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Blockbuster Incorporated A Strategic Analysis for the Troubled Movie Rental House (Internal Analysis) Erin M. Clark December 4, 2007 BUSA 499: Strategic Management Pacific Lutheran University Dr. Pham Clark 2 Table of Contents I. Introduction/Strategic Profile A. Executive Summary B. Company Overview II. Appendix B: Internal Analysis A. Financial Analysis B. Resources C. Value Chain Analysis D. Capabilities E. Distinct Core Competencies III. Appendix C: Strategy Formulation A. Major Issues B. Sustainable Solutions C. Implementation Plan IV. Works Cited Clark 3 I. Introduction/Strategic Profile A. Executive Summary The purpose of this case analysis is to evaluate the internal and external environment of Blockbuster Incorporated to determine the strategic position of the firm. This evaluation will be further used to identify and recommend solutions to problems being faced by Blockbuster. Blockbuster is the largest retail movie rental store in the world. Responsible for over a billion rentals of DVDs and video games per year, the organization operates in over twenty-two countries with over eight thousand stores. In addition to further expansion into other countries, they have recently made the transition into a new market. Utilizing a web based rental system, they are taking on serious competition such as Netflix and Comcast by offering both DVD by mail and downloadable, or streaming, rentals. Blockbuster is currently undergoing an organization-wide overhaul and divesting from foreign interest and refocusing on their core businesses in the United States. (1) B. Company Overview The company was founded in 1982 in Dallas, Texas. Since then Blockbuster has spread out and made their brand a household name. They contribute their success to great customer service and loyal customers. As cited in their website, Blockbuster prides themselves in their products and has launched a totally new way to rent movies, through its Total Access Pass. With the new package, online renters are granted unprecedented access to movies through mail or returning them to any store for an exchange at no additional cost. “At Blockbuster, diversity means valuing differences. It is a corporate value that must be continually developed, embraced and incorporated into the way we do business.” (2) Blockbuster is the leading global provider of movie and game entertainment with stores throughout America, Europe, Asia and Austria. It is one of the strongest entertainment companies in the world reported with revenue worth more than 5.5 billion in 2006. Although the entertainment business has made many changes, Blockbuster will adjust and move in the direction that is necessary to make the business successful. “Blockbuster believes it has the assets that will enable the Company to bridge to the future.” (3) This includes the brand that stands for rented movies, relationships with tens of millions of customers, good relationships with the Hollywood studios and other content providers, and entertainment marketing know-how. Blockbuster operates in a highly competitive market offering a variety of movies, television shows, and video games for various consoles. With their core business dealing in “in-store rentals” they have expanded into other markets, such as the online rental market, as well as utilizing recent technology allowing for “digital distribution” over digital cable and satellite mediums. Since 2004 they have made significant progress with their new product offerings. This being noted, Blockbuster is still facing significant Clark 4 challenges as they progress towards their ultimate goal of complete integration of their new online business units and their core business of in-store movie rentals. With the introduction of Blockbuster Total Access and the elimination of late-fees, they have successfully warded off competition from significant competitors, excluding Netflix. They have subscribed over two million online consumers to their Total Access program, allowing them to close stores in areas with lesser demand and show and post increases to their year-end financials. (4) The Blockbuster website proudly displays their mission statement, saying that Blockbuster is “to perform for our customers the highest level of quality construction services at fair and market competitive prices, to ensure the longevity of our company through repeat and referral business achieved by customer satisfaction in all areas including timeliness, attention to detail and service-minded attitude, to maintain the highest levels of professionalism, integrity, honesty and fairness in our relationships with our suppliers, subcontractors, professional associates and customers.” As cited on their website, Blockbuster feels that films are meant to be watched and enjoyed. They believe that the consumers want variety in their options of films. With over 60,000 titles for customers to rent, Blockbuster feels that their customers are getting the most for their time and money. This is one reason they started with the Total Access program, so that their customers would have complete access to all movies and other titles though internet access. The Blockbuster business model provides an advantage over other large video chains and significant advantages over single store competitors. The key elements of this business model are to: provide a large number of copies and broad selection of movie titles, operate conveniently located and highly visible stores, offer superior and consistent customer service, optimize their pricing to local market conditions, nationally advertise and market Blockbuster brand name and the differences between them and other competitors, use their extensive customer transaction database to effectively operate and market their business, and improve their efficiency and lower their costs through self distribution. (4) Blockbuster has several distinct business divisions that service uniquely different people. Each of them adapts as the market changes. This market is different, however, in that it is based not always on what the customers want, but they do not yet know about. Like other movie rental enterprises, Blockbuster aims at offering the most current movies and games as they become available. If they waited to see what the customers wanted to see, it would simply be too late. Much of this business is a gamble, and it does