for. It's even starting to look like the Total Access ball is still rolling around the rim -- maybe it will drop through, maybe it won't.

The first red flag came in the form of a trial balloon from Blockbuster that quickly found its way onto blogs devoted to the online DVD-rental industry. The site HackingNetflix, which despite its illicit-sounding name has become something of a clearinghouse for Netflix and Blockbuster tipsters, said Blockbuster may be raising the subscription fees for Total Access.

At first blush, this seems like a boon for Blockbuster: CEO John Antioco would love to justify his income by telling shareholders he's bringing in even more revenue without weighing down margins.

But the truth is that this strays from the secret formula of hitting Netflix where it's weak. In fact, it's hitting Netflix where it's strong. After a few missteps in its early years, Netflix finally hit on the delicate balance in subscription fees. It learned the hard way that raising fees can drive customers away.

Blockbuster must be thinking something like this: Netflix and Blockbuster offer the same thing in online DVD rentals. Therefore, Total Access makes Blockbuster more attractive than Netflix. Therefore, Blockbuster can woo Netflix members over, then raise fees because everyone will understand it's fair to pay a premium for the better service.

And therein lies the weakness of Total Access. First of all, Netflix and Blockbuster are not equal online. Compete.com shows just how much more "long-tailish" (selling less of more) Netflix is than Blockbuster: 3% of Blockbuster DVD rentals were one title, The Illusionist, vs. 0.5% at Netflix.

In fact, there were nearly as many Netflix rentals of the 2005 movie Crash (0.4%) as there were of the recent DVD release of Crank (0.5%). Over at Blockbuster, 2.5% of rentals were for Crank.

This is important, because as more people wake up to the lure of the "long tail" of movies, the more Netflix's broad selection will become useful, and the less the narrow selection of Blockbuster stores will be in demand.

A more thorough summary can be found on the LAist blog. These gripes reflect those of other renters: poor search, even worse recommendation software and longer turnaround times than even the throttle-prone Netflix.

Poor turnaround has become an especially sore point for Blockbuster subscribers, just as the company is surveying them on how much they'd enjoy a fee hike. First reported on HackingNetflix and later expanded on tech-news site Ars Technica, an apparent glitch has prevented some Blockbuster renters from receiving movies from their online queues for as long as two weeks.

A Blockbuster spokesperson said the glitch may have affected a "small but vocal" fraction of its 2 million subscribers, who were unfortunate enough to report an issue before the DVD had cleared from their queue. The glitch had been fixed, he said.

But from the comments posted on those sites, as well as consumer bulletin boards like FatWallet, there were a lot of users put out by that glitch.

Blockbuster may have Netflix on the defensive, and investors eating out of the palm of its hand, but it's clear that victory is never a clear-cut matter in this evolving industry.

Netflix could take one simple step to strike back at Blockbuster: end throttling and hold to its prices. Then the race would be wide open again.