How Did Netflix Disrupt the Market?

new business model, nixing late fees among innovations

By Jonny Lupsha, Wondrium Staff Writer

At the turn of the millennium, Blockbuster Video was the king of video rental stores. Ten years later, they were bankrupt. How did Netflix beat Blockbuster?

Man deciding what movie to watch on streaming platform
Photo by Said Fx / Shutterstock

In the late 1990s, when people wanted to see movies that were no longer in theaters, video rental stores were the places to go. Chief among them was Blockbuster Video, which stocked dozens of copies of recently released popular films that could be rented for a few dollars for two to five days. Then, Netflix introduced its DVD-by-mail service and massively disrupted the video rental market.

Recently, Netflix announced that after 25 years, it will close its DVD service and focus exclusively on its streaming platform. But how did it take the lead over Blockbuster in the first place? In the video series Critical Business Skills for Success, Dr. Michael Roberto, the Trustee Professor of Management at Bryant University in Smithfield, Rhode Island, explains this surprising turn of events.

What Did Netflix Do Differently?

The first main difference between Netflix and Blockbuster—besides the former being a mail-in service and the latter being a chain of brick-and-mortar stores—is its customer base. Dr. Roberto pointed out that the average Blockbuster customer was a suburban mother, age 30 to 45, in search of recently released, triple-A Hollywood titles on VHS, when DVDs were still in their infancy.

Netflix’s main customer was an 18- to 29-year-old male living at home or on his own, renting DVDs to watch on a computer, often a laptop. And he wasn’t interested in renting new movies; he wanted cult classics, independent films, and tried-but-true classics like Caddyshack and The Godfather.

“Think about Blockbuster’s market research at the time, in 1999,” Dr. Roberto said. “They were asking that soccer mom what she liked and disliked about Blockbuster. She wanted more copies of hit movies [because] she could recall those instances where little Sally, her six-year-old, had cried all the way home because Blockbuster didn’t have any more copies of [a Disney movie she wanted].”

So, Blockbuster increasingly made space for additional new movies, shrinking the inventory of other titles and losing the average Netflix demographic. Netflix didn’t have that problem; for some time, they had largely focused on older movies.

Additionally, Netflix didn’t charge late fees that prevented customers from renting more movies if customers kept one until it was overdue. That was key.

How Did Netflix Disrupt Blockbuster?

“Blockbuster was pursuing what we call incremental innovation: They were talking to their customer and offering small improvements in their service, in their in-store experience, in the availability of movies,” Dr. Roberto said. “But along came Netflix with what we call disruptive innovation: A fundamentally [new] product and service—in fact, a whole new business model—and it undermined Blockbuster’s advantage.”

According to Dr. Roberto, there are three main threats to competitive advantage. Imitation is when someone does what another company does, but does it better. Substitution is when someone comes along with an alternative product or service that fulfills the same need. Hold up is when a company’s buyers or suppliers gain leverage over them and begin to extract more profit from the value chain.

“In many ways, the most serious threat is substitution, and that’s what we’re seeing here with Netflix offering, really, a substitute to the traditional brick-and-mortar store that rented movies to customers,” he said. “Why is the most serious threat substitution, in many cases? It’s because it’s so hard to foresee, and perhaps it’s even harder to respond to, as we [saw] with Blockbuster.”

Blockbuster was slow to make any major changes to their operation, only appearing online years after Netflix had. It was too little, too late. Eventually, Redbox finished the job that Netflix started. By using vending machines at supermarkets to rent DVDs, Redbox was more cost efficient and effective than Blockbuster. The final nail was in the coffin.

Critical Business Skills for Success is now available to stream on Wondrium.

Edited by Angela Shoemaker, Wondrium Daily