Jewish World Review Dec. 11, 2008 / 14 Kislev 5769
Creative destruction: Some businesses deserve to die and we're better for it
By Jonathan V. Last
http://www.JewishWorldReview.com | With all the talk of bailouts, it's worth remembering this cardinal truth: Some businesses deserve to die.
Creative destruction is the term Joseph Schumpeter used to describe the healthy evolution of economies as outmoded businesses are displaced by more efficient ones. Take, for example, the case of Blockbuster and Netflix.
We all know Blockbuster, which was founded in 1985 and became America's biggest video rental chain. Pre-Blockbuster, video stores were mostly mom-and-pop affairs, but Blockbuster introduced economies of scale and expanded aggressively.
At its height, Blockbuster owned more than 9,100 stores and commanded nearly half the U.S. video rental market. Its big profits prompted Viacom to purchase the business for $8.4 billion in 1994.
But markets change.
The DVD emerged as the successor to the VHS tape in the late 1990s. The movie studios wanted to keep the rental arrangement that had existed with VHS tapes. When a movie was first released on VHS, a single copy would cost about $120. This price was intentionally prohibitive, so that the only practical way for consumers to see a movie at home was to rent it.
Only after several months of release would the price be dropped to "sell-through," or about $20. In return for this window, Blockbuster gave the studios 40 percent of their rental revenues.
The executives at Blockbuster, however, demanded a greater percentage of the rental revenues from DVDs. It was a disastrous decision. In response, the studios adopted the sell-through model we know today: The day a DVD is made available for rent at Blockbuster, it is also available for purchase for about $20 from retailers.
While Blockbuster was foolishly forcing the movie studios to change the economics of movie rentals, a rival company emerged to change the delivery mechanism. In 1999, a little outfit called Netflix started charging users a flat monthly subscription fee and delivering DVDs by mail, allowing people to rent as many movies as they liked for as long as they wanted.
Netflix represented an immediate, existential threat to Blockbuster. The giant should have acquired or crushed the upstart. Indeed, a former executive told Variety in 2005 that Blockbuster had passed up an opportunity to purchase Netflix for $50 million. Blockbuster believed it could preserve its outmoded model even in the face of tectonic shifts in the market.
Netflix saw its subscriber base rocket from 239,000 in 1999 to 1.5 million in 2003. Today it stands at 8.7 million. The company's revenues went from $270 million in 2003 to $1.2 billion in 2007.
It took five long years just for Blockbuster to launch a copycat version of Netflix's DVD-by-mail system. By then it was too late. Beginning in 2001, Blockbuster took staggering losses for six years out of seven. It lost $1.2 billion in 2004 alone.
Eventually spun off from Viacom, Blockbuster's stock today hovers around $1 a share. Purchased just 14 years ago for $8.4 billion, Blockbuster now has a total market capitalization of $227 million.
And Netflix? It now has a market capitalization of $1.4 billion and growing. In nine short years, it destroyed Blockbuster and created a new mode of home-video delivery.
Yet Netflix is now intent on destroying its own business model and creating a more efficient one. In 2007, the company began streaming some of the movies in its library over the Internet.
Today Netflix has the most seamless digital-download system going. Subscribers can access 12,000 movies and TV shows to watch on their computers or televisions.
Digital downloading has long been thought of as the Holy Grail of home video. Instead of trying to protect its mail-order model against it, Netflix tackled the new technology head on.
It's not clear how streaming video will affect Netflix's DVD-by-mail business or its bottom line. But Netflix decided digital downloading is the future, and that if the company didn't embrace it, someone else would.
As for Blockbuster, its days are numbered.
When the behemoth finally breathes its last, should Congress bail it out? Because if the president-elect and the Democratic Congress are going to give handouts to every poorly managed concern suffering the effects of creative destruction, there's a line around the block of people who'd like some cash.
For instance, you may have noticed that the newspaper industry isn't doing so well. And this week the WNBA saw a franchise go bust. And ... well, let's not go giving anyone ideas.
Jonathan V. Last is a columnist for the Philadelphia Inquirer. Comment by clicking here.
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