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Aron

Wednesday ;) .. or perhaps that was on purpose.

Let's see if they continue their -5% Y/Y same-store rental decline. Hollywood Video posted -8%.

I would look for analysts to question the long-term profitability of the online model at 17.50$. In conjunction, perhaps an update on the timeline for store-based fulfillment. We should get a healthy dose of "We stuck it to 'em good this quarter". I wonder if they'll report churn or SAC.

Penetration of their in-store subscription should be interesting as well. They are aiming for 8% of customers by year-end. A hybrid service will probably appeal more to these customers then others.

Aron

Well the earnings results came in. Blockbuster continues to show decreasing same-store sales of rentals (-7.4% year over year). Combined with investment costs of their multiple initiatives, Blockbuster will continue to show earnings decline even into next year. The Blockbuster future still appears to be dim.

This unfortunately does not translate into good news for Netflix. It is not 100% clear that Blockbuster can make its online program profitable (neither can Netflix at these prices), but it is quite clear that they are accumulating customers rapidly, and have a potential cost-structure advantage in store fulfillment.

Important notes:
1) Blockbuster claims an add rate of 10K subs/day. At 900K per quarter this would exceed Netflix's best ever Q104 rate of 762K.
2) Blockbuster will increase its DC's from 10 to 15 this quarter, and 15 to 20 next quarter. Their growth is even more phenomenal considering their lack of 1-day coverage area.
3) Blockbuster claims that use of their free coupons is extremely high and that these customers are indeed buying/renting product when they come into the store. Therefore, despite losing ~1$ per coupon, they are getting that money back through additional merchandising.
4) Blockbuster claims that 50% of their online customers had not used a store in the last 12 months.
5) Blockbuster claims that online customers who were store users are now spending more then before in total.
6) Rental gross margin continued to increase, this is counter to what one would expect as subscription models take root. The subscription model is a comparatively high revenue/low margin model.
7) Blockbuster continues to aim for 500K subs end of year.
8) They did not pin point or refine the timeline for store-based fulfilllment (still "in 2005"). They did seem to make clear that video game rentals as part of the program will come after store-based fulfillment (if it comes at all).
9) They appeared to waffle on whether they would actually introduce a full store and online buffet: 1 plan, unlimited rentals in both places. I can see the plan structure and pricing problems they have with that.
10) It's important to note that while the rental component of Blockbuster's business is declining, the retail of games and movies has been performing quite well. This helps to slow Blockbuster's death.

So I continue to gather a sense of confirmation about the decision to liquidate my Netflix investment. Blockbuster is diminishing but it has all the tools and desire to take Netflix with it.

Netflix, IMO, needs to show innovation in product development and partnerships. They really only push 1 product alternative(3 out Unlimited), and thus homogenize their customer base. If they seek to be quick and nimble they need to develop tailored experiences that cater to the nuances of their customer base. The price war is ill-advised. Now that I'm just a customer though, I guess I shouldn't care so much ;)

vn

Nice comments Aron. But why the pessimism? Are you saying netflix & blockbuster are going to lowball each other to death? Because clearly there's a market. It's matter of making money from it. Also, I didn't understand the subscription figures. Does blobkbuster online already have ~1 million subscribers? They have been around for a quarter, have they not? If true, then they are going to overtake netflix in 2 more quarters! One figure I had read earlier was blockbuster claiming that 75% of their subscription base is former netflix subscribers. Given that this is less than 6% netflix's total membership, the numbers don't add up.

Aron

I may have overstated my pessimism a bit.

I do think this market is here to stay. 10 Million subscribers by end of 2006 I think is possible. Then as rental stores start disappearing and detuning their service levels, there will be more people drawn to alternatives (VOD, online, retail). The end market size could hit the 15-20 Million that Reed has discussed before VOD really starts to take over.

Management's decision to throw-out profits and aggressively price cut prior to the Amazon entry proves to me that they are focused on long-term strategy. Hastings also stopped his weekly divestiture of shares about a month ago.

Blockbuster has equal or worse questions of sustainability. I didn't mention before the 950 Million dollars in debt they've taken on to pay for a massive dividend to shareholders. One need merely look at their stock direction to understand investor's general opinion of their future.

Amazon may or may not be interested in this market at this level of competition. Seems to me like Netflix could strike a deal for a huge IMDB affiliate contract and an exclusive retail partner relationship. Amazon would effectively have a risk-free revenue pipeline. Investors have been unhappy with their margin and growth story lately as well. They may have their technical plates full with their high-tech initiatives (A9, Alexa, etc).

My basic stipulation is that growing your customer base is not worthwhile if you can't show an ability to retain them. Netflix has a serious problem with customer retention. Price is a significant component to this. Netflix was able to prove this with it's 20$ to 22$ price hike. The problem with Netflix's strategy is that they appear to be relying entirely on price. This *could* end up being a genius move, but it looks like shooting the moon to me. If it leads to the "emptying of stores" that Hastings predicts then they will have subverted Blockbuster, but in the meantime they will have a fickle customer base and a poor financial position for taking on the additional competition they are bound to face. That's putting a lot of eggs in one basket.

I would prefer to see Netflix adopt a suite of alternatives:
1) Implement rental limits. Forsake the permanently unprofitable members by putting limitations into their plans, at the same time provide incentives to members that hit dry spells to keep them from quitting. Netflix does this by offering "stick around please" discounts when people quit but that requires customers to have already formulated the decision to quit before they see it. There's a big psychological difference in cutting them off before they get to even pondering quitting.
2) Increase the prominence of New Releases. These are more expensive to support but Netflix's current approach gives it a cultish atmosphere that is unappealing. Mainstream customers want to see a frontpage that seems up to date with current movie news and releases. It's only more expensive if people take advantage, and if people are taking advantage its probably because they prefer to do it, and if they do things they prefer they will like the service more, and if they like the service more they won't leave, if they don't leave you get money from them in the future. Hey, how's that Aristotle?
3) Increase website functionality and IT staffing. Queue functionality is medieval. Where is multi-person family support? There is a myriad of missing functionality there. Cinematch does not appear to be living up to its vision. Why not provide more open user input? Directly allow them to specify their favorite actors, directors, genres, etc. and then craft the website experience around these choices.
4) Focus on external partnerships. Netflix is like an island. No ads on their site. No ads on their mailers. Little creative partnering. They need innovative relationships with AtomFilms, IFilm, IMDB, RottenTomatoes, Yahoo! Movies. The Best Buy relationship is good, TiVo is a good future partner. Blockbuster places a top 5 rentals module on the MSN movies page. That's an interesting small example.

Ok, I'll shut up now.

Oh, to answer your question. Blockbuster is probably around 300K subs and is aiming for 500K at the end of the year. The 10K/day add rate is the rate of trial members it doesn't count cancellations so you can't predict they will have 900K more subs in 3 months. The number seems a bit high to me as well though.

Regardless of what happens it's all quite interesting drama. If things don't work out in Netflix's favor it's not necessarily their fault either.

vn

Hey thanks that was great.
I do think that announcing a limit will have an adverse psychological effect. I think there's something really, really nice about the concept of unlimited rentals even if it's not the reality.
The other thing is they don't highlight new rentals because they can't afford a large spike (tens of thousands at a time) in the rental of any movie leave alone a dozen or so new releases every week. Do you think IF they could offer new releases to anyone who wants it on time, it would help? From what I see complaints about lack of new rentals is already down significantly.

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