not always turn out in their favor. However there are many tools for them to utilize, such as reviews and sales data from the original release of the films. Blockbuster has the unique ability, setting them apart from other “typical” movie rental stores, to use its online division to find ratings, reviews, and rental data on each movie that it offers. With this, they can apply to their other business division, in sales and in-store rentals. There is a lag time using this approach, so there truly is a mix of looking at data from movie releases, data from online rentals, and persons with the movies “in-queue,” and ultimately guessing what the members will want to see. Clark 5 With such a large market share, Blockbuster can, to an extent, drive the market and release what they want, when they want to. All of this comes with a grain of salt; choosing to or not to offer the rental or sale of certain movies may be in their best interests with regards to their bottom line, but not their image. With such a large market share, they need to be aware of what people interpret their business moves to mean. If, for example, Blockbuster chooses not to release a movie featuring a newly found Jewish star because its ratings were less than that of another movie released at the same time, and focused its advertisements on the other movie instead, they may actually alienate their Jewish members. The same goes for any minority group who might misinterpret their strategically designed move. (5) (6) The organizational structure of Blockbuster is somewhat traditional, but relatively flat in comparison to most. This contributes to their success. There is Blockbuster Corporate, as most corporations traditionally have, and strategic business units, each running their own unit as if it were a standalone business. According to Fidelity, there are several distinctly different business units: corporate, franchises, sales, and online, with corporate backing each unit with a centralized marketing, research and development and IT department. Each business, although separate, shares information on their members, with regards to rental and purchase history. (6) II. Appendix B: Internal Analysis 1. Internal Analysis An internal analysis is conducted in order to identify current and potential sources of competitive advantages. This process is accomplished by understanding Blockbuster’s resources and capabilities, and identifying what does and does not create value. A. Financial Analysis Blockbuster has a very high amount of debt and cannot rely on their financial leverage or strength for growth; they state in their 2006 Annual Report that it may become “necessary for us to divert our cash flow from operations to debt service payments.” As of December 31, 2006, Blockbuster’s total outstanding debt was approximately $984.2 million. The following list describes the adverse impact on earnings and cash flow due to their debt service obligations: i. Make it more difficult for to pay debts as they become due during general adverse economic and market or industry conditions because any related decrease in revenues could cause Blockbuster to not have sufficient cash flows from operations to make their scheduled debt payments Clark 6 ii. Limit flexibility in planning for, or reacting to, changes in business and the industry in which Blockbuster operates, including limiting their ability to invest in strategic initiatives, and, consequently, place them at a competitive disadvantage to their competitors with less debt iii. Require a substantial portion of cash flows from operations to be used for debt service payments, thereby reducing the availability of cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes iv. Cause trade creditors to change their terms for payment on goods and services provided to Blockbuster, thereby negatively impacting their ability to receive products and services on acceptable terms v. Result in higher interest expense in the event of increases in interest rates since some of Blockbuster’s borrowings are, and will continue to be, at variable rates of interest Clark 7 Blockbuster Financial Comparison Data (Source: Hoovers (14)) Profitability Company Industry Market Gross Profit Margin 52.70% 49.10% 52.10% Pre−Tax Profit Margin -1.00% -15.00% 6.10% Net Profit Margin -1.70% -12.90% 4.80% Return on Equity -13.70% 10.10% 9.20% Return on Assets -3.40% -14.00% 1.50% Return on Invested Capital -5.50% 5.60% 3.90% Valuation Company Industry Market Price/Sales Ratio 0.08 1.93 1.84 Price/Earnings Ratio −− 21.99 16.87 Price/Book Ratio 0.7 2.39 1.78 Price/Cash Flow Ratio 3.58 11.29 11.02 Operations Company Industry Market Days of Sales Outstanding 8.09 33.04 58.08 Inventory Turnover 5 23.3 5.6 Days Cost of Goods Sold in Inventory 72 12 65 Asset Turnover 2 0.5 0.6 Net Receivables Turnover Flow 46.8 8.6 6.5 Effective Tax Rate -46.80% 3.50% 28.90% Financial Company Industry Market Current Ratio 1.14 0.97 1.71 Quick Ratio 0.8 0.9 1.2 Leverage Ratio 0.32 0.32 0.24 Total Debt/Equity 1.25 0.61 0.64 Interest Coverage 0.41 3.77 5.33 Per Share Data ($) Company Industry Market Revenue Per Share 45.54 0.79 5.7 Fully Diluted Earnings Per Share from Total Ops −− −− −− Dividends Per Share −− 0.25 0.62 Cash Flow Per Share 1.05 0 0.5 Working Capital Per Share 1.23 0 0.58 Long−Term Debt Per Share 6.51 0.08 2.6 Book Value Per Share 5.38 0.08 5.2 Total Assets Per Share 21.1 0.26 10.66 Growth Company Industry Market 12−Month Revenue Growth -2.40% -1.10% 11.40% 12−Month Net Income Growth 0.00% 3.20% 12.90% 12−Month EPS Growth 0.00% 19.0%) 7.80% 12−Month Dividend Growth 0.00% 0.00% 0.00% 36−Month Revenue Growth -6.90% 11.10% 36.30% 36−Month Net Income Growth 0.00% 117.50% 39.00% 36−Month EPS Growth 0.00% 150.00% 34.30% 36−Month Dividend Growth 0.00% 0.00% 0.00% Clark 8 Key Numbers Blockbuster Hastings Netflix −− −− Annual Sales ($ mil.) 5,523.50 548.3 996.7 −− −− Employees 67,300 5,962 1,300 −− −− Market Cap ($ mil.) 445.6 90.3 1,579.90 −− −− Profitability Blockbuster Hastings Netflix Industry Market Gross Profit Margin 52.70% 35.00% 36.00% 49.10% 52.10% Pre−Tax Profit Margin -1.00% 1.90% 9.30% -15.00% 6.10% Net Profit Margin -1.70% 1.30% 5.60% -12.90% 4.80% Return on Equity -13.70% 7.50% 16.10% 10.10% 9.20% Return on Assets -3.40% 2.90% 11.20% -14.00% 1.50% Return on Invested Capital -5.50% 5.00% 16.00% 5.60% 3.90% Valuation Blockbuster Hastings Netflix Industry Market Price/Sales