On Blockbuster's Decision to Drop HD-DVD

The Diffusion Group

TDG Opinions

Premature Prognostication?

On Blockbuster's Decision to Drop HD-DVD

Michael Greeson, President & Principal Analyst

The News

Last week, Blockbuster announced that it would carry high-definition DVDs in only the Blu-ray format, at least in its brick-and-mortar stores. The selection of DVDs available for online rental would include both, at least for the time being.

The chain had been stocking both Blu-ray and HD DVD discs at 250 stores around the country, but reported that Blu-ray accounted for 70% of all high-definition DVD rentals.

Consequently, Blockbuster said by mid-July it would be offering at least 170 Blu-ray titles in 1,700 stores worldwide. Those 250 stores which already stock HD DVDs would continue to do so but receive no new releases.

Matthew Smith, Blockbuster's senior VP of merchandising, did suggest that Blockbuster would "...continue to closely monitor customer rental patterns at our stores...so we can adjust our inventory mix accordingly. Obviously, when customers are ready, [Blockbuster] can expand the Blu-ray offering into more stores and add HD DVD to more locations if that is what customers tell us they want.[1]"

The Logic

So for Blockbuster, the logic seems pretty simply. First, the physical reality was that its brick-and-mortar stores simply didn't have sufficient space to stock a wide variety of titles in both high definition formats. Second, given consumer rental data which found that 70% of rentals were Blu-ray, this provided empirical data that HD DVD was being used by only a minority (30%) of its customer base. Third, it is simply not cost effective to purchase and stock two different copies of the same high-definition title if both weren't going to generate sufficient rental revenue. In the end, the capital would be better invested in expanding the variety of movies available on Blu-ray.

This logic doesn't seem completely unreasonable. Then again...

The Fallacy(ies)

While this argument makes sense on some prima facie level, it fails to take into account several key issues, a few of which are summarized below.

(1) Blockbuster drew this conclusion far too early in the evolution of the market. It was in November 2006 that Blockbuster added high-definition DVDs to their rental offerings, meaning that:

(a) high-definition DVD sales in general still accounted for but a fraction of DVD sales and rentals,

(b) it had (at best) about six months of initial/early data to analyze, and

(c) the data was collected during a time which Blu-ray was enjoying the fruits of a mass-market campaign and a wider variety of DVD titles. HD DVD, on the other hand, was supported by very few players and had an extremely limited number of titles in circulation.

In other words, Blu-ray got a head start on HD DVD and was able to leverage this early lead to generate significantly greater sales and rental revenue for distributors. This data is hardly representative of this emerging, rapidly evolving market space and thus "shifting sand" compared to the type of market data needed to justify such as aggressive posture.

(2) Not surprisingly, HD DVD sales are already picking up. According to the May 2007 data from the North American HD DVD Group, only four weeks into its marketing campaign, HD DVD players accounted for 60% of unit sales and HD DVD says were ramping up nicely.

(3) Even Blockbuster admits the move is a bit premature. Matthew Smith, the brains behind this decision, noted that it was "too early to say which high-definition format will become the industry standard.[2]" But given early sales, he believes that Blockbuster's customers had already made their decision and that Blu-ray is the winner.

Why would anyone, be it a CE retailer or a movie rental company, try and call this battle as finished when it's only now beginning? The "battle" was really just a skirmish until Toshiba and others began rolling out significantly less-expensive HD DVD players. You may recall that late last year, HD DVD was the leading player, but with the release of the PS3 (which has an embedded Blu-ray player), HD DVD fell behind. Then in May 2007, Toshiba drastically cut prices on its HD-A2 unit to $299 (the significance of which we are only now beginning to realize as new sales numbers arrive). This must be considered a major shift in this strategic battle, yet Blockbuster failed to acknowledge the impact that such pricing battles would have on demand.

Yes, Sony responded by dropping its low-end Blu-ray models to $499 (they were around $999 only six months ago). I wouldn't be surprised to see Sony forced to drop its prices down around $300 in the next few months (in time for holiday sales, for sure). Again, once new sales data has arrived for June and July 2007, we will have a better idea of the impact of Toshiba's $299 move.

All this simply provides validation for my belief that Blockbuster acted prematurely. In an effort to improve its financial performance (think decreasing costs/subscriber) and improve its customer experience (think increasing revenue/subscriber), Blockbuster was declared Blu-ray the victor before the real war had even begun.

[1] "Blockbuster Opts for Blu-Ray," B&C MultiChannel News, HD Update, June 21, 2007

[2] Ibid.

About The Diffusion Group

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