Netflix introduced video download services to Canada (21 September) and two days later, the US-based Blockbuster video rental service declared bankruptcy (23 September). It is a clear example of the power of creative destruction in capitalism. It is also a perfect illustration of how two companies competing for essentially the same customers can have distinct business models based on different driving forces, with, so far at least, highly divergent outcomes.

Blockbuster’s business model is basically to have a large number of neighbourhood stores to provide walk in clients with the opportunity to buy or rent videos. Prospective customers come into the store with the idea of renting a video, but not necessarily with a precise idea of which one. Blockbuster’s business model is entirely based on the method of sale. No stores, no business. It’s as simple as that. This requires an investment in store infrastructure to ensure that customers are able to purchase or rent videos.

However, with increasing competition from alternative sources (online video on demand, cable video on demand, and the Netflix model, i.e., home delivery of videos after online ordering), the physical costs of operating a chain of video stores became too onerous.

Netflix is one of Blockbuster’s main competitors. Its business model is built around a different driving force, one based on method of distribution instead of method of sale. Rather than operating a chain of physical store locations, it built out a distribution network to service subscribers ordering a list of movies through their online reservation service. Costs are easier to control because of the greater efficiencies inherent in a centralized distribution network. Presentation and merchandising costs are also eliminated because there is no physical location needed to attract and please walk in customers.

However, Netflix has even more of an advantage because the transition to other modes of distribution has less inherent inertia to overcome in order to introduce alternate viewing media. Netflix’s success is due to a mail distribution model for DVDs and Blu-ray discs. But this is just one way of getting video to the end user. Online distribution is an optional means of doing so, and there is less reason to resist changing to that model because the sunk costs of the mail order model are not as high as those of a video stores chain. There are also fewer employees, and no franchisees to contend with. (The challenge that GM has faced in reducing its number of franchisees over the years provides another illustration of the inertia such a model can present when a company wants to change or modify its business model.)

In the final analysis, Blockbuster’s bankruptcy shows that its business was built around a narrow definition of its value. Blockbuster was founded in 1985 and defined itself as a chain of video rental stores. The chain of stores was its raison d’être, but the customers didn’t care about the stores, only the videos. Blockbuster experimented with larger locations that offered a variety of in-store entertainment experiences, but this just showed that customers didn’t care to hang out in a glorified arcade, when all they wanted was to rent a video for an evening.

Netflix, on the other hand, defines itself by the service it provides – the possibility of watching a video without leaving the couch to order it. That’s the same value proposition as cable channels’ on-demand video service. However, the customer doesn’t need to lock in with a cable company. Now that Internet downloading and streaming are feasible and cost effective, customers have even less lock in. They can just use their existing computer and Internet connection. Smart phones also provide another vector for downloading or video streaming. The fact that Netflix has chosen to enter the Canadian market only with the streaming service indicates that the mail order model is obsolescent. The company will probably continue to offer it in its home U.S. market for the foreseeable future, but it is the Internet streaming model that is the way of the future for video viewing.

People know what videos they want to watch. Whether intentional or not, Netflix’s method of distribution driving force gives it greater flexibility in delivering a video watching experience to its customers. Mail order is one way to do so, but so is the Internet, or a smart phone for that matter. I predict that as long as Netflix remains flexible about its methods of distribution, it will continue to be successful. If, however, it becomes enamoured with one method in particular, it will probably experience challenges similar to Blockbuster’s.

Every company and non-business organization must examine its business model on the basis of its driving force. I’ve written more extensively about different driving forces in other articles. A good start is to ask, “What IS our driving force?” The next question should then be, “Should this even BE our driving force?” When senior management starts to ask itself these questions, the answers can sometimes be surprising and are always powerfully revealing.

© 2010 Richard Martin. Reproduction and quotes are permitted with proper attribution.

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