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Why Blockbuster Has to Lose the Stores

Even as Blockbuster engages with the high-tech/low-tech combination of Netflix, the real online threat thumps steadily closer.
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Blockbuster hasn't reached the Web 2.0 point just yet. On July 2nd, the retail video-rental chain announced its decision to hire James W. Keyes, former President and CEO of 7-Eleven, as its Chairman and CEO.

This is a decision made more interesting by Blockbuster's strategic position, as the company is engaged in one technological battle and is on the brink of another. The internet has already served up Netflix, which grabbed a chunk of Blockbuster's market share with its subscription-based service. At first it seemed that for many video consumers, the internet combined with the U.S. Postal Service made brick and mortar retail stores irrelevant.

This was half true. Blockbuster countered with its own online subscription service, bolstering it with the option to return videos to retail locations instead of mailing them back. Instead of dropping videos off in the mailbox, waiting for them to reach a facility, get processed, etc., Blockbuster subscribers can choose to drop their movies off at the store and get new ones. Once Blockbuster went to the online model, the physical stores became a competitive advantage that Netflix didn't have. They will not be an asset in the larger challenge that Blockbuster faces.

Even as Blockbuster engages with the high-tech/low-tech combination of Netflix, the real online threat thumps steadily closer. Streaming video technology, accessed either through internet players like Google and YouTube or traditional cable providers, has improved dramatically. Movies are already becoming available online over iTunes and Netflix. Once we hit the point where consumers can order movies online and watch them instantly, the value-proposition of the retail location starts to disappear. Right now, Blockbuster can offer its stores as an enhancement on the Netflix model. As more and more feature length movies become available online and on-demand, however, stores start to matter less and less.

All of which goes back to the central question -- why is Blockbuster hiring a retail chain CEO? And is there an alternative? James Keyes made 7-Eleven more tech-oriented in terms of supply chain, but there's a big difference between convenience stores, which can never be entirely digital, and video providers, which can. There is a significant possibility that, sometime over the next five years, Blockbuster will drastically have to reduce its number of physical locations or abandon them altogether. This will be a difficult decision for a retail CEO to make -- for Keyes to recommend that Blockbuster move away from physical stores would be to make his own core experience less relevant to his business.

It would appear that Blockbuster has a choice of mutually exclusive strategies -- one is to play deeper to their physical locations, to try to drive new traffic to their stores. Rick Aristotle Munarriz at the Motley Fool lays out some key points for Blockbuster to bring back some of the magic to the in-store experience. In order for the company to survive as a retail chain, he argues, it needs to make the locations fun again, with videogames, kids activities, etc. This will drive more traffic to the stores and more purchases. It is the sort of work that Keyes will excel at.

Unfortunately, there are two problems with this strategy. One, it is difficult to revitalize some stores as your employees watch you shutter others. From an investor presentation, their plan to close 282 stores in '07 is "expected to have similar benefits to 2006 closures." Anyone working at Blockbuster can see the trend of more and more closures, and given that landscape, infusing the stores and employees with new energy is a tough proposition. Troops cannot rally when they're in full retreat, and right now morale has got to be pretty low at the retail locations.

Secondly, it can only delay the inevitable. No matter how consumer-friendly the stores are, they still need a raison d'etre. Unless Blockbuster plans to become ultimately an arcade or a restaurant, they must rent (or sell) movies from their stores to create revenue, and that model will only become more and more anachronistic as time goes on.

Instead, Blockbuster should pursue an alternative strategy -- reorient entirely toward an online model. The company's core competency isn't maintaining retail locations but renting movies. After a decade of large-scale advertising campaigns (remember "Make it a Blockbuster Night?"), its greatest asset is its name and brand. Its stores, as they suffer dwindling profits and falling morale, are endangering that brand. Keyes, it seems, is a savvy enough manager to shepherd what's left of the stores forward, but he cannot save them. Blockbuster's only hope is to become a primarily online entity, and that is where Keyes must focus his company's money, planning, and effort.