Ratio 0.08 0.14 1.34 1.93 1.84 Price/Earnings Ratio −− 10.6 24.55 21.99 16.87 Price/Book Ratio 0.7 0.77 3.64 2.39 1.78 Price/Cash Flow Ratio 3.58 3.7 5.4 11.29 11.02 Operations Blockbuster Hastings Netflix Industry Market Days of Sales Outstanding 8.09 104.13 0.87 33.04 58.08 Inventory Turnover 5 −− −− 23.3 5.6 Days CGS in Inventory 72 −− −− 12 65 Asset Turnover 2 2.2 2 0.5 0.6 Net Receivables Turnover Flow 46.8 6.8 316.3 8.6 6.5 Effective Tax Rate -46.80% 30.40% 40.10% 3.50% 28.90% Financial Blockbuster Hastings Netflix Industry Market Current Ratio 1.14 1.81 2.23 0.97 1.71 Quick Ratio 0.8 −− −− 0.9 1.2 Leverage Ratio 0.32 −− −− 0.32 0.24 Total Debt/Equity 1.25 −− −− 0.61 0.64 Interest Coverage 0.41 4.08 −− 3.77 5.33 Per Share Data ($) Blockbuster Hastings Netflix Industry Market Revenue Per Share 45.54 50.55 17.94 0.79 5.7 Fully Diluted EPS from Total Ops −− −− −− −− −− Dividends Per Share −− −− −− 0.25 0.62 Cash Flow Per Share 1.05 1.92 4.45 0 0.5 Working Capital Per Share 1.23 7.16 3.5 0 0.58 Long−Term Debt Per Share 6.51 3.97 −− 0.08 2.6 Book Value Per Share 5.38 9.2 6.6 0.08 5.2 Total Assets Per Share 21.1 22.42 9.49 0.26 10.66 Growth Blockbuster Hastings Netflix Industry Market 12−Month Revenue Growth -2.40% 1.30% 29.90% -1.10% 11.40% 12−Month Net Income Growth 0.00% 14.00% -8.80% 3.20% 12.90% 12−Month EPS Growth 0.00% 19.60% 23.4%) 19.0%) 7.80% 12−Month Dividend Growth 0.00% 0.00% 0.00% 0.00% 0.00% 36−Month Revenue Growth -6.90% 4.20% 166.10% 11.10% 36.30% 36−Month Net Income Growth 0.00% 33.6%) 260.90% 117.50% 39.00% 36−Month EPS Growth 0.00% 30.2%) 172.20% 150.00% 34.30% 36−Month Dividend Growth 0.00% 0.00% 0.00% 0.00% 0.00% Clark 9 The Economic Value Added (EVA) measurement is used to determine the true economic value of a company. It is also a measure that reflects the absolute amount of shareholder value created or destroyed during each year. Blockbuster had an EVA measurement of -139.2 in 2006. This negative value indicates Blockbuster lost value and did not earn a sufficient return to its stockholders for their investment risk. Economic Value Added (2006) NOPAT Net Sales (Revenue) $5,462.3 Less Cost of Goods Sold $2,475.7 Sales/General/Admin Expense $2,755.0 Depreciation $208.6 Operating Income $23.0 Tax $6.6 NOPAT $16.4 Company's Capital Total Liabilites $2,394.8 Accounts Payable ($517.7) Accured Expenses ($670.9) Capital $1,206.2 Capital Cost Rate (CCR) (Avg Equity Proportion)(Equity Cost) + (Avg Debt Proportion)(Debt Cost) Economic Value Added (631.6)(0.0952) + (1158.0)(0.0595) 12.9% Economic Value Added EVA = NOPAT - C * CCR 16.4 - 1206.2 * 0.129 = -139.20 EVA = -139.20 Clark 10 B. Resources: Tangible Financial Due to Blockbuster’s high amount of debt, their borrowing capacity is severely limited. Currently they utilize variable rate loans, and likely they will continue to do so, thereby increasing the amount of interest payments. Funds for operations may be diverted to honor debt service payments, and ultimately it may be possible that Blockbuster will not have sufficient cash flows to meet both operational and debt service payment demands. (15) Organizational In 2006 Blockbuster enhanced their enterprise resource planning system and upgraded their corporate productivity tools. High level management and other corporate positions have experienced a large amount of turnover (see the Human Resource Section), making it difficult to consider their planning, controlling, and coordinating systems a valuable resource. (15) Physical Blockbuster has 5,194 stores within the United States, of which 939 are franchised; and 3,166 stores in 22 markets outside of the United States, of which 870 are franchised. Their primary distribution center is located in McKinney, Texas, with an additional 35 online distribution centers spread throughout the United States to support their domestic online rental service. (15) International offices are maintained in Buenos Aires, Argentina; Toronto, Canada; Santiago, Chile; Uxbridge, England; Dublin, Ireland; Milan, Italy; and Mexico City, Mexico. The international method of distribution is similar to the methods used in the United States. (15) Technological Blockbuster invested significantly in their online subscription service in 2006, including the launch of their Total Access plan in November. This plan grants customers the option to exchange their DVDs through mail or returning them to a local Blockbuster store in exchange for free in-store movie rentals. The online rental program and the new Total Access plan have allowed Blockbuster to exceed their goal of 2 million online subscribers by the end of 2006, with a total of 2.2 million as of December 31, 2006. Also, Blockbuster began providing laptops and cellular internet access at US retail locations to allow for in-store sign-ups for online subscribers. (15) The online services system uses internally developed software that focus on optimizing the online supply chain in order to ensure timely delivery of products, as well as offering a user-friendly website to customers. These online systems transmit data from operations Clark 11 to a data center and other systems which support content delivery, customer web analytics, and offer management tools. In 2006, Blockbuster re-launched their website to provide customers with a better online experience. The website was changed to offer a more modern look and feel, improved navigation, advanced user functions, and more flexibility and scalability of the information obtained. (15) In August of 2007, Blockbuster bought Movielink, an internet company offering movie downloads. Their websites have not been completely merged yet, but Blockbuster intends on providing customers with the option to download a movie directly from their website with Movielink. This technology will compliment their already successful online movie rental program. (16) Blockbuster uses Management Information Systems to accurately and efficiently manage their purchasing, inventory, and sales records. They maintain information, updated on a daily basis, regarding revenues, current and historical sales and rental activity, demographics of store customers and rental patterns. All Blockbuster retail stores use a point-of-sale system. In the United States, the point-of-sale system is linked with a data center located in their distribution center. Using scanned bar code information, all products distributed from the distribution