Blockbuster Becomes a Casualty of Big Bang Disruption

DISH Networks, the owners since 2011 of video rental giant Blockbuster, announced Wednesday the shuttering of all remaining company-owned retail locations and of Blockbuster’s DVD-by-mail service. The shutdown will be completed by early 2014, bringing to a close a dramatic story of rise and fall at the hands of disruptive technological innovation, or what we have called “big bang disruption.”

Classic disruptive innovation says that a cheaper, but lower-quality, innovator can eventually overtake an incumbent by gradually siphoning off customers the incumbent doesn’t find it profitable to defend. As the disruptor improves its offering, though, the incumbent’s position becomes increasingly fragile. Big bang disruption differs in that the start-up offers an innovation that’s not only cheaper, but better — higher quality, more convenient, or both — almost right off the bat. The Blockbuster-Netflix skirmish is a case in point.

For years, Blockbuster seemed unbeatable. At its peak, the company operated 10,000 stores. As recently as 2002, the company had a market value of $5 billion. Then in 1997, Netflix happened. The scrappy start-up built a distribution model that relied exclusively on mailing DVDs to customers through the low-cost U.S. postal service. It was almost as convenient as a neighborhood retail store but at a fraction of the price—and without the late fees that annoyed Blockbuster customers.

Where big bang disruption comes into play is with the advent of Netflix’s streaming video service in 2007.  At the time, less than 50% of U.S. homes had a broadband connection, but CEO Reed Hastings clearly saw the writing on the flat screen. The gamble on streaming content has paid off handsomely. Netflix now represents the single largest source of Internet traffic in much of the world, helping to drive both adoption and network expansion. Today, 70% of U.S. homes have broadband, and network operators continue to invest in ever-faster cable, satellite, and fiber-based technologies. Just last week, for example, industry research consortium Cable Labs released a new cable transmission standard, DOCSIS 3.1, which promises transmission speeds up to 10 Gigabits per second—enough for multiple streams of next-generation ultra-high-definition programming.

With the launch of its digital service, Netflix moved from a slightly less convenient but cheaper competitor to the realm of big bang disruption—an innovator offering better and cheaper goods than Blockbuster.  For a monthly fee, Netflix customers can watch all the movies and television programs they want, whenever they want, and without ever leaving the house and without the need for physical media of any kind.

Netflix’s digital transformation has led the company to even more dramatic innovations, including original programming such as “House of Cards” and “Orange is the New Black.” In September, Netflix became the first video distribution company to win a major Emmy award. It is now the largest paid television “network” in the country, with close to 30 million subscribers.

Blockbuster ultimately launched its own digital download service. But by then its one-time core assets — retail stores — had become expensive liabilities, weighing down the company’s effort to compete in the winner-take-all kind of market that is often characteristic of Big Bang innovation. Revenue and profits continued to decline. In 2010, the once-unbeatable company declared bankruptcy.

Satellite maverick DISH bought what was left of Blockbuster for a little over $300 million the next year, largely for the value of the digital service and its 3.3 million customers. Since then, DISH has been busily cutting costs, shutting down hundreds of retail locations across the U.S.

With this week’s announcement, the company has acknowledged the accelerating decline in value of Blockbuster’s remaining physical locations, assets stranded by the lightning-fast pace of digital disruption. In a statement, DISH President and CEO Joseph P. Clayton said, “This is not an easy decision, yet consumer demand is clearly moving to digital distribution of video entertainment.”

That’s an important insight. In markets where customers can shop, buy and consume goods and services digitally, innovation is increasingly being driven not by the marketing plans of even dominant providers so much as the seemingly insatiable appetite of consumers for the newest technology. Companies no longer offer—consumers now demand.

DISH continues to see hope of a return on its investment in Blockbuster. But like many companies whose physical products, distribution channels and retailing operations have suddenly gone digital, the value that remains will come not from the stores and inventory that once dominated Blockbuster’s balance sheet. It comes instead from what economists call the intangibles–including copyrights, trademarks, and patents.

As DISH’s Clayton put it: “Despite our closing of the physical distribution elements of the business, we continue to see value in the Blockbuster brand, and we expect to leverage that brand as we continue to expand our digital offerings.”

In the strange new world of better and cheaper innovation, every industry will experience similar transformations. Yet most executives, in our experience, underestimate the potential of digital disruptors. In doing so, they systematically undervalue their own intangible assets.

Why not start now to get to know them better? They may show the only path to escape when your blockbuster products get wiped out by big bang disruptors.