A Look Back At Why Blockbuster Really Failed And Why It Didn’t Have To

In 2000, Reed Hastings, the founder of a fledgling company called Netflix, flew to Dallas to propose a partnership to Blockbuster CEO John Antioco and his team.  The idea was that Netflix would run Blockbuster’s brand online and Antioco’s firm would promote Netflix in its stores.  Hastings got laughed out of the room.

We all know what happened next.  Blockbuster went bankrupt in 2010 and Netflix is now a $28 billion dollar company, about ten times what Blockbuster was worth. Today, Hastings is widely hailed as a genius and Antioco is considered a fool. Yet that is far too facile an explanation.

Antioco was, in fact, a very competent executive—many considered him a retail genius—with a long history of success.  Yet for all his operational acumen, he failed to see that networks of unseen connections would bring about his downfall.  Over the past 15 years, scientists have learned much about how these networks function and how his fate could have been avoided.

A Social Epidemic

When Hastings flew to Dallas and proposed his deal in 2000, Blockbuster sat atop the video rental industry.  With thousands of retail locations, millions of customers, massive marketing budgets and efficient operations, it dominated the competition.  So it’s not surprising that Antioco and his team balked at simply handing over the brand they had worked hard to build.

Yet Blockbuster’s model had a weakness that wasn’t clear at the time.  It earned an enormous amount of money by charging its customers late fees, which had become an important part of Blockbuster’s revenue model.  The ugly truth—and the company’s achilles heel—was that the company’s profits were highly dependent on penalizing its patrons.

At the same time, Netflix had certain advantages.  By eschewing retail locations, it lowered costs and could afford to offer its customers far greater variety.  Instead of charging to rent videos, it offered subscriptions, which made annoying late fees unnecessary.  Customers could watch a video for as long as they wanted or return it and get a new one.

Netflix proved to be a very disruptive innovation, because Blockbuster would have to alter its business model—and damage its profitability—in order to compete with the startup.  Despite being a small, niche service at the time, it had the potential to upend Blockbuster’s well oiled machine.

The Threshold Model

While Netflix’s model clearly had some compelling aspects, it also had some obvious disadvantages.  Without retail locations, it was hard for people to find it.  Moreover, because its customers received their videos by mail, the service was somewhat slow and cumbersome. People couldn’t just pick up a movie for the night on their way home.

Still, customers loved the service and told their friends.  Some were reluctant at first, they actually liked being able to browse movies at the store and pick one up at a moments notice, but others jumped right in.  And as more of their friends raved about Netflix, the laggards tried it too, fell in love with it and convinced people they knew to give it a shot.

Network scientists call this the threshold model of collective behavior.  For any given idea, there are going to be people with varying levels of resistance.  As those who are more willing begin to adopt the new concept, the more resistant ones become more likely to join in.  Under the right conditions, a viral cascade can ensue.

The best way to understand thresholds is to look at the diffusion of ideas model formulated by Everett Rogers in the 1960’s.

While ideas usually take hold in small niches of innovators, they can often spread to early adopters, who are only slightly more resistant likely to join in.  Once they’re on board, those in the early majority begin to feel comfortable giving it a try.  As each threshold is past, the next group becomes more likely to adopt the new idea.  That’s how disruption happens.

Unfortunately, this effect is devilishly hard to quantify.  Duncan Watts, a pioneer in network theory, is quick to point out that social dynamics tend to be idiosyncratic and it’s not always clear exactly where thresholds exist.  Still, you can use conventional marketing analysis to evaluate whether an idea is spreading to new groups or just growing within a niche.

It is not clear whether Antioco’s team did such an analysis or not, but by 2004—six years before the company went bankrupt—he sensed that Netflix had become a significant threat and sought to change his firm’s policies.  Yet how he went about doing that sealed his, and ultimately Blockbuster’s, fate.

A Different Network Altogether

Once John Antioco became convinced that Netflix, and to a lesser extent Redbox, was a threat, he used his authority as CEO—as well as the credibility he had earned by nearly doubling Blockbuster’s revenues during his tenure—to discontinue the late fees that annoyed customers and invest heavily into a digital platform to ensure the brand’s future.

Antioco’s article in Harvard Business Review describes what happened next.  While he convinced the board to back his plan, the costs — about $200 million to drop late fees and another $200 million to launch Blockbuster Online—were damaging profitability, which caused turmoil internally.

Eventually, an activist investor, Carl Icahn, began to question Antioco’s leadership.  Antioco lost the board’s confidence and left over a compensation dispute in 2007.  Keyes was named CEO and immediately reversed Antioco’s changes in order to increase profitability. Blockbuster went bankrupt three years later.

Icahn would later write:

Keyes felt the company couldn’t afford to keep losing so much money, so we pulled the plug. To this day I don’t know what would have happened if we’d avoided the big blowup over Antioco’s bonus and he’d continued growing Total Access. Things might have turned out differently.

So networks that would help determine John Antioco’s fate twice.  First, he failed to realize how quickly a niche idea could snowball into a viral cascade.  Second, he had to fight networks within his own organization that resisted the change he needed to bring.

Strategy In A Networked World

For all the excitement surrounding online social platforms such as Facebook and Twitter, we really haven’t scratched the surface on the networks we encounter in real life: The networks of consumers that make up our brands and industries as well as the organizational networks that determine how things get done—or don’t get done—in our enterprises.

And it’s imperative that we start thinking about them more seriously.  We need to stop acting as if there is a recipe for business—like a cake or a casserole—and start thinking in terms of how factors are connected.  The structure of those unseen connections, their context and how they relate to our objectives increasingly makes the difference between success and failure.

Unfortunately, there are no definitive answers.  As Duncan Watts told me, “You have to test and learn as you’re going along, but if you understand how networks work and are willing to invest resources into researching the ones that affect your business, you can significantly improve decision making.”

Watts points to recent research done at Facebook as an example how a well designed study can reveal much about how influence spreads through networks.  He also notes that that digital trails left by emails and electronic calendars can be very useful for mapping organizational networks.  Fortunately, we have far more tools today than Antioco did then.

The irony is that Blockbuster failed because its leadership had built a well-oiled operational machine.  It was a very tight network that could execute with extreme efficiency, but poorly suited to let in new information.  Antioco’s fatal flaw wasn’t one of intelligence or capability, but a failure to understand the networks that would determine his fate.

– Greg