center to each US store are tracked and recorded. At the close of business each day, the point-of-sale system transmits the domestic rental and sales transactions data to the data center and the membership transaction database. (15) On November 8, 2006, the Chief Executive Officer, Jim Keyes mapped out his plans and vision for Blockbuster to Wall Street. He described the following technological strategies: (17) i. Adding more electronic hardware to the merchandise mix, including iPods and a Disney portable DVD player for children. ii. Selling the PlayStation 3, bundled with Blu-ray movies, out of a Sony-built display area in 2,000 stores. iii. Offering movies preloaded on flash drives for convenient viewing on PCs or laptops on a jetliner. iv. Offering online DVD downloads from a new Blockbuster.com site merged with that of Movielink, which Blockbuster recently acquired. v. Testing kiosks in stores that burn DVDs and download movies onto flash drives while you wait. vi. Testing DVD vending machines such as Redbox. Clark 12 Resources: Intangible Human Resources Blockbuster hired James Keyes, former president and chief executive officer of 7-Eleven Inc. Keyes has 21 years of experience working in the world’s largest chain of convenience stores, during which he helped the company achieve 36 consecutive quarters of same-store-sales growth and as well as record sales and profits. He guided the company into implementing new retail systems technology that improved product assortment decisions in every store. He also introduced a variety of new electronic services and collaborated with manufacturers across all merchandise categories to develop new products, enabling 7-Eleven to introduce as many as 50 new items each week in advance of competitors. Keyes served in several positions with 7−Eleven, including chief financial officer, executive vice president and chief operating officer, and in 2000 was named president and CEO of 7−Eleven Inc. Blockbuster has tied James Keyes personal value into the company’s stock by giving him $3 million worth of stock that will vest on the third anniversary of his hire date. In addition, Keyes has agreed to purchase $3 million worth of common stock within his first 30 days of employment. James Keyes has both personal and professional interests in helping Blockbuster to succeed. His retail background and success, as well as his financial knowledge, are certainly assets for Blockbuster. (14 & 15) Innovation Resources The most innovative step Blockbuster has taken was to launch their online rental program, then tie it together with their physical store locations with the Total Access program. No other movie rental chain offers both in-store and online rental options. Blockbuster decided to back Blu-ray DVD format, thus picking a side between the battle between Blu-ray and HD DVD. This decision has helped relations with Sony because Sony invested heavily in Blu-ray technology by putting one of the drives into every PlayStation 3, relying on the value of Blu-ray to justify the premium price to consumers. Blockbuster announced its decision to pick Blu-ray over HD DVD, and reported Blu-ray rentals are "significantly outpacing" HD DVD rentals at its stores. However, Blockbuster will continue to offer both HD DVD format as well as Blu-ray DVDs as rental options to consumers. (18) Reputational Resources Blockbuster’s reputation has taken several hits as their debt has increased, stock value has plummeted, and revenues continue to fall short of operational needs. Heavy competition between Blockbuster and Netflix has caused the company to reshape much of the way they run business, including eliminating late fees and competing in a price war. Customers enjoy the lack of late fees, online or in-store options, and price reductions, but Clark 13 are not as pleased with customer support. Many consumers feel Blockbuster is on the path to “extinction,” while others are invigorated due to the new CEO, Keyes. Blockbuster is a recognized name brand throughout the country, but it is unclear as to whether this should be considered an asset or not. C. Value Chain Analysis A value chain analysis is used to determine the value in particular segments of Blockbuster’s operations. The value chain is broken down into primary and support activities. Primary Activities Inbound Logistics Inbound logistics are activities such as materials, handling, and inventory control used to receive, store, and distribute inputs to a product. Because Blockbuster does not “create” a product, but merely packages and distributes it, there are no raw materials or a production process. Items are purchased and shipped directly to distribution centers. Blockbuster purchases their movie rental inventory for US company-operated stores directly from the studios by two methods, the first being a title-by-title basis through purchase orders, and second through various “revenue-sharing” arrangements. International locations utilize the same two methods as the US purchase system, with the addition of one other method. Some studios appoint sub-wholesalers to distribute the studios’ product in certain countries. Blockbuster also acquires retail movie and game inventory through various trading programs. In these programs, Blockbuster purchases general merchandise that is complementary to rental and retail movie and video game inventory, such as confection (candy and other sweet things), game and other accessories and consumer electronics, from a variety of suppliers on a product-by-product basis through purchase orders. One particular advantageous agreement Blockbuster has right now is between them and The Weinstein Company. The deal offers an exclusive four-year deal, starting in 2006, which provides Blockbuster exclusive US rental rights to all of Weinstein's movie releases. The Weinstein Company was created by the founders of Miramax, Harvey and Bob Weinstein. A few of their released films include Derailed, Lassie, Hannibal Rising and Sicko. Some of their future releases include Rambo, Sin City 2, and Diary of the Dead. Blockbuster’s inbound logistics are roughly equal in value to their competitors, with exception of the exclusive deal with The Weinstein Company that is superior to their competitors. (15) Clark 14 Operations Operational actives are used to convert inputs provided by inbound logistics into the final product form. Because Blockbuster does not