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Hubris — and late fees — doomed Blockbuster

For now, Blockbuster intends to continue operating its remaining 3,300 U.S. stores under Chapter 11 protection.
Image: Blockbuster store
Blockbuster was the first rental service to serve billions and billions of home videos to a mass audience. It popularized the VCR and built up a chain of stories that peaked at 9,100 in 2004.Kevork Djansezian / Getty Images
/ Source: The Associated Press

Blockbuster video stores used to be the town square for home entertainment, bustling with people roaming the aisles in search of a movie that the whole family could enjoy in their living room for just a few bucks.

The stores melded discovery and convenience, making it possible to stumble upon a movie that you would never have bothered to see in the theaters and be back on your couch in a matter of minutes with your own bowl of popcorn.

And if you were on the fence about buying a VCR back in the 1980s, Blockbuster was everywhere, turning the decision into a no-brainer.

Now we're more likely to pluck DVDs out of a mailbox or a vending machine in the local supermarket — or get even more immediate gratification by playing a movie through cable or high-speed Internet.

The long shift finally pushed Blockbuster Inc. into bankruptcy Thursday, raising the possibility that another cultural touchstone could crumble amid the upheaval unleashed by new technology and savvy entrepreneurs who know how to exploit it.

For now, Blockbuster intends to continue operating its remaining 3,300 U.S. stores under Chapter 11 protection, although analysts expect hundreds of them to close under new owners led by billionaire investor Carl Icahn.

That will likely mean mass layoffs among Blockbuster's 25,500 employees, including 7,500 full-time workers. And if Icahn and the rest of the new ownership hope to save Blockbuster, it will require coming up with an antidote to the dual threats posed by Netflix and video vending machine operator Redbox, which is owned by Coinstar Inc.

Blockbuster's decade-long downfall from video-rental powerhouse to has-been is a story of how shortsighted management and corporate arrogance helped turn a couple of brash upstarts into the new stars of home entertainment.

It probably would have been in a far better position had it taken a company called Netflix more seriously in 1999 when the upstart started taking DVD rental orders online and mailing the discs to people's homes.

Netflix added a twist that immediately appealed to Blockbuster customers longing for another choice: monthly subscription plans that allowed households to keep up to several DVDs at a time without incurring late fees.

The offer tapped into consumer anger because Blockbuster's fees could double or triple the cost of a video rental. And Netflix's flat-fee system also ended up killing a golden goose for Blockbuster. In 2000 Blockbuster collected nearly $800 million in late fees, accounting for 16 percent of its revenue. Last year, those late fees had plunged to $134 million, or just 3 percent of the company's revenue.

Blockbuster tried dropping its late fees a few years ago, but that didn't work out well because it kept the most popular DVDs out of its stores for long stretches.

And when Blockbuster finally tried to counter Netflix with its own DVD-by-mail service, its average revenue fell even further to just $2.79 per disc, nearly a buck below previous levels.

Even when Netflix started to gain enough traction to go public in 2002, Blockbuster's then-CEO John Antioco dismissed it as a niche service.

"The best analogy I can think of is that Netflix seemed like a buffet," said Securities analyst Michael Pachter. "While you could see some people liking the idea of having all you can eat for one price, you would never imagine it turning into a major competitor to McDonald's."

Blockbuster was the first rental service to serve billions and billions of home videos to a mass audience. It popularized the VCR and built up a chain of stories that peaked at 9,100 in 2004.

Later, it helped turn DVD players into household staples, opening new revenue streams for Hollywood studios. In the process, it drove hundreds of mom-and-pop video stores out of business.

"It was the big kid on the block," said Stanley Baran, professor of communication at Bryant University in Rhode Island.

Now, it's the weakling getting sand kicked in its face.

The company has cumulatively lost more than $4 billion since 2002, and suffered the embarrassment of being taken off the New York Stock Exchange. Leading up to the bankruptcy filing, Blockbuster's market value had fallen to just $12 million, from $4 billion eight years ago. Its shares will be rendered worthless if the bankruptcy plan is approved.

Netflix, in contrast, now boasts a market value of $8 billion, reflecting investor expectations that its earnings will continue to soar as its total subscribers swell from 15 million now to more than 20 million some time next year.

Blockbuster, founded 25 years ago in Dallas, is hoping it can rewrite the script by using the bankruptcy process to reduce its debt from nearly $1 billion to about $100 million under a reorganization plan that it hopes to get approved by early next year.

Besides purging debt, the bankruptcy case also will make it less expensive for the company to shed the leases of stores that aren't making money. But those cost-cutting measures won't be enough to save Blockbuster unless it can figure out a better strategy for countering Netflix and Redbox.

Those low-cost alternatives have made it difficult for traditional video stores to bring in enough money to cover their expenses, even after dumping debt. Movie Gallery Inc., formerly the No. 2 chain behind Blockbuster, finally decided to close its doors earlier this year after its second trip through bankruptcy court since 2007.

Icahn, who did not return calls requesting an interview, should be well aware of the challenges facing Blockbuster. He tried to engineer a previous turnaround after buying a nearly 10 percent stake in the company and muscling his way onto its board, but Blockbuster kept losing ground.

This time around, Icahn will share control with several little-known funds that try to capitalize on the demise of companies by buying their debts for pennies on the dollar: Owl Creek Asset Management, Monarch Alternative Capital, Varde Partners and Stonehill Capital Management.

Under its new ownership, Blockbuster plans to build upon its recent efforts to rent videos through the mail and over high-speed Internet connections, just as Netflix does. It also stamped its brand on 6,600 kiosks, owned and operated by NCR Corp., that are similar to Redbox's nearly 27,000 DVD-dispensing machines.

But it could prove to be too little too late, especially with technology heavyweights such as Inc., Apple Inc. and Google Inc. all angling to deliver more video to living rooms through Internet lines that are increasingly being connected directly to television sets.

Blockbuster has been "slow because they were big, and other competitors were nimble," Baran said.

The company opened its first store in 1985 when its founder, David Cook, was looking to branch out of the oil and gas software business. The rental chain took off in 1987 after Waste Management Inc. founder Wayne Huizenga took control.

Huizenga reaped a blockbuster gain when he sold the chain to Viacom Inc. for $7.6 billion in 1994. But Blockbuster never fit well with the rest of Viacom's advertising-driven TV and radio businesses, and the video chain spun itself off in 1999.

Antioco ran Blockbuster until he departed in 2007 under pressure from Icahn, who helped bring in former convenience store executive James Keyes to draw up new strategies.

Keyes helped bring in more customers by stocking Blockbuster's shelves with electronics to supplement its DVDs, but he has spent most of his time trying to put out the company's financial fires.

It will be up to Icahn and the rest of the board to decide whether to retain Keyes or bring in someone else. A Blockbuster spokeswoman said Keyes was unable for interviews Thursday.

"Keyes is a capable guy, he just happens to be the captain of the Titanic," Pachter said. "He came on board after the company had already hit the iceberg. It will be sad if they can't find a way to keep it afloat."