How Blockbuster Plans to Beat Netflix

With a new business strategy and fresh IT, Blockbuster is attempting to reinvent the DVD rental business for the age of movie downloads and video on demand.

Action! Adventure! Thrills! Spills! The high-stakes drama of fixing the money-losing Blockbuster movie rental company has it all, except a happy ending yet. Can the duo of CEO Jim Keyes and CIO Keith Morrow, together again after a highly successful run at 7-Eleven, remake Blockbuster?

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This storied CEO-CIO team wants to translate the technology-enabled retail ideas they developed to sell snacks and Slurpees to rented entertainment—on land and online. That is, using IT to make sure the right amount of the right product is available at the right time. "You can do it anywhere," Morrow says. "The lifecycle on a sandwich or doughnut is measured in hours and days. The lifecycle of a new movie or game title is not very much longer."

At 7-Eleven, legend has it, the most loyal customers visited an average of twice a day, such as for morning coffee and a snack for the commute home. But Blockbuster patrons are deserting to competitors including Netflix and video-on-demand. Under Keyes' leadership, 7-Eleven cultivated customer loyalty by giving local managers control over their merchandise. With near real-time access to customer activity and inventory data, a manager could see that, for instance, he couldn't keep bear claws on hand for two days running—and he could change his bakery order for day three. The insight to use IT to fine-tune local inventory came from Morrow, but Keyes supported it—pushed for it even. "Jim's a believer in trying things to see how they work," Morrow says.

Their partnership played a large part in turning 7-Eleven into the United States' largest convenience store chain, with sales of $12.2 billion at the time Keyes left in 2005. By reprising their roles at Blockbuster, which has posted $4.8 billion in losses since 2000, Keyes and Morrow are betting that, even in this economy, they can turn the company around.

The pair is nearly two years into a three-tier transformation to stabilize Blockbuster's core rental-store business, diversify sales and build an online distribution system to handle growing demand for downloadable and streaming media. Keyes expects to show a profit this year, but Wall Street remains doubtful about the future: Blockbuster's $258 million market valuation is a fraction of Netflix's $2.2 billion. Even with IT and business in lockstep, that skepticism portends a nail-biter.

Stars in Their Eyes

At its founding in 1985, Blockbuster ruled video rentals. Its blue-and-yellow signage stood for VHS tapes, and later DVDs, to rent for a few days then pay a late-fee when you didn't return them on time. Remember those "Be kind, rewind!" stickers?

As the century turned, Blockbuster's business began to slide. Profits steadily drained away as physical and then online competition grew. It didn't help that customers couldn't get popular movies at Blockbuster stores up to 75 percent of the time, according to the company's own figures. Losses mounted. When billionaire investor Carl Icahn joined the board in 2005 as a significant shareholder, he went after CEO John Antioco publicly.

That same year, on the other side of Dallas, Jim Keyes retired from 7-Eleven, where he'd been for 21 years. During his last six, as CEO, he had hired Morrow.

In 2007, Antioco stepped down at Blockbuster, which wooed Keyes for the job. Sitting in shirt sleeves in his 21st floor office recently, Keyes recalled that period, when he had to contemplate unretiring. He liked the challenges he saw in movie rentals, he says. But he wanted a trusted CIO—his trusted CIO—with him.

"Retail is so dependent on technology," he says, leaning forward. "I met with Keith before I accepted the job." He took it in July 2007. Two months later, Morrow joined him.

Now Keyes and Morrow face some of the same obstacles many executives do. They have to attract and retain new customers, capitalize on competitor weaknesses and predict the direction and pace of change in a volatile market. But they also have to deal with the ugly backstory.

On arrival, job number one for the team was to figure out how better to run its 4,005 U.S. company-owned stores. (Blockbuster also franchises 850 stores.) Yes, the world is webified, Keyes acknowledges, but he contends that there's life yet in Blockbuster's physical stores—not only in traditional rentals, which still account for 85 percent of the $26 billion industry, but also as a way to seed the ground for new-style consumers.

Blockbuster very much wants the 18-year-old college kid to click on to download Spider-Man and Spider-Man 2 to his laptop for the flight to spring break. And the company doesn't want to ignore the 47-year-old mom who drives to its storefront at a strip mall to rent High School Musical for that night's sleepover.

But Blockbuster also wants to cultivate new kinds of customers, such as people who bring a portable video player to a kiosk to download digital content. Or someone who will stop at a vending machine at the train station to pick up a disc or a download.

"What we want to provide is convenient entertainment everywhere," Keyes says.

While Blockbuster expands the idea of what a video rental store is and does, its field of competitors has also grown, says Bobby Tulsiani, a senior analyst at Forrester Research. Beyond battling Netflix, it must also compete with giants such as Apple's iTunes store, Amazon's digital downloads and discs, as well as cable and broadband companies offering video on demand and sites such as Hulu, which offers free ad-supported video streams. Meanwhile, Wal-Mart and Target entice budget shoppers to buy super-cheap DVDs and electronics. And getting ready for their close-ups are still relatively unknown players such as Redbox, plunking down movie vending machines in the lobbies of grocery stores.

"Blockbuster has to transform its business, but so does Netflix and all the others. We don't know which method of entertainment will become most powerful," Tulsiani says. "So far, consumers are saying they can live with a multiplatform strategy for movie viewing."

Yet even if Blockbuster keeps pace on the Web and with kiosks as digital demand grows, it will still have to determine what to do with its physical stores, says Carla Casella, an analyst at JPMorgan. "New Blockbuster management is doing a good job building [other forms of] retail through its stores so the business is less reliant on rental. This takes time and initially hurts margins," Casella says. Real estate leases also drag Blockbuster finances. Blockbuster has closed about 250 U.S. stores since 2006 but is obligated to pay about $2 billion in operating leases for its remaining stores, according to its latest annual report.

