Blockbuster/Netflix

Big news that Blockbuster is pulling out of Canada and bankrupt in the US. One of my favourite frugal hobbies was shopping pawn shops for DVDs at $3 or less and then selling them back to Blockbuster when I was done with them, which in Calgary had a mandatory policy that they would give at least $3 credit for just about anything. Often, this would actually generate a profit, even though it was in store credit and not in cash. Now that Blockbuster is going under, I had to try and use up my $100 credit (had the balance as high as $300 in the past). I had always kind of thought they would be around forever and I would never have to pay for rentals again.

The lesson here is that they had a good business model, but high fixed costs (rent, payroll, investment in movies). One of the basic lessons in finance and accounting is that the higher the fixed costs, the greater the risk. They actually grew too big to compete, since they developed such a huge administrative budget that they had to spread across all their stores. The biggest problem in the Blockbuster business model, however, is that it became obsolete to a vastly superior model demonstrated by Netflix. Netflix took away enough business that it made Blockbuster's narrow margins turn to losses.

Now, I think I understand how far behind the curve I am with the arrival of Netflix in the competitive scene. People saw this coming years and years ago, which is why the stock price has been built up so high. Still, I think it is overpriced. Book value of $5-6 per share, and EPS of $3 per share does not justify a $300 stock price. This price assumes 500-600% increase in profits over the next few years. With Blockbuster gone and subscribers looking to rent from other places, I think it is good news for Netflix. However, they are not without competition. The cable networks are also providing video on demand services, and the only proprietary advantage of Netflix is their negotiated deal with movie studios for the rights to distribute their movies (they have infrastructure for online delivery, and brand name appeal, but this can be copied by competitors). Cable networks bundle video on demand with something Netflix does not offer, which is live television. Now if Netflix could break into that business, then perhaps the current share price would be justified.

To reduce drain on bandwidth, the streamed video provides a reduced # of frames, which makes it inferior to Blu Ray discs, and we need to see an increase in the efficiency of internet delivery before this problem will be overcome. It will not be as clear cut who will pick up the slack from the loss of blockbuster, but there will also be a market for physical rental, which Netflix cannot compete with. You need to provide a list, and plan your DVD rentals with Netflix mailing service, while with a physical video store, you can walk in and choose whatever you want in the inspiration of the moment.

There is also an interesting angle on who will benefit from the massive amounts of prime real estate that will be up for sale from Blockbuster's many store locations. It is too big to be economical for small business, and probably not big enough to be useful to large businesses. Whatever various real estate companies that own the locations for Blockbuster stores are going to be out a lot of rent across North America, and in the current economic environment, it is going to be tough to fill those locations with new renters.

Anyway, lots to think about, but no real conclusions here. What are your thoughts? Is Netflix a good buy since they will have huge growth potential over the next few years, or will cable companies try and muscle in on their business model? The real power in all of this is held by the movie studios, who control the distribution rights. If competition comes in and starts a bidding war over the rights to distribute movies, Netflix can quickly see their margins erode. I don't like the risk/reward tradeoff in Netflix's current share price. Much too risky.

From a customer standpoint, Netflix was entertaining for the first few weeks. After I figured out that they had degraded quality video and a VERY limited selection of titles I promptly cancelled my subscription and continued to download movies the old fashioned way

Having said that, Netflix has everything in place and a customer base, so in my opinion all they need to do is convince some movie studios to give them the rights (exlusive rights?) to NEW titles! If they had a substantial new release section of movies I would definatly get anothe subscription.

As far as video quality goes, Bandwidth is becoming less of a problem as Most ISP's now have 25-100Mbps connections that can be had for under $75/month. Netflix just needs to offer a HIgh BW/Low BW option when selecting movies.

As far as cable companies go I can only speak from my personal experience with Shaw. They have a great VOD service with relativly new releases and free kids movies! The only problem is the cost of each rental wich ranges from $0.99 to around $8.99 a title (not including adult content of course .

In my opinion shaw will have troubles breaking into the Netflix style VOD because it will cut into their regular cable programming. Why would you pay $50/month for regular old cable when for say $50/month you can get unlimited movie titles through their VOD service?

Thanks for the pawn shop/Blockbuster trick....now that there will be no Blockbuster!

Netflix is starting to get a lot of bad press (similar to RIM), with people saying competitive pressures are getting too strong to justify the current stock price. Netflix has not declined anywhere near as badly as RIM, but I think there will be a few more questions coming up as to how they are going to keep their competitive edge going forward.

Again, I think in this industry the studios are the ones in control.