convert inputs into a product, but merely distributes products, their operations focus more on retailing and tracking demand for their products. Blockbuster uses Management Information Systems to accurately and efficiently manage their purchasing, inventory, and sales records. They maintain information, updated on a daily basis, regarding revenues, current and historical sales and rental activity, demographics of store customers, and rental patterns. All Blockbuster retail stores use a point-of-sale system. In the United States, the point-of-sale system is linked with a data center located in their distribution center. Using scanned bar code information, all products distributed from the distribution center to each US store are tracked and recorded. At the close of business each day, the point-of-sale system transmits the domestic rental and sales transactions data to the data center and the membership transaction database. (15) Blockbuster’s operational activities are neither inferior nor superior, but basically equal in value, to those used by their competitors. Outbound Logistics Outbound logistics are activities that focus on collecting, storing, and physically distributing final products to customers. Blockbuster has 5,194 stores within the United States, and 3,166 stores in 22 markets outside of the United States. Their primary distribution center is located in McKinney, Texas, with an additional 35 online distribution centers spread throughout the United States to support their domestic online rental service. International distribution occurs similar to the methods in the US. The distribution center in McKinney, Texas, is a highly automated, centralized facility that is used to mechanically repackage newly-released movies and games to make them suitable for rental at retail stores. This center is also used to restock products and process returns, as well as to provide some office space. The McKinney distribution center supports virtually all of Blockbuster’s company- operated stores in the United States and operates 24 hours a day, six days a week The other 35 distribution centers are spread throughout the United States, in strategic locations. Blockbuster uses the United States Postal Service to deliver their online product DVD orders to customers. The closer a customer is to a distribution center, the faster a customer will receive an online rental product. Approximately 90% of Blockbuster’s online customers are reachable within one business day from distribution centers due to the utilization of roughly 90 different mail entry points. Also, store locations are used to fulfill a portion of online orders in order to keep up with demand. Clark 15 Blockbuster uses a network of third-party delivery agents for delivery of products to US stores. Products are shipped to delivery agents, located strategically throughout the United States, and they in turn deliver them to Blockbuster stores. The use of third-party distributors allows Blockbuster to process and distribute a greater quantity of products while reducing costs and improving services to stores. (15) Netflix currently has roughly 40 distribution centers; however, the delivery time of their product when compared to Blockbuster is not significantly better or worse. Customers of each service report higher or lower delivery times, depending on their location. Because of this, it seems that the outbound logistics activities utilized by Blockbuster are roughly equal in value compared to their competitors. Marketing and Sales Marketing and sales activities are carried out for the purpose of providing means through which customers can purchase products, and to induce them to do so. Blockbuster designs their marketing and advertising campaigns to best maximize opportunities in the marketplace, and thereby increase the return on their marketing and advertising expenditures. Information for marketing is obtained from their membership transaction database, their real estate database, and outside research agencies. This information is then used to formulate and adjust marketing and advertising campaigns based on the following factors: 1. Membership behavior and transaction trends 2. Consumer needs and attitudes 3. Market share in the relevant 4. Financial position; 5. Evaluation of industry trends 6. Local demographics 7. Other competitive issues Blockbuster uses a customer relations management (CRM) business strategy to build relationships with specific customer segments. The CRM program is used to maintain relevant value across all customer groups and to introduce customers to new customer proposition initiatives. The process of segmenting the customer base and targeting their direct marketing channel communications, Blockbuster tries to improve the effectiveness and efficiency of their direct marketing efforts. They use a variety of communication channels, to include direct mail and e-mail, as well as non-traditional channels such as voice marketing and point of sale. During 2006, Blockbuster focused their advertising on growing their online rental subscriber base in support of their Total Access program. As a result, they surpassed their goal of 2 million subscribers with a total number of 2.2 million as of December, 2006. (15) Clark 16 Blockbuster’s marketing and sales methods are not distinguishable from methods used by Netflix, their biggest competitor. The only exception would be their in-store sales option, which makes them superior on that particular front. Service Service activities are designed to enhance or maintain a product’s value. The following is a list of services offered by Blockbuster: i. Online Subscription Service: launched in mid-2004. This program allows customers to rent DVDs by mail and offers a much larger selection that traditionally maintained in physical store locations. The only competitor to this program is Netflix and is about equivalent in quality. ii. Blockbuster Total Access: Under the Blockbuster Total Access program, online subscribers have the exchanging their DVDs through the mail or returning them to a nearby participating Blockbuster store in free in-store movie rentals. Again, Netflix is the only competitor for this type of service; however, Netflix does not offer the in-store option making this service superior to competitors. iii. No Late Fees: The “no late fees” program eliminates extended viewing fees on movies and games at