Blockbuster: The Sequel

Revived, can it now double sales via DVDs and games?

For two weeks in June, Blockbuster Inc. (BBI ) Chairman and CEO John F. Antioco parked himself in a San Antonio courtroom where a federal antitrust lawsuit against his video chain was under way. The case, brought by three small video-store operators, claimed that Blockbuster and Hollywood had conspired through revenue-sharing deals in the late 1990s to monopolize the video-rental market and drive them out of business. Antioco attended the trial every day, arriving promptly at 8 and sat squarely facing the jury. After all, his turnaround of the chain over the past five years had been powered in large part by the revenue deals in question. A loss in court would be a serious setback. "It was hard not to take [the lawsuit] personally," says Antioco.

In the end, the case was dismissed. And a vindicated Antioco, 52, went quickly back to work on the next chapter at the country's No. 1 video rental chain. It may have been the rentals of VHS tapes that helped transform Blockbuster from a laggard to a star unit within parent Viacom Inc., but this time, it's all about DVDs. The new strategy for growth is not only to rent movies but also to sell them--at about $20 a pop. Last year, revenues worldwide topped $5 billion, and nearly 20% of Hollywood's rental revenues come from the chain. Boasts Viacom (VIA ) President Mel Karmazin: "Today, Blockbuster is synonymous with movies."

But Antioco's challenge will be to stay in the lead in the crowded home- entertainment world. Now that he has restored Blockbuster's credibility, the one-time Taco Bell exec is setting even more ambitious goals. He says he will double the chain's U.S. sales, to $8 billion, by 2006, largely through DVDs and games. DVD spending--for rentals and sales--has exploded, opening up "a whole new world of opportunity for us," says Antioco. Already ubiquitous, with 5,400 blue-and-yellow stores in the U.S., Blockbuster plans to open 120 to 140 new outlets in each of the next four years.

Blockbuster is zooming in on sales because the VHS rental side of the business is slowing. Execs realized what a gold mine sales could be when they looked at games, which primarily had been rentals. But with the release last fall of hot new formats like PlayStation 2 and Xbox, and games selling at about $55 each, the equation shifted. Now, Antioco figures hardware and software sales can help lift that business from $400 million last year to $1 billion in 2006.

Even with its powerful brand and 48 million customer accounts, Blockbuster will have to battle discounters Wal-Mart (WMT ), Best Buy (BBY ), and Target (TGT ) in the DVD sales market. Those giants use DVDs as loss leaders to lure shoppers with special offers of new releases for about $16, vs. $20 at Blockbuster. "You always want to be leery [with] Wal-Mart as a competitor," says analyst Kavir Dhar of Jefferies &Co.

So Antioco is hoping to play off Blockbuster's strength and make rentals, which the other stores don't offer, part of the bargain. The plan: Entice customers, who enter the store with the intention of renting a flick, to consider buying one, too. In August, stores sported banners shouting: "Rent It! Like It! Buy It!"--a program urging customers who rent a new DVD to buy a previously viewed copy for $9.99. Another initiative: a free rental with every purchase of a new DVD, a perk the discounters can't match They're also testing flat rates for unlimited 30-day rentals.

For all the bets everyone--including Blockbuster--is placing on sales, Antioco argues that rentals will still have a competitive advantage against the Wal-Marts of the world. "How many movies are most consumers going to want to pay about $20 to own?" he asks. "Most people only watch a movie once. The reality of the economics--$20 vs. a $4 rental--is that the rental market will be predominant for a long, long time."

Antioco has been pushing hard at Blockbuster ever since he arrived from Taco Bell Corp. five years ago. Back then, Blockbuster's prospects were dim, displeasing the Viacom brass. "From my standpoint, the situation at Blockbuster was not hopeless. But it was a disaster," Viacom Chairman Sumner M. Redstone wrote in his 2001 autobiography A Passion to Win. Sales, profits, and cash flow were falling amid a video-rental industry slump, the growing popularity of movie-rich satellite services, and Blockbuster's own stumbles, including a foray into T-shirts and books. But its main problem, like other video stores, was the hefty $65 it paid each studio per videocassette. It couldn't afford to stock enough new releases to satisfy demand.

Antioco moved swiftly to negotiate revenue-sharing agreements with the studios that let Blockbuster boost its inventory while decreasing its average cost per tape, to about $23. The revenue split: 40% for the studios, 60% for Blockbuster, which had to take all the studios' offerings. By 1998, most of Hollywood had signed on. The change, along with a doubled ad budget and redesigned stores, boosted free cash flow by 85%, to $339.7 million, between 1999 and last year. In 1999, Viacom spun off 18% of Blockbuster, whose shares have since risen 53% (chart).

With DVDs, the economics have changed some. Blockbuster buys most disks outright from the studio, for an average $17 each--end of deal. The studios prefer offering sales and rentals of DVDs at the same time, without the delay that used to favor the chains. For Blockbuster, the negotiated price is low enough to keep its shelves full and still rack up 70% margins, vs. about 60% for tape. Viacom's Karmazin says Blockbuster hasn't ruled out coming up with a new formula with the studios "if it's important to them."

The studios are busy elsewhere these days trying to figure out how to make a business out of video-on-demand, the system that pipes movies to PCs or TV sets for a fee. VOD has been a threat to video retailers for over a decade, but it's still nascent. In fact, it was Blockbuster's interest in getting into VOD itself that led it to strike a deal in 2000 with Enron Corp. when it had big plans for broadband. After test-marketing for eight months, the partnership collapsed. Today, Blockbuster execs say they are not worried about VOD. "VODis available now," says Antioco. "We're video on demand. Come in, demand a video, and you get it." That's not exactly what VOD fans have in mind, but until Hollywood and cable work out the bugs, a trip to the local Blockbuster will still be the routine.

By Stephanie Anderson Forest in Dallas, with Tom Lowry in New York

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