How Blockbuster Failed at Failing

In retrospect, it seems obvious that the practice of driving to a store to rent a movie to watch at home was preordained to extinction. The surprise, and the business tragedy, is this: the company that delivers movies to 15 million doorsteps these days isn't Blockbuster — the retail chain that once dominated the industry — but an upstart, Netflix, that used little more than a website and knowledge of the postal service to topple a far more powerful and wealthy rival.

It had been clear for years that Blockbuster's model was unsustainable. Heck, Netflix was operating for six years before Blockbuster launched its own movie-by-mail service. So Blockbuster had more than enough time to adapt. Instead, its bosses hinted they could copy Netflix and crush the upstart. When that didn't work, they could have smartly managed the demise, handing whatever money the firm made over to shareholders. Blockbuster didn't do that either. It's one of those companies that failed at failing. Since 1999, Blockbuster has paid out in dividends just 12% of the cash its operations generated. Worse, a succession of managers squandered cash on schemes to keep the outmoded retail business alive. That just delayed the end. On Sept. 23, Blockbuster filed for bankruptcy, a few weeks shy of its 25th birthday. (See pictures of retailers that have gone out of business.)

For now, Blockbuster's more than 3,500 stores will remain open. It has worked out a deal with lenders to wipe out most of its $1 billion debt. In return, those lenders will be Blockbuster's new owners. Analysts estimate the company will have to close as many as two-thirds of its outlets, though CEO Jim Keyes says no determination has made. The same can be said for Keyes. Blockbuster has reportedly hired executive search firm Korn/Ferry to help the company find a new chief executive. While Blockbuster says Keyes may remain in the company's top job, he is also playing an active role in evaluating any successors.

Blockbuster's bankruptcy is more bad news for the struggling economic recovery. The Dallas-based organization has 25,500 workers, of which 7,500 are full time. More than half could find themselves out of work. The bankruptcy will also create more vacant spaces in strip malls, adding to the woes of the lagging commercial real estate industry.

Bankruptcy could finally give Blockbuster the chance to provide movies to customers not only through stores but also via vending machines — it currently has 6,630 DVD dispensers — by mail and through a streaming service for Internet-connected DVD players and wireless TVs. "It's about being the most convenient for the customer," says Keyes. "Our business model, with multichannel distribution, is well positioned for the future."

So Blockbuster may survive. But the market has changed so much that the former giant is unlikely to thrive. Its rival Redbox already has 24,000 video kiosks, more than three times the amount Blockbuster has, at supermarkets and other stores, dispensing DVDs at $1 per rental. Blockbuster has matched that price at its vending machines but gets three to five times that for a new release at its stores. In streaming video, Netflix has a huge lead on Blockbuster, yet Netflix is facing stiff competition from the likes of Apple, Amazon and Walmart. "Blockbuster doesn't have a clear run at the finish line," says Steve Harnsberger, who follows the market for the technology consulting firm FreeStyle. "Even if they transition to digital, it's not going to be what they used to make at the stores." (See the 100 best movies of all time.)

A Breakthrough Goes Broke
Blockbuster, ironically enough, was the product of a tech advance. Entrepreneur David Cook founded the outfit in 1985. A computer programmer, Cook noticed that typical movie-rental-store owners had no idea what they had in stock. Customers would pick an empty title case off a shelf and wait while a clerk hunted in the back room to see if there were any copies left. Cook programmed computers to keep track of inventory and give him a daily report of what customers were renting. While every video store had the newest releases, Cook's computers also allowed him to determine which older, classic titles people wanted and which ones to ditch. That allowed Blockbuster to optimize its movie selection. Today it's Retailing 101, but back then it was a revelation. Combine Cook's computers with brightly lit stores that had a family-friendly, no-porn policy and Blockbuster was a retail hit.

Over dinner not long ago at a restaurant in Dallas, Cook, 59, who left Blockbuster in 1987 and has since started two technology companies, says the current situation is a shame. "It didn't have to be this way," he says. "They let technology eat them up." Just as Cook's larger, better-stocked stores had done in the '80s, Netflix made it easier to find the films you wanted, especially if you weren't looking for just new releases. (See five ways to fix Netflix.)

Cook sold a controlling stake in Blockbuster to H. Wayne Huizenga for $18 million, and the new owner turned it into something worthy of its name. When Huizenga took over, Blockbuster had just 19 stores; he increased the number by some 500 a year. He would go on to own AutoNation and sports teams, including the NFL Miami Dolphins, as well as help bring the Marlins to Florida. These days, Huizenga, 72, seems more interested in the Ab Circle, a piece of exercise equipment in his Fort Lauderdale office, than in film rentals. But before Blockbuster went under, he shared some of its secrets.

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