Red Team - Was Blockbuster Wrong?

A red team is a group that helps organizations to improve themselves by providing opposition to the point of view of the organization that they are helping. They are often effective in helping organizations overcome cultural bias and broaden their problem solving capabilities. - Wikipedia.

It’s a classic phenomenon. An established corporate giant is offered the opportunity to buy a small, upstart company with low (or no) profitability and a cute idea. The commercial titan scoffs at the possibility of purchasing such a small, insignificant company and thus gambling on a technology that isn’t yet salient. Ten years later, the behemoth has collapsed as the upstart flourishes, and business schools develop a case about “disruption.” In those courses and all over the internet, students eviscerate companies for being so blind to innovation, for ignoring what’s right in front of them.

There are plenty examples of this. Comcast failing to buy Disney in the mid 2000’s (the decade, not the century). Yahoo failing to acquire Google. Yahoo also failing to buy Facebook.

Perhaps the most well-known of these was Blockbuster passing up on Netflix for just $50 million. In my class on innovation strategy, this trend was manifest in our discussion of Blockbuster’s blunder, with students of many backgrounds damning the company for its shortsightedness.

So if you haven’t picked it up by now, via the semi-cryptic Wikipedia definition and the introduction, I’m going to argue that Blockbuster was not, in fact, wrong. Before I jump in - let me clarify. Proving that Blockbuster wasn’t “wrong” doesn’t mean that they made a good decision, or that their business strategy was successful. That’s not a hill I’m prepared to die on. Instead, I’m going to argue that Blockbuster deserves a lot less flak than we’ve given them. In many ways, their decision not to acquire Netflix was natural given their business model and structure. More importantly, Blockbuster’s business model and structure were exactly what any rational, successful company’s would be. The implication (foreshadowing) is that very few companies, especially when effectively run, are impervious to Blockbuster’s fate.

Let me start by explaining why Blockbuster, in hindsight, should have bought Netflix. For one, Netflix is worth a ton of money right now. Beyond that, Blockbuster is no longer in business. Some simple math suggests that if Blockbuster had owned Netflix, the world today would look very different.

Beyond that, there were some hints. For one, Netflix was capitalizing on a growing platform: the Internet. By purchasing Netflix and even just providing funding, Blockbuster would have had a foothold in the most profitable playground of the 21st century.

There are some other reasons Blockbuster should have bought Netflix, but this is about it. I’m going to put my Red Team jersey on, and start talking about why Blockbuster’s decision wasn’t as insane as it seems now.

Let’s put ourselves in the year 2000. Netflix is a company built on the Internet. That means several things that are not yet true. Netflix’s ability to serve customers is still pretty limited. Internet speeds are barely good enough to download photographs, let alone stream live videos. We’re still about five years before the first iteration of Youtube.

Back then, Netflix just delivered DVD’s. This is before the days of Amazon Prime, when getting something online wasn’t as quick as punching in your credit card (or having your browser do it for you) and checking your doorstep a day later. There should be some real questions around whether this kind of movie rental is reasonably feasible, let alone profitable. Think about Amazon, a company who’s business-to-customer model is almost entirely premised on delivering goods, and how much they’ve invested in the last 20 years to be where they are.

The calculus was simple. Netflix wasn’t blowing up anytime soon.

For the sake of argument, let’s assume this kind of quick delivery was feasible. Blockbuster/Netflix would still have their work cut out for them. According to Pew, about half of adults in the US used the Internet. Half! And given that it was only half, it’s not likely that they were all heavy internet users, either. So where Blockbuster had captured a market consisting of the majority of American families, Netflix offered just a small fraction of it.

So let me synthesize and boil it down. Netflix is a bad buy because:

Internet speeds are slow. Using the Internet to get things is generally more inconvenient than getting those things in person.Feasibility. How was Netflix even going to deliver all these DVDs? That logistical problem was (is) enormous, and wasn’t even close to being solved by anybody, let alone a small, niche startup.Small market. There aren’t a lot of people using the Internet.Different market. Netflix is a niche product for tech nerds and cinema buffs, with a low risk of stealing customers from Blockbuster

Through all of this, it’s important to remember that both Netflix and the world were entirely different from how they are today. The infrastructure for Netflix’s eventual business model hadn’t yet been built. Their user base was tiny compared to that of Blockbuster. And the business model was still a decade away from being adopted at all, let alone becoming mainstream. The company that put Blockbuster in the ground might share a name with the one they could have bought, but it is most definitely not the same company.

For the sake of argument, let’s just say that Blockbuster had access to perfect information. If they’d looked hard enough, they’d have found a crystal ball the would’ve told them enough to know that these prerequisites were eventually going to be met. Even in that case, there some big obstacles that would’ve still held them back.

Blockbuster by 2000 was already a (if not the) leader in the movie rental business. The business model had been fully defined, and innovation was far from first priority.

This actually makes a lot of sense. As a publicly traded company that had already reached a “steady-state,” their primary goal became to improve their process and, by extension, their profitability. As part of that shift, their leadership must have changed. A brief skim of Wikipedia suggests that Blockbuster’s CEO, John Antioco, focused on process improvements, from a rewards program to shifting to DVDs to even taking some initial steps to internet rentals in 2004 (that one doesn’t come up often in the B-school conversations). During this period of consistent growth, Blockbuster’s stock followed suit, reaching its peak in 2002. A reasonable bystander would conclude that Antioco and his team were effectively running the company.

