The Rental Giant and the Mail-Order Upstart
You run the largest video rental chain in the country, with thousands of stores and billions in annual revenue. The founders of a small, loss-making online start-up that rents DVDs by mail have come to see you.
They propose that you buy their company for $50 million, and that they run your online business. Do you accept?
The situation
It is 2000. You run the largest video rental chain in the country. It has thousands of stores, a famous brand and annual revenue in the billions of dollars. Customers rent VHS tapes and, increasingly, DVDs, and pay late fees when they return them late, which they often do. Late fees are a significant part of your profits.
The dot-com bubble has just burst. Dozens of online businesses that raised money in the last two years are failing. Investors who were euphoric a year ago are now sceptical of anything online.
What you know
A small start-up rents DVDs by mail. Customers choose films on its website, receive discs in envelopes and send them back. It has recently moved to a subscription model: a monthly fee for unlimited rentals, a few discs at a time, with no late fees. It has a few hundred thousand subscribers and is losing a lot of money; by some accounts its losses that year were larger than its revenue.
Its founders have asked for a meeting. They propose that you buy their company for $50 million. They would run your online operation as part of your company, while your stores handled the rest.
DVD players are selling well but are not yet in most homes. Broadband internet is spreading but most people still use dial-up. Online retail is real, but the companies doing it are struggling.
What you don’t know
You do not know whether DVD rental by mail will become a mass market or remain a niche for enthusiasts. You do not know whether the start-up will survive the funding drought. You do not know how quickly broadband will spread, or whether films will one day be delivered over the internet instead of on discs.
The voices in the room
Some of your executives see the start-up as a niche business run by people who need a rescue. Others point out that $50 million is small for a company of your size, and that the subscription model could appeal to your customers. Still others warn that removing late fees would damage your profits and that integrating a loss-making online company would distract management in a difficult market.
What happened
The companies were Blockbuster and Netflix. According to Netflix co-founder Marc Randolph’s account, he and Reed Hastings met Blockbuster’s leadership, including chief executive John Antioco, in Dallas in 2000, and proposed that Blockbuster buy Netflix for $50 million and that Netflix run Blockbuster’s online brand. Blockbuster declined. Antioco has said that he does not recall serious discussions of an acquisition, so the details of the meeting are disputed.
Netflix survived the funding drought and went public in 2002. Blockbuster launched an online rental service in 2004 and, in 2006, Total Access, which let customers return mail rentals to stores. By several accounts Total Access was winning customers from Netflix in 2007. After a change in leadership, Blockbuster scaled back the effort. Netflix moved into streaming from 2007. Blockbuster filed for bankruptcy in 2010.
Judging the decision apart from the outcome
This is the most famous case of hindsight in business folklore. Judged by the outcome, declining to buy the company that would destroy you for $50 million looks absurd. Judged by what was knowable in 2000, it looks very different. Netflix was small and losing money heavily, online businesses were collapsing, DVD players were not yet universal, and its model threatened Blockbuster’s late-fee profits. Many executives in the same position would have declined, and most online start-ups that sought rescues in 2000 did fail. That is why the process grade is Sound.
Where the process was weaker was in valuing the option. Even if Netflix’s business was small, $50 million was a small price for a possible future, and a staged response, a minority stake, a partnership or a fast-moving internal effort, would have been cheap insurance. Blockbuster eventually built a strong competing service, which suggests the capability was there. The larger failure came later, in 2007, when an effective response was scaled back.
What a good process would have weighed
A good process would have separated two questions: is this business worth $50 million today, and what is it worth to own an option on a model that could threaten our core? The first answer was arguably no. The second was arguably yes. It would also have asked how much of the chain’s profit depended on a feature, late fees, that customers disliked, which is a classic vulnerability to a competitor without it.
Sources and limitations
The account of the 2000 meeting comes mainly from Randolph’s memoir and interviews; Antioco has disputed aspects of it. This page does not attribute motives to individuals. The later history of Total Access draws on press accounts and Keating’s book. Financial details of Netflix’s 2000 results are described approximately because exact figures were not verified for this page.
The reveal
Blockbuster and Netflix, 2000
Decline. Their business is small and losing money, and you can build your own online service later if the market develops.
Backfired
The chain declined. The start-up went public in 2002, grew into the dominant subscription service and moved into streaming. The chain launched its own online service in 2004 and gained ground in 2006–07, then pulled back, and filed for bankruptcy in 2010.
Sound
Judged on what could be known at the time, separately from the outcome. See moral luck.
The forces pulling at the people deciding
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Few decisions are mocked as often as this one. At the time, the start-up was small and unprofitable, the dot-com crash was under way, and DVD players were not yet universal. The decision looks foolish mainly to people who know the ending.
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The start-up served a small group of customers, early DVD owners comfortable ordering online, with a model that would have damaged the chain's lucrative late fees. By the standards of the existing business, it was not worth much.
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Late fees were a large part of the chain's profits. A subscription model without late fees was a direct threat to them. Adopting it meant giving up something certain for something speculative.
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Many online start-ups that approached incumbents in 2000 failed soon after. The ones remembered are the few that succeeded, which makes declining them look obviously wrong.
Signals that were visible at the time
- The start-up's subscription model removed late fees, which customers widely disliked.
- DVD player sales were growing quickly, and DVDs were cheap to mail.
- Broadband internet was spreading, making online services more convenient each year.
- The start-up was losing money heavily, and online businesses were failing in large numbers.
Judge an offer by the option it buys, not only by the business as it is today.
Follow the thread
Connections
Where this comes from
Sources
- Marc Randolph, That Will Never Work (Little, Brown, 2019).
- CNBC, “How Netflix almost lost the movie rental wars to Blockbuster” (2020).
- Fortune, “Netflix cofounder Marc Randolph recalls Blockbuster rejecting chance to buy it” (2023).
- Gina Keating, Netflixed (Portfolio, 2012).
Teaching this case? The teaching note has learning objectives, a 60-minute session plan, discussion questions and the key facts on one page.
Shrikant Kumar. “The Rental Giant and the Mail-Order Upstart.” Decide case, Telos. https://shrikantk.com/decide/the-rental-giant/