substantially company-operated Blockbuster stores in the United States and Canada and at certain participating franchise in the United States. The “no late fees” program was launched to eliminate our most prevalent customer complaint movie rental experience and to combat our competitors’ use of “late fees” as a means of differentiating their service offerings. Of Blockbuster’s three top competitors, Netflix, Hastings Entertainment, and the Movie Gallery, both Hastings and the Movie Gallery still have late fees associated with rentals, making this service offered by Blockbuster superior to competitors. iv. Guaranteed in Stock: The Guaranteed in Stock program offers customers the assurance that certain popular newly video titles will be in stock or the customer will receive a coupon that can be redeemed for a free rental of that the following 30 days. Of Blockbuster’s three top competitors, Netflix, Hastings Entertainment, and the Movie Gallery, all three have similar services, making this service offered by Blockbuster equivalent to competitors. v. Blockbuster Movie Pass and Blockbuster Game Pass: These in-store programs allow customers to watch an unlimited amount of movies or games (the number of movies or games allowed out at a time is dependent customer selects) for one monthly price and keep them for whatever period of time that they desire during the pass, subject to certain limitations. Of Blockbuster’s three top competitors, Netflix, Hastings Entertainment, and the Movie Gallery, all three have similar services, making this service offered by Blockbuster equivalent to competitors. Clark 17 vi. Blockbuster Rewards: This premium in-store membership program is designed to offer benefits to our customers enhance customer loyalty by encouraging our customers to rent movies and games only from our stores. This program is not really applicable in comparison with its competitors because Netflix does not have in-store rentals, and Hastings and the Movie Gallery do not offer online rentals and therefore do not need an extra incentive to customers for renting only in their stores. (19) Support Activities Procurement Procurement activities are those used to complete the purchase of inputs needed to produce the end product. Purchased inputs are consumed completely during the manufacture of products. Because Blockbuster does not manufacture any sort of product, this level of the Value Chain Analysis is not applicable. Technological Development Technological development activities are used to improve a firm’s product and the processes used to produce it. Blockbuster’s biggest use of technology to improve their product would be their online DVD rental program, especially when combined with their in-store rental option. Recently Blockbuster redesigned their website for a more user-friendly and resourceful site. The company also uses an Information Management System, and recently bought Movielink that will make their product (relatively) instantly accessible via online downloading. Blockbuster’s technological development activities are superior to all of their competitors except for Netflix. Human Resource Management Human Resource Management activities are those involved with recruiting, hiring, training, developing, and compensating all personnel. Blockbuster has experienced a high rate of turnover in high-level corporate positions, including hiring a new Chief Executive Officer, Chief Financial Officer, Managing Director, Chief Information Officer, Vice President of Merchandising, Distribution, and Logistics, as well as laying off their Chief Operating Officer (to cut costs). This is very indicative of serious internal issues and a weakness in the value chain for Blockbuster as far as Human Resource Management activities goes, making Blockbuster clearly inferior to their competitors in this activity. (14) Clark 18 Firm Infrastructure Firm infrastructure activities include: general management, planning, finance, accounting, legal support, and government relations in support of the value chain. The firm infrastructure is responsible for effectively and consistently identifying external opportunities and threats, identifying resources and capabilities, and support core competencies. The general management aspect of Blockbuster is very weak, but ideally going through drastic improvements, especially with the addition of their new CEO, James Keyes. The firm infrastructure was successful in indentifying the possibility of accessing the online renter market, previously held by Netflix. However, Blockbuster has been facing increasingly dire financial strain with the very real possibility of the situation getting worse, not better, in the future. Previous firm infrastructure activities have been inferior to their competitors at being effective or consistent in identifying threats and opportunities as their current financial status would indicate. D. Capabilities As a result of the in-depth look at the resources available and the value chain analysis, the following capabilities are identified for Blockbuster: 1) Market saturation and ability to reach US customers: Blockbuster currently has 5,194 stores within the United States and 36 distribution centers. The placement of the distribution centers and the 90 different US Postal Mail entry points make it possible to deliver an online rental product within one business day to customers. a) Value: YES - the ability to deliver an online rental product within one business day makes this very valuable to Blockbuster. b) Rare: YES - Blockbuster is the largest movie rental firm in the United States; no other company has as many stores/distribution locations. c) Costly to Imitate: YES - to build an equivalent resource network would take substantial funds. d) Nonsubstitutable: NO - the strategy of having multiple distribution centers and mail-delivery rentals is used by other competitors. 2) Variety of product rental options (online, in-store, download). Blockbuster offers customers the ability to rent DVDs either online or in-store, also with the option to exchange online-rentals with in-store movies. Blockbuster will also be offering the option to download movies. a) Value: YES - Blockbuster enjoys the status of being sole provider of both services (online and in-store) and the resulting value. b) Rare: YES - No other company currently offers both online and in-store rental options, especially with the ability to interchange them. Clark 19 c) Costly to Imitate: YES - to set up a comparable system of stores and online-rental distribution chain would be very capital intensive. d) Nonsubstitutable: YES - because Blockbuster is currently the only company offering both online and in-store rental options. 