Blockbuster, Netflix, and The Innovator’s Dilemma

Once upon a time, Netflix was not guaranteed to beat Blockbuster. Blockbuster had a DVD-by-mail Netflix competitor called “Blockbuster Online” that later evolved into “Blockbuster Total Access”. I vaguely remember seeing its commercial announcement in 2006:

Try putting yourself in 2006 and seeing this commercial for the first time: what’s not to like? Total Access customers could now take advantage of the convenient home delivery option without foregoing the familiar, reliable brick-and-mortar experience. Running a Google Search at the time shows a pretty even race in public perception. In fact, an NYT article cited Blockbuster “adding a staggering 700,000 subscribers” to its new service, with Netflix shares dropping 12% a few months after the announcement. By the end of 2006, Total Access reached 2 million users. Netflix Co-Founder Marc Randolph called the situation “very scary” once Blockbuster got serious about online business.

Two decades later, we know how this story ends. But, how did Blockbuster fumble the bag so hard on this opportunity?

“Frankly, we see online subscriptions as a niche business… we think the real win-win will be a combination of an online and in-store service.” - Blockbuster Spokeswoman, 2003 Q1 Earnings Call (Forbes)

At face value, this quote suggests Blockbuster’s demise stemmed from a combination of laziness, arrogance, and stupidity. However, I think there’s something more systemic influencing this decisioning, and it’s a lesson that companies of all sizes should know.

The Innovator’s Dilemma

Clayton Christensen’s The Innovator’s Dilemma is described as “the holy book for entrepreneurs in Silicon Valley”. First published in 1997, the timeless classic argues that large incumbents fail to adopt innovative technologies because they are drowned in their existing success. Despite seeing a clear opportunity of a new technology, executives cannot allocate appropriate resources if the tech does not appease their largest customers and short-term financial goals. This is how Kodak, despite literally inventing the digital camera, could not capture that market, because their best customers all worked with film. Christensen argues the new technology should be approached as a new business unit.

Blockbuster, the incumbent of the DVD rental market, found itself in an innovator’s dilemma. Although investing sizable chunks of money in at-home delivery, Blockbuster’s heart (and wallet) were forever tied to brick-and-mortar. SEC filings show metrics like “sales per square feet” as a key indicator to shareholder success. Franchise owners began suing Blockbuster, arguing that online rentals violated franchise agreements by undercutting in-store business. It became clear that as Blockbuster Total Access grew, the traditional metrics of brick-and-mortar sales dropped, which Wall Street and legal agreements were invariably tied to. In 2007, Blockbuster fired its CEO and replaced him with the 7-Eleven CEO, who almost immediately killed Total Access to reroute the company’s focus to brick-and-mortar.

With The Innovator’s Dilemma in mind, the intentions of the Blockbuster Spokeswoman in 2003 are more clear. The intent was to extend an olive branch to Blockbuster’s existing shareholders, franchise owners, and brick-and-mortar talent. Leaders don’t do things because they’re stupid. They do the things that got them to their current success and ensure that little black line goes up for at least another quarter. Smaller companies, like a 2006 Netflix, do not have this limitation.

And So It Goes…

The ocean of disruption is fierce and unforgiving. DVD-by-mail got completely disrupted by streaming. Digital cameras became commodified in the smartphone era. The pace at which technology changes is what makes the industry both inspiring and terrifying. I thank books like The Innovator’s Dilemma, as it attempts to give some advice in how to navigate this ocean.