Can you really blame Blockbuster for focusing on perfecting their product? In a moralistic sense, Blockbuster was doing exactly what they should’ve been doing: making the best possible product for their customers. Sinking tens of millions of dollars into an unheard-of, unprofitable, Internet startup in the heat the dot-com bubble burst was both entirely out of the company’s strategic scope at the time and, more importantly, very far out of its leadership’s expertise. Developing and creating a new business and running an established one are almost diametrically opposed efforts. This is why the founders of startups who enjoy the “scrappy, underdog days” of a startup eventually leave.

In addition to the C-Suite’s process-focused expertise, large incumbents have another structural hindrance to pre-empting disruption: their board of directors. Not only must at least one person step out of their expertise to argue for one of these unicorn acquisition. They have to convince their board, who are generally interested in how the company is going to make money in the present, to make a bet on a very uncertain future. This is especially difficult when the pre-requisites for this disruption (like some very large advances in Internet technology) are hard to fathom.

So here’s my big point. Blockbuster wasn’t wrong. They didn’t fail to see the opportunity despite being a successful company. They failed because of their success. By shifting their efforts, investment, and leadership to perfection of their craft, Blockbuster opened themselves up to the dramatic disruption that would see them topple over the next decade. The same things that made Blockbuster great became the harbinger of its downfall.

This point should be at least a little disturbing. What I’m arguing here is essentially that no company can easily guard itself against disruption while considering how to be great in the present.

Proof of how deeply this underestimation of disruptive risk was most clearly manifested in the ensuing discussion of that particular class. After talking about how Blockbuster had missed a slam dunk with Netflix, we pivoted into discussing online learning platforms. These platforms range from things like Khan Academy to platforms sanctioned by the the world’s top educational institutions. The discussion was quickly filled with a whole host of familiar arguments.

It’s a different market.

The physical presence of an instructor is difficult to replace. There isn’t a way to make learning online productive or enjoyable.

These kinds of services wouldn’t have a lot of credibility.

Would any of these arguments not have applied to Netflix in 2000?

These are all fair arguments, just like any argument companies make to suggest the persistence of the status quo. If you don’t believe this point, go ahead and pick a developing technology in its infancy, but potentially threatening to a mature business establishment, and ask people in that establishment what they think about it. You’ll hear the same arguments.

Of course, companies aren’t doomed to be disrupted. There are productive ways of conceptualizing these potential changes. This leads me to a thought experiment I’ll call identifying linchpins. Instead of asking a broad question, like “Will this idea disrupt industry and reach business maturity?” strategists should ask a more particular one: “What will it take for this idea to disrupt the status quo?” This more nuanced question gives a better structure for evaluating not only whether an industry will be disrupted, but also how and potentially when.

More importantly, it gives incumbents a framework for vigilance. Like watching for clouds to predict a storm, keeping track of the linchpins gives companies better information on where the industry is going. To tie it to a previous post, these linchpins are the assumptions that threaten our grip on reality. Keeping track of these linchpins is akin to questioning assumptions, tightening our grip on reality.

Let's take an example: grocery delivery. Ten years ago, grocery delivery was unheard of. The closest you could get was purchasing packaged foods online, and even that was a fragmented process. Today, delivery is far from the norm, but there is still a sizable minority (10%, according to Business Insider) that regularly uses online delivery services. This percentage likely swells significantly when you consider customers who only get delivered groceries when on a time crunch, or during a snowstorm.

So let’s imagine we were grocery giants (Walmart, Kroger, etc) in the year 2010, thinking about grocery delivery. What needed to change for it to become possible?

For one, online shopping interfaces needed to improve, both in design and in performance. In addition to being easy to use, web services needed to provide accurate and updated information of what was available. Beyond that, consumer trust of online services needed to grow. While food delivery has been around for a long time, allowing someone to choose good produce and trusting them to safely transport it can be a tall ask.

But along the way, there were things that suggested these consumer shifts were around the corner. As Amazon began to grow to its current primacy, shoppers became more accustomed to buying all sorts of products online.

As for the second one, tracing the preferences of consumers is a little more empirical. With the advent of third-party services like Instacart, grocery stores had an opportunity to watch someone else do the heavy lifting of developing a market and a business model. An analogous storyline is playing out with Tesla’s work to make electric cars mainstream, and the choice of automotive giants to wait before following suit.

This particular example requires a caveat. Shifting from purchasing groceries in-store to ordering online is not (yet) an enormous disruption. This is an example that’s relatively easy to track; each of the linchpins was fairly minor. As a result of that, you could guess with relative certainty in 2010 that grocery delivery would become a part of the future.

But as these disruptions become more profound (like moving from physical movie rentals to streaming), the linchpins become less likely. For Netflix to eventually succeed, the Internet had to explode both in capability and adoption over 15 years. There were more technical barriers like getting licensing from studios (a move you'd expect a giant like Blockbuster to oppose). And beyond that, the engineering and acceptance of online streaming had to be pioneered. Each of these things would have been hard to predict back in 2000, which makes Blockbuster’s decision more justifiable. But if, instead of rejecting outright, they had taken stock of the linchpins, they just might have been able to self-disrupt, and the world would have adopted “Blockbuster and chill.”

Let me tie this all together. In hindsight, it’s easy for us to damn a now-defunct company’s choice to pass on acquiring our favorite 2020’s tech giant. In reality, there are a host of barriers to making this kind of decision. The largest disruptions have the smallest probability of success. Companies that operate at large profits are led and filled by people dedicated preserving and improving their business model, not uprooting it. This creates a structural barrier to acknowledging and investing in disruption. But despite that, all hope is not lost. With some careful analysis, like “identifying linchpins” and continued vigilance, companies may be able to catch a crack in their foundation before an industry collapses.