3) Complete entertainment package offered for entire family. Blockbuster offers rental options for movies, games, as well as food and other related products. a) Value: YES - offering rental options for movies and games, as well as selling food/snacks/etc. provides value in that it attracts both children and adults as customers. b) Rare: NO - Hastings and other movie rental companies offer the exact same products. c) Costly to Imitate: NO - it cannot be overly costly to imitate considering most of Blockbuster’s competitors already offer a similar product package. d) Nonsubstitutable: NO - customers could substitute Blockbuster for Hollywood video, Hastings, The Movie Gallery, or any local movie rental store and receive practically the same product. 4) New upper management. The new management team at Blockbuster has the potential to help the company crawl out of the debt and unfavorable situation they are currently in, and to eventually become a successful company again. a) Value: YES - Potentially the new CEO will help provide value to Blockbuster, but it is undetermined yet. b) Rare: N/A c) Costly to Imitate: YES - It would be expensive to lure management away from Blockbuster. d) Nonsubstitutable: NO - other competitors have their own management teams that help produce value. 5) Extensive use of Information Management Systems. Blockbuster utilizes a point- of-sale system which is linked with a data center located in their distribution center. Using scanned bar code information, all products distributed from the distribution center to each US store are tracked and recorded. At the close of business each day, the point-of-sale system transmits the domestic rental and sales transactions data to the data center and the membership transaction database. a) Value: Yes - the information systems allow Blockbuster to track inventory and customer demands. b) Rare: NO - other firms use similar systems. c) Costly to Imitate: NO - point-of-sale systems are common and affordable. d) Nonsubstitutable: NO - other point-of-sale systems, or similar strategic systems, can be utilized. Clark 20 6) Exclusive relationship with certain suppliers. Blockbuster has a 4-year deal with The Weinstein Company that grants Blockbuster exclusive US rental rights to all of Weinstein's movie releases. a) Value: YES - Because Blockbuster is the only company that will carry Weinstein titles, the deal is very valuable to the company. b) Rare: YES - Blockbuster is the only company that will carry Weinstein movies in the next 4 years. c) Costly to Imitate: YES - Unless the deal is broken, competing firms cannot pay to carry Weinstein films purchased directly from Weinstein. d) Nonsubstitutable: NO - Consumers can substitute renting Weinstein films by purchasing them from other retailers or simply decide not to rent them from Blockbuster. 7) Ability to compete with Netflix. Currently Blockbuster is the only other major contender in the online DVD rentals business. a) Value: YES - Since no other firm has the ability to compete with Netflix, Blockbuster offers an alternative to Netflix for consumers. The online market customer base adds clear value to Blockbuster. b) Rare: YES - Blockbuster is the only other firm to compete with Netflix. c) Costly to Imitate: YES - The financial investment necessary to create a similar online-rental and distribution system to compete with Netflix or Blockbuster is considerable. d) Nonsubstitutable: YES - Blockbuster is the only firm competing effectively with Netflix. E. Distinct Core competencies A review of Blockbuster’s capabilities results in two distinct core competencies that possibly offer a sustainable competitive advantage: 1) Variety of product rental options Blockbuster is currently the only firm offering the combination of online and in- store DVD rentals. This attracts customers that prefer the experience of browsing in a physical store and selecting a movie. The customer can pick a selection on the spot, then walk out of the store with the movie of their choice and have instant entertainment. Blockbuster also attracts online customers that want the ability to browse a wider selection of DVDS, create an online queue that automatically sends out the next DVD on the list when the prior selection is returned, and do so from the ease of their personal computer. The distinct advantage occurs where Blockbuster combines the two options into one convenient package. Consumers can have their online selection and queue, but also take movies into the store for instant movie rental ability. Clark 21 2) Ability to compete with Netflix Against all other competitors, being the only company that can truly compete with Netflix is a sustainable competitive advantage in the online renter market. Currently, Netflix and Blockbuster are the only two companies genuinely competing for online customers. III. Appendix C: Strategy Formulation A. Major Issues Blockbuster has many problems to confront in the coming years. Four of the biggest issues are identified as follows: 1) Constant Price war with Netflix Reduces Margins Further Blockbuster has been experiencing a decrease in rental gross profit primarily due to a decrease in rental gross margins. In 2004 it was 71.7% and 66.4% in 2005. Also in 2005, Blockbuster experienced a $215.8 million decrease in rental revenues. These decreases were due to several reasons, including: The launch of Blockbuster Movie Pass and Blockbuster Online in 2004, then the “no late fees” program at the beginning of 2005. To support their new online operations, in 2005 Blockbuster increased their product purchases in order to grow and answer the increased product demand. As Blockbuster lowers prices in the constant struggle with Netflix for market share, their margins are tightened further. 2) Instability of Upper Management The high rate of turnover in upper management is indicative of internal problems that may demotivate other employees and discourage investors. The change of CEO and CFO can create accounting inconsistencies which make interpreting the true financial status of the firm difficult as there are modifications and amendments from accounting methods used in prior years. 