MARKETING (AND LIFE) LESSONS FROM THE RISE &
How Sunk Costs Sink Companies
By Keith Dickinson 09 November 2013
When Blockbuster’s current owner, Dish Network, announced on November 6, 2013 that the company would close its remaining US stores by the beginning of 2014, reactions fell into two general categories:
1) Blockbuster was still in business? With 300 stores? Who knew?
2) This was inevitable due to the dominance of Netflix and Redbox.
As more than one online headline put it, “Streaming killed the video star.”
The end was clearly in sight back in 2010 when Blockbuster filed for Chapter 11. But here’s the thing—there was nothing inevitable about Blockbuster’s long, slow, sad slide into obsolescence—unless you believe that the human propensity to fixate on investments that have already been made is inevitable and simply cannot be overcome.
This tendency is known as the sunk cost dilemma or the sunk cost trap. It explains why gamblers dig themselves deeper and deeper, losing more and more money than they could ever hope to recover with a winning hand. Or why investors hold on to losing stocks long past the time they could have dumped them and at least made some money—instead of losing everything.
But this is far from just a trait of individual human beings. As Investopedia puts it:
Individuals, businesses and governments fall into the sunk cost trap when they base their decisions on past behavior and a desire to not waste the time or money they have already spent, instead of cutting their losses and making the decision that would give them the best outcome going forward. People are reluctant to admit, even to themselves, that they have wasted resources on a past decision. Changing directions is viewed, perhaps only subconsciously, as admitting failure. As a result, people tend to stay the course or even invest additional resources in a bad decision in a futile attempt to make their initial decision seem worthwhile.
The first Redbox vending machines showed up in 2004. Blockbuster didn’t respond with their own (dysfunctional) blue boxes until 2009. By that time, Redbox had the best locations locked in—a benefit of being part of the Coinstar organization, which meant they already had relationships with Kroger, Walmart and other retailers.
But video vending is hardly a breakthrough concept. There were some scattered VHS video vending machines back in the 1980’s. (Weirdly, many were located in movie theater lobbies.) The size of the tapes clearly limited the number of choices and the concept didn’t catch on.
But once the smaller, lighter DVD took over the movie rental market, it was suddenly easier to stock a single machine with dozens of the latest movies. And the price—initially $1.00—was right.
Blockbuster could have built and branded the first DVD vending company but they didn’t. Redbox did.
But one can go back even further to seek how Blockbuster continually overlooked or threw away opportunities to be a first mover in getting movies to customers faster and cheaper.
In 1999 and 2000, Blockbuster briefly explored and then walked away from partnerships that would have allowed them to offer online video-on-demand
The broadband capability to handle streaming movies was not then widely available, but still, deciding not to pursue alternative delivery channels when others were actively exploring them was foolish.
And it’s not as if no one could foresee what the future of entertainment was going to be. In June 1999, the Chicago Sun-Times wrote the following:
“Imagine a Blockbuster night without Blockbuster, a time when no video store will ever slap you with a late fee or fine you for failing to rewind. Because in this world, there are no videos, only home computers”
The media could imagine such a future fourteen years ago, but apparently, Blockbuster could not.
Blockbuster was also slow to make the move to offer the then-new DVDs.
Sunk costs. They had an enormous investment in VHS tapes. Even though DVDs were smaller, lighter, less bulky and offered better sound and picture, Blockbuster seemingly believed that people would prefer to feed their VCRs for the indefinite future.
This also shows a fundamental misunderstanding of the technology shifts that were taking place. VHS reproduction was costly because tapes had to be made in real time. While DVDs (and DVD players) were initially expensive, anyone who understood the technology could have predicted that DVD costs would fall if only because they were fast and cheap to duplicate digitally.
Founded in 1997, Netflix saw an opportunity to develop strengths in areas that were Blockbuster’s weaknesses:
√1) DVDs— Blockbuster, with its huge inventory of VHS tapes, didn’t offer many DVDs. Netflix offered only DVDs—which they also realized were cheap to mail
√ 2) Convenience— Easy mailing meant that the movies could come to you. No more trips to the store that might or might not have what you wanted—even if you had the time to go.
√ 3) No Late Fees— You could keep the movies as long as you wanted and return them free by dropping in a mailbox. At Blockbuster, late fees were a big customer turn-off, yet a huge profit-maker. By some estimates, those fees accounted for 20% of the company’s revenue.
