Charles Hudson's Weblog

I cancelled my Netflix subscription awhile ago, but it was not because I had any issues with the service. Netflix is a very cool product and I really think that they should be commended for what they have built and developed. If I were at Netflix, I am not sure that I would be overly concerned about Blockbuster’s efforts in this space.

Let’s be clear on a few things. Blockbuster certainly has the resources to attack this market aggressively. Netflix should take them seriously. There are two things to address before we get to the main reason why I believe that Netflix should not be as concerned:

Legacy investment in physical retail locations – Most economists will tell you that firms should disregard sunk cost investments when defining strategy. However, if you are running Blockbuster, one of your greatest assets (and potentially greatest liabilities) is your extensive network of retail locations. Regardless of the rhetoric, I believe that the presence of this heavy investment in brick-and-mortar infrastructure will play a role in how Blockbuster seeks to transform itself. If DVDs-by-mail are one baby step toward VOD in some way, shape or form, Blockbuster will have to figure out what to do with its retail locations. I don’t think the “impulse rental” market is going to disappear anytime soon, but I do believe that market has seen its finest hour.

They named themselves “Netflix” and not “Mailflix” for a reason – I know this sounds silly, but I think that companies choose their names carefully and including the “net” in the name was not an accident. Sure, Netflix uses the mail to deliver DVDs, but most of the smarts are in the database backend. Netflix has been pretty clear that they have aspirations to compete in the video-on-demand (VOD) market. If DVDs-by-mail is just a baby step towards eventual VOD, the real question is not about who can mail more DVDs; the real question is about who will be the winner when we get to where these two companies want to go.

If you shift the focus from DVDs-by-mail to a shift from in-store rental to VOD, I’d argue that in the world where VOD becomes real, there are four things that will form the basis of competition (listed in order of relevance):

-Brand Awareness
-Breadth of titles
-Quality of Service (everything from speed of download, to flexibility in terms of where/when/how video is consumed, to platforms supported)
-Price

Scanning down this list I see a good news/bad news scenario. The good news is that if these are the correct set of dimensions along which companies will compete, Netflix stacks up very well relative to Blockbuster. The bad news is that if these are the correct dimensions along which companies will compete, Netflix is going to see competition from a whole lot of players who are not major players in the video distribution business today. People with large content libraries might choose to distribute on their own. Network operators might want to get involved in the distribution of content. You get the picture.

Blockbuster will win some converts, but they will not put Netflix out of business. Things could get worse for Blockbuster before they get better.

On a random note, this seems eerily similar to Amazon vs. Barnes in Noble in the late 90s (how’s that for a dot.com redux?) in the book market. What was viewed as a niche distribution channel became very important. It didn’t make the physical distribution resources completely worthless, but cracking the market was much harder than expected.

As always, you can reach me at blog at charleshudson.net