You have to work with what you've got, Morrow notes. So Blockbuster's current plan is to turn its stores into "destinations" where people can get not just videos but the consumer electronics gear to play them on. Blu-ray DVD players, digital picture frames, e-book readers, portable MP3 players, major game consoles, flat-screen TVs—Blockbuster now sells all of these products from Sony, Nintendo, Archos, Samsung and several other electronics makers.

Rolling out across the country are stores-within-a-store to let curious customers try these gadgets while sipping a cold drink, seated in a cushy gaming chair.

This strategy to blanket retail and online outlets to sell consumer hardware next to rent-or-buy video software opens "fresh" terrain for the industry, says Tulsiani. Netflix, for example, has no physical stores and Best Buy doesn't offer media rentals. And another major electronics competitor, Circuit City, is liquidating (Blockbuster tried last year to buy Circuit City but could not reach an agreement with the company).

"There's no reason not to offer a wider array of products, beyond popcorn, when you have all this foot traffic," Tulsiani says. "It's not crazy. It is a modern electronics store."

What Morrow and his IT staff must do to enable this hopeful pioneering involves tactical as well as strategic projects to get customers to Blockbuster locations. For example, the IT staff had to set up new databases to track digital rights for movies delivered on disc and online. Movie companies negotiate different viewing windows for streamed, downloaded and DVD content. For example, you might be able to check out The Dark Knight on DVD for five nights. If you download it on demand, once you hit play, you have just 24 hours to view it. You can also buy the digital copy and keep it forever. Parameters differ for renting a movie on an iPhone, PC or gaming machine such as a Playstation. Blockbuster subscribes to a Web service that updates its Oracle-based digital rights management database. "We've got to get that right at all times," Morrow says.

But diversifying sales means more than branching out into new product lines. It also involves coaxing a different kind of customer to look at Blockbuster.

Who Gets the Girl?

There's a scene in All Quiet on the Western Front where soldiers vie for the boots and other valuables of a dying comrade. The corporate corollary is grabbing the customers of a rival heading to bankruptcy. But you can't do that without good data.

Over a Bento box lunch near Blockbuster headquarters in December, Morrow explained how technology helps with the time-honored retail practice of capitalizing on casualties.

Before Morrow arrived, Blockbuster kept an Oracle database with information about its competitors' stores. But the system wasn't updated much and needed new analysis tools, he says, "to help us with store profitability and finding where the best opportunities are." At 7-Eleven, for example, sales and inventory data was updated frequently throughout the day to keep store employees in the know about which merchandise moved and which got dusty.

Now at Blockbuster, financial and real estate analysts add data to the system regularly—including anything public and confirmable about locations and sales statistics—to compare with the performance of Blockbuster's own stores and to jump on opportunities to grab market share.

For example, Movie Gallery, which owns Hollywood Video and is Blockbuster's nearest competitor in video rental stores, entered Chapter 11 bankruptcy protection in 2007. The court required it to release the addresses of the locations targeted to close.

Blockbuster analysts were able to take that information and fill in anything missing from their Oracle records. Then they ran queries using Oracle business intelligence and SAS statistical analysis tools to figure out whether to lease vacant Movie Gallery spots and where to do local marketing to lure customers to nearby Blockbuster stores. Movie Gallery emerged from Chapter 11 last May, about 560 stores smaller.

Morrow declines to cite specifics about the financial gain from such moves, but he carefully lays down his fork and says, "We absolutely made that a priority. It's a pretty important tactic, to go after the revenue of closing stores."

Of course, no one thinks scavenging will be enough to lift Blockbuster's financial results. A happy ending means Blockbuster—to borrow from another movie genre—has to get the girl. Not lovable Meg Ryan in any of her numerous chick flicks, but that ravishing beauty known as a loyal customer.

The Once and Future Patron

Blockbuster is striving to attract customers from various demographics to its stores and ease them gently into new technology. If people can relax in a cool, low-pressure environment to learn how to load movies onto portable MP3 players, do the hula hoop on Nintendo's Wii and watch a feature film through kooky computer eye glasses, they'll be grateful. They'll see what else you offer. They'll come back in person and on the Web. When they someday spot the Blockbuster name on a kiosk at the supermarket or a vending machine at the mall, they'll walk right up and swipe a credit card. Blockbuster will have diversified its sales and been sustained into the future.

That's the theory, anyway, that pushed the redesign last year of about a dozen stores in Nevada and Dallas to house new "Rock the Block" shops: stores-within-the-store that display gear for shoppers to touch and try. These internal shops are dedicated either to gaming consoles and accessories, consumer video equipment or a kids' play area to relieve tense parents trying to browse.

In Dallas, Jeff Gloor, Blockbuster's senior director of operations strategic development, walks among clean white counters arranged in a circle to show off electronics at the center of a downtown store. The space is open, airy, neat. "It's like an Apple store," he notes. "Not like a Best Buy, where it's all crowded."

Gloor sweeps his arm above the gear. "These are all products you can load content onto." For example, there's an Archos portable media player ($100) and docking station ($70) to use the player on a home TV, such as a Sony Home Theater ($250) sitting nearby. In time for Christmas, Blockbuster released a set-top box it built with 2Wire; $99 gets you the device and 25 downloaded rentals.

"These products might not be familiar to some customers, so they can experiment here. See what it's all about," he says. "Whole families come to hang out on a Friday night."

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