But Blockbuster couldn’t or wouldn’t see the new technologies as a threat. Or that disaffected customers would ever go anywhere else. The company was fixated on their rivals in the video rental business. They had successfully eliminated most of the small, corner rental locations, and then set their sights on Hollywood Video, the next largest rival. Ultimately, they were never able to take over Hollywood (which went bankrupt in 2010), but in 2004, Blockbuster was the undisputed king of the rental world.
Blockbuster at the time, reached its peak with over 9,000 locations in the US, plus Europe and South America.
But each of those locations had, of course, huge fixed- cost liabilities A store needs employees, insurance, maintenance, cleaning, HVAC and more. Netflix used the postal service and an envelope. All they needed at the beginning were distribution centers. Each Redbox could be placed almost anywhere they could be plugged in.
The two fast-rising rivals simply did not have the ongoing expenses that a chain with thousands of stores did.
According to a 2005 article in the industry trade paper Variety, a former Blockbuster employee admitted, “We had the option to buy Netflix for $50 million and we didn’t do it. They were losing money. They came around a few times.” As their own name indicates, Netflix was founded with the expectation that eventually movies would be offered online, and the company began their very successful streaming service in 2008.
The graph below from the Yahoo! Consumerist tells the story:
Yes, Blockbuster eventually copied Netflix by offering both movies-by-mail and a streaming service. But from all reports, neither option worked as well as their rival’s services. Blockbuster By Mail had turnaround times of a week or longer and faced customer complaints of receiving damaged or incorrect movies. And as Harry McCracken wrote in Time magazine in 2010, Blockbuster’s streaming capability seemed almost perversely designed to fail:
Blockbuster does have an online service, but it’s an embarrassment–it requires Internet Explorer and a Windows download, uses flaky Microsoft copy protection, doesn’t seem to be compatible [with} Windows 7, and is overpriced. It’s as if the company isn’t even trying to be part of the 21st century.
Blockbuster had over 15 years in which it could have reinvented itself and continued to be in the consumer entertainment business. Instead, its senior management seemed to believe it was only in the rental of physical movies from brick-and-mortar locations.
They seemingly couldn’t conceive of a future when consumers wouldn’t want to be disappointed by a shoddy selection of overpriced, damaged movies and dinged by whopping late fees, even when they returned movies before the deadline. (“You can’t prove you brought it back on time,” I once heard a Blockbuster clerk sneeringly tell a young father in front of his children who had been hoping to rent some more movies—but not before those late fees were paid. Dad swore he had put it in the drop box but hey, rules are rules.)
A fixation on sunk costs—existing investments—can make it impossible for a company to seek out or even consider better, more efficient and more customer-centric alternatives. Blockbuster had grown by having more locations than anyone else and their dogged commitment to that expensive real estate kept them from seeing that movie rentals were no longer dependent on physical storefronts. Astoundingly, in 2008, the company even considered buying Circuit City, just before that company went under.
The upper-management myopia at Blockbuster and its complete inability to proactively change with the entertainment market led to nothing but ineffective, purely reactive tactics. Ultimately, it was far too little, far too late.
Time’s McCracken summed up Blockbuster’s fate in his online Technologizer column:
Blockbuster had plenty of time to reinvent itself. It’s just that its strategy consisted mostly of imitating Netflix, too slowly and too incompetently to make a difference. The thing that did in Blockbuster wasn’t the Internet: It was Blockbuster.
Bottom-line: Embrace change. Because if you don’t disrupt your current business model in a world of new paradigms, someone else most certainly will.
“Don’t Get Left Behind” [Web log message]. (2011, August). Retrieved from https://blog.accountants.intuit.com/wp-
Investopedia explains “Sunk Cost Trap”. (n.d.). Retrieved from http://www.investopedia.com/terms/s/sunk-cost-trap.asp
Goldsmith, J. (2005, October 09). Blockbusted!. Variety.
Retrieved from http://variety.com/2005/biz/news/blockbusted-1117930420/
McCracken, H. (2013, November 06). Goodbye, Blockbuster. i won’t particularly miss you. Time, Retrieved from http://techland.time.com/2013/11/06/goodbye-blockbuster-i-wont-particularly-miss-you/
Poggi, J. (2009, September 23). [Web log message]. Retrieved from http://iwitness.tumblr.com/post/1176046933/great-article-on-blockbuster-written-by-jeanine-poggi