Why Blockbuster brick-and-mortars will be gone in five years

Over the past few years, Blockbuster has been a victim to a changing environment in the movie rental industry that has seen a mass of people leave brick-and-mortars in favor of online services like Netflix.

No better evidence of this is shown than the comparison between the net income Netflix enjoyed in 2006 ($49 million) and the net loss Blockbuster incurred -- $588 million. Just one year later, Blockbuster was able to turn things around slightly and enjoyed a net income of $54 million, but in 2007, the company didn't have such great luck. According to its most recent filing (September 2007), Blockbuster incurred a loss of $35 million in just one quarter.

So what's really going on at this company? Unfortunately, it doesn't look like anything good. After examining Blockbuster's 10-Q filed in September and evaluating prior year annual reports to estimate the impact on its upcoming annual report sometime next month, it not only looks like this company is in dire straits, I would venture to say that all of its brick-and-mortars will soon be closed. In fact, I give it about five years.

Aside from being on pace to record about $1 billion less in revenue, Blockbuster could be poised to post one of the largest losses the company has ever incurred. To make matters worse, its stock price is hovering at about $2.84 and with very light trading, and the chances of that turning around are nil.

Perhaps most damning to Blockbuster is its inability to compete in the online space. Aside from getting hammered by Netflix, the company is trying desperately to make its mark in the movie download business. But after acquiring Movielink, it not only wasted approximately $7.0 million, adjusted to Movielink's cash on-hand, it looks like it was a poor move.

According to the company's latest 10-Q, if the acquisition occurred at the beginning of the quarter and not in August of 2007, Blockbuster would have lost about $37 million subsequent to the acquisition and $130 million if Movielink was acquired 39 weeks prior to September 2007. In other words, the company is basically throwing money at an operation that not only doesn't work, it's losing valuable capital it will need to keep it afloat.

Of course, the story of Blockbuster's woes doesn't quite end there. According to its filing, Blockbuster currently owns or franchises out about 7,800 stores all over the world. But what becomes most vexing to the reader of this document is what Blockbuster's strategy actually is.

Early on in the 10-Q, the company tries to tell the reader that it's committed to expanding its business outside of the costly brick-and-mortar section, but then later on, explains that it increased prices and decreased advertising expenses for its Total Access Program resulting in a mass exodus "subscribers to other services." In fact, in just two months, the company lost approximately 500,000 Total Access subscribers.

And aside from closing 526 stores in an attempt to jump start sales, the company has been relatively incapable of turning things around on the brick-and-mortar front, even though it's ostensibly focused on doing just that.

But luckily for all of you Blockbuster fans out there, the company thinks it knows why this is happening: "the decline in the worldwide in-store home video rental industry has been caused primarily by (i) increased competition from retail mass merchant sales of low-priced DVDs, by-mail rentals and other sources of in-home entertainment such as digital video recorders and other devices that are capable of downloading content for in-home viewing; (ii) competition from piracy in certain international markets; and (iii) competition from other forms of leisure entertainment."

Ah, the ol' piracy trick, eh? So will piracy be to blame when the US brick-and-mortars are shut down? Probably.

But what's most ironic is Blockbuster really has no idea how to turn things around. It has already failed at trying to take on Netflix and its Movielink acquisition has been an unadulterated flop. So where does it want to go next to try to jumpstart sales? "Complementary services."

"We believe that there is a significant opportunity to both increase revenue and improve profitability by offering complementary entertainment-related merchandise, products and services in our stores," the company claims.

Ironically, though, those complementary services that Blockbuster is so quick to cite have yet to prove their worth. Just one page down in the 10-Q, the company claims movie sales increased by $2.0 million, game sales decreased by $42 million and "other revenues" decreased by approximately $8 million, representing a 50 percent decline. Hm. Sounds good, doesn't it?

Lastly, Blockbuster believes it will be able to increase its revenue through better customer service. To that assumption, I choose to ask the company a simple question: why would any employee want to trust your company or work harder for your company if you just laid off thousands of their colleagues and will probably do it to them as sales continue to decline?

So why do I think Blockbuster will close all US brick-and-mortars within the year? Simple -- because the company has no idea what it's doing. First, it tried (and still does) charge too much for rentals and attempted to woo customers through a "no late fee" scheme that was an even bigger blunder than charging them. In fact, the company has been sued numerous times for that policy and most have yet to be settled.

Secondly, Blockbuster tried to take on the leader in the movie rental industry -- Netflix -- and in so doing, ruined its standing in the industry by providing an inferior service.

But alas, none of these are nearly as damning to this organization as its awful management and misguided beliefs on what customers actually want. Instead of offering more "complementary services" and better customer service, Blockbuster needs to find a way to cut costs drastically (also known as close stores) and decide which business it will be in -- the brick-and-mortar rental business or the online rental industry.

And once it does make that decision, look for the latter to become the new focus. After all, its stores are largely unprofitable, it can't sustain these kinds of losses going forward if it wants to compete in the future and I think it's slowly realizing that if it can gain a foothold in the next wave of video rentals it can possibly turn things around.

Blockbuster is officially old and decrepit. And if it continues down this path it will soon be a memory. Realizing this and understanding that no other company is willing to acquire it, Blockbuster will make the tough decision to close its brick-and-mortars and go elsewhere. And believe it or not, its shareholders will actually like it.

Now, let's just hope we do.