3) Financial Weakness Blockbuster cannot guarantee that their future cash flows will be sufficient enough to meet their obligations and commitments. Funds may be diverted from operations to cover interest payment expenses, and growth will be negatively impacted if debt payments increase. 4) Decline in Demand for Movie Rentals Movie rental demand occurs on a seasonal basis, with slower business occurring in April and May, (due partially to Spring and Daylight Saving Time), and in September and October (due partially to school starting and fall TV programs Clark 22 starting). For Blockbuster, typically November and December are the highest revenue months. Overall revenues for the in-store home video industry are expected to continue to decline as a result of mass retailers, such as Wal-Mart, offering low-priced DVDs. B. Sustainable Solutions 1) Increase Profit Margins: Change In-store Packaging To increase their profit margin, Blockbuster would need to either lower their costs or increase prices. Since Blockbuster is in a tight price war with Netflix, increasing prices, or reintroducing late fees, would not be a sensible route as they would likely anger current customers and lose their loyalty, or potential new clients may substitute Blockbuster products with Netflix or another in-store movie rental chain, such as Hollywood Video. Since increasing prices does not seem feasible, lowering their costs is the direction Blockbuster would need to take. Currently Blockbuster uses hard plastic cases at their store locations when a customer rents a DVD. Their online service uses paper cases to deliver the DVD product in. Blockbuster could convert the packaging at their store locations from the more expensive plastic cases to the cheaper paper envelopes used for online DVD rentals. The paper envelopes would take up much less storage space, and allow Blockbuster to take advantage of economies of scale for using all paper cases instead of a mixture of paper and plastic. This packaging cost reduction may help Blockbuster to increase their profit margin. 2) Increase Online-Renter Market Share Blockbuster and Netflix are fighting for market share of the online renter market. Blockbuster is planning to market specifically to internet consumers by marketing on the popular social network website, Facebook. This strategy may attract some of the online users of Facebook, especially if Blockbuster offers a discount specifically geared towards Facebook users. Blockbuster could also offer an online option to rent movies without paying a monthly fee for the subscription to their Blockbuster Online program. Consumers currently are not offered the option to rent a movie purely on a movie-by-movie basis from any online rental provider. Blockbuster may have a small niche market for individuals who prefer not to have a monthly plan, but like to rent from the convenience of their home computer. 3) Debt Relief: Chapter 11 Bankruptcy Because Blockbuster is struggling to honor its debt payments, revenues have been decreasing and are expected to decrease further, and Blockbuster admits they may Clark 23 not have the cash flows to meet all their financial obligations, filing for bankruptcy is a real and viable option. A Chapter 11 Bankruptcy is considered a reorganization and focuses on restructuring the firm. In this type of bankruptcy the creditors and the debtor (the firm filing for bankruptcy) formulate a plan under which the debtor pays a portion of its debts and the rest are discharged. The debtor is permitted to continue doing business, and managers of the firm may continue operating the business. A firm need not be insolvent to quality for a Chapter 11 Bankruptcy. C. Implementation Plan: Chapter 11 Bankruptcy Because Blockbuster’s most urgent problem is their high level of debt and interest payments, Chapter 11 Bankruptcy may be the best option for Blockbuster. The threat of decreasing product demand and the resulting decrease in revenues, tied with their constant price war with Netflix and the inability to widen their profit margin, Blockbuster may face serious cash flow insufficiencies. Their option of borrowing further funds to cover financial obligations would be a short-term solution that would likely be accomplished with high interest, or more variable rate, loans. This would pose a long- term financial strain if Blockbuster’s future cash flows were not adequate enough to meet their debt obligations. If the bankruptcy were approved, then Blockbuster would have the financial freedom to focus more on operations and growth, rather than on interest and debt payments. The implementation plan for Chapter 11 Bankruptcy could take form in the following format: 1. File a petition with the bankruptcy court. The petition must include: (1) Schedules of assets and liabilities (2) A schedule of current income and expenditures (3) A schedule of executory contracts and unexpired leases (4) A statement of financial affairs 2. File a written disclosure statement and a plan of reorganization with the court. The disclosure statement must contain information concerning the assets, liabilities, and business affairs of the debtor that is sufficient enough to enable a creditor to make an informed judgment about the debtor's plan of reorganization. The plan of reorganization must include a classification of claims and must specify how each class of claims will be treated under the plan. Creditors whose claims are impaired (those whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan) vote on the plan by ballot. Clark 24 3. The disclosure statement must be approved by the court and must conduct a confirmation hearing to determine whether to confirm the plan. The plan must be accepted by at least one class of impaired claims and the bankruptcy court must determine that the plan is feasible in order to confirm it. 4. Confirmation of a plan under Chapter 11 acts as a discharge of all debts, filed or not, excluding those specified as not dischargeable elsewhere in the Bankruptcy Code. Both the debtor and the creditors are bound by the terms of the confirmed plan. (20) Clark 25 V. Works Cited 0. http://www.dictionary.com (referenced throughout paper) 1. Zemke, R. et al 2000, Generations at work, AMACOM books, New York. 2. Blockbuster Homepage. (2007, April 1). 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