Blockbuster dominated the movie rental business. It had stores all over the U.S. Renting movies was a good business with good margins.
The big drawback was when the movies were not returned on time. With a DVD sitting in someone’s house it could not make more money for Blockbuster. To prod renters to return the DVD on time, Blockbuster charged high late fees. If you waited too long you paid more in late fees than buying a brand new copy of the DVD.
It was a hassle to make an extra trip to return the movie on time. Then it was another hassle to drive back and rent another movie later in the week. But if you didn’t your wallet suffered. It wasn’t the best consumer experience.
Then came Netflix.
Instead of paying for each individual rental, you paid a monthly fee and received the DVD in the mail. You could keep the movie for as long as you wanted. You wouldn’t receive the next movie in your queue unless you returned the previous disc. And Netflix made this easy by including a prepaid pre-addressed envelope.
The user experience was much better. You didn’t pay huge late fees and it was much easier to return the movies. You simply dropped them in the mailbox.
Netflix was a threat but Blockbuster didn’t realize it until it was too late.
Marginal Costs vs Total Costs
Blockbuster did a marginal cost analysis on competing with Netflix when Netflix was still small. Blockbuster decided that the