The Rental Giant and the Mail-Order Upstart

Learning objectives

1. Judge an offer by the option it buys rather than by the business as it is today.
2. Recognise hindsight bias when a famous outcome is known.
3. Understand why an incumbent's profitable business makes a small threat look unimportant.

Session plan

1. 0–5 min Read the situation, what is known and unknown, and the voices in the room. No discussion yet.
2. 5–13 min Each participant chooses an option on the case page, states a confidence and writes a one-line pre-mortem: if this choice fails, the most likely reason is…
3. 13–28 min Debate by option. Ask each group to estimate what the start-up could be worth in five years in a good case and a bad case.
4. 28–33 min Reveal the outcome.
5. 33–50 min Separate process from outcome. Most participants will condemn the decision; ask them to argue that it was reasonable given what was known in 2000, then to say what a better process would have weighed.
6. 50–60 min Transfer: participants name a small, unprofitable threat to their own business and what a cheap option on it would cost.

The case page records each participant’s choice, confidence and pre-mortem in their own browser, and scores the confidence once the outcome is revealed. Nothing is sent anywhere, so it can be used in any classroom.

The key facts on one page

• The offer was to buy the start-up for $50 million and let its founders run the chain's online business.
• The start-up went public in 2002 and became the dominant subscription service before moving into streaming.
• The chain launched its own online service in 2004, gained ground in 2006 and 2007, then pulled back.
• The chain filed for bankruptcy in 2010.

Where discussions go wrong

• Treating the decision as obviously foolish. In 2000 the start-up was small and unprofitable, and many similar offers were rightly declined.
• Assuming the acquisition would have succeeded. Many incumbents buy start-ups and smother them.

The forces at work

• Hindsight: 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.
• The innovator's dilemma: 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.
• Loss aversion: 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.
• Survivorship: 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.

The lesson to carry out of the room Judge an offer by the option it buys, not only by the business as it is today.

Pairs well with: The strategy question “Should we buy the company that threatens us?” and the idea Hindsight and the Illusion of Inevitability.