HISTORY CERTAINLY REPEATS itself and this time around, you have to look back only four years. When the world's largest video-rental company, Blockbuster, bought KPS, many people wondered how the company planned to turn it around. After all, KPS was not known to have been plagued by serious management problems, it just had trouble finding customers. In the same year, Hongkong Telecom's video-on-demand service, which also failed, was having difficulty finding customers to rent films, as opposed to buying them. Blockbuster's demise in Hong Kong is the result of a flawed strategy and a poor understanding of the market. The company says that it opened up shop here to tap into the mainland and that four years down the road, it is still facing serious piracy issues. If Blockbuster's ultimate prize was the mainland, what benefits did it expect from operating in Hong Kong? Costing an industry average of only HK$2 million to open a new store, Blockbuster could certainly have afforded to open a few trial shops across the border. Even if Blockbuster had legitimate reasons to use Hong Kong as the site for a trial run, that trial was still destined to fail. Blockbuster's business model hinges on consumers making trade-offs between inconvenience (the returning of movies and a limited viewing duration) and savings. In Hong Kong, the inconvenience factor works against the company, as a short stroll to most of its outlets will take you past a handful of video shops. Meanwhile, the savings that it could offer customers were not that great due to the existence of cheap VCDs. Blockbuster itself conducted a study concluding that consumers would start to purchase rather than rent when the price of videos dropped below US$8 - a price below which most VCDs are selling. The demise of Blockbuster in Hong Kong is a portent of the difficulty the company is beginning to face worldwide, as the inconvenience versus savings equation deteriorates quickly in other markets. In the United States, some DVDs are already priced below the US$8 threshold. Wal-Mart, for one, is now pushing some DVDs at prices as low as $5. If you are mentioned in the same breath as Wal-Mart and are not a partner, you should be feeling a chill down the spine. It seems that Blockbuster was so busy trying to fight potential online rental rivals and video-on-demand entrants a few years ago that it forgot that its biggest potential threat lay in the old economy. Blockbuster, to its credit, has been switching its business model from rental to retail. Retail sales account for about 20 per cent of its revenue, up from 14 per cent in 2000, and the company acknowledges the need to push ahead on the retail front in the next few years. The success of this model, however, is yet to be seen. For one, Blockbuster does not have the economies of scale in the retail business that it has in the rental business, and competing with Wal-Mart when it comes to economies of scale is always a one-sided game. Secondly, retail margins are much worse than those for rentals. On average, Blockbuster generates about US$3.50 per DVD on rentals, assuming that each DVD is rented out the industry-average 10 times. Each retail sale, however, grosses the company only $1.50. As consumers switch from rental to purchase, Blockbuster's top line will grow quickly but its bottom line will be a different story. High shop leases in Hong Kong and piracy in China are common excuses for companies retreating from the country but Blockbuster's exit will be missed only by its employees. What has happened here gives a glimpse of the eventual fate of the company and, unless it can find some clever way out of this tough spot, it might find its name shortened to Bust. Ken Lo is managing director of BusinessDevelopmentConsultants & Company, a strategy and management consulting firm
