The Netflix Effect

Blockbuster doesn't publicly break out the cost of individual IT efforts, although a $100 million jump in capital expenditures from 2003 to 2004—even factoring in the cost of 160 new stores—indicates the overall restructuring effort has been huge. Among the biggest expenses has been Blockbuster's head-to-head response to Netflix.

After initially pooh-poohing the lack of immediacy and spontaneity in renting movies from an online subscription service, Blockbuster rapidly learned how to sing the online subscription hallelujah chorus. Netflix's market share jumped from 2 percent in 2003 to 7 percent in 2004. And the Internet upstart already has more than three million subscribers and expects to hit four million by the end of this year. Blockbuster had just under one million online rental subscribers at last count and hopes to be up to two million by early 2006.

Rather than trying to build an online mirror of its physical stores, Blockbuster instead established a separate online division in new offices situated about two blocks from its Dallas headquarters. That was a huge gamble, notes Frank Paci, executive vice president of finance and accounting, strategic planning and development. "The online business was a financial leap of faith, as opposed to the in-store initiatives, where we could try it out in a couple places and then change the system as needed," he says. "With online, we had to build the system before we had any customers for it. And you can't just try it out. The moment you're online, somebody in Alaska and somebody in Florida can use it."

That meant developing an entirely new business model inside Blockbuster's existing one, Polizzi notes, not just writing a new set of applications. At the outset, Blockbuster had roughly 100 IT people devoted to the effort, both from within the company and from outside IT consultancy Accenture.

"Now we're building our own internal capability to support the business," says Polizzi. Blockbuster also has contracted with India-based Infosys for both onshore and offshore IT help.

Why bring in outside IT resources? "Typically, when you start something new like this, you don't know what you don't know," Paci says. "You anticipate that there will be things you didn't anticipate and you need the flexibility to deal with that."

Such rapid expansion requires easy access to top IT people, Polizzi adds.

"The need to be able to extend your resource capability quickly with strong, skilled and competent people is critical," he says. "Infosys right now provides mostly onshore resources, but we're working with them with the idea that we'll eventually move some of it offshore."

Company Profile
Company: Blockbuster Inc.

Corporate Headquarters: Dallas

CIO: John Polizzi

Revenues: $6.1 billion(trailing 12 months)

EBITDA: $1.42 billion (ttm)

Stock Price: $8.35 (July 22, 2005)

52 week high-low: $6.50–$13.95

A key part of taking down Netflix will be figuring how best to leverage the existing 4,500 stores in Blockbuster's domestic network. Rather than relying solely on its 30 distribution centers scattered around the country—Netflix has 35—Blockbuster has created pilot programs in which store clerks can use the slow retailing hours between 10 a.m. and 4 p.m. to prepare and ship out online orders. And online subscribers can use two coupons each month to get free 7-day and new-release rentals at any Blockbuster store.

"They have a chance to eat Netflix's lunch," says Michael Pachter, a senior research analyst at Wedbush Morgan Securities in Los Angeles.

With each store operating as a distribution center, he notes, Blockbuster will be able to wield one or two orders of magnitude more inventory than Netflix. "WebVan was going to put grocery stores out of business and eToys was going to put toy stores out of business. But you like to touch the tomatoes and try the pants on. People want to browse through a physical store. That constituency isn't ever going away."

This article was originally published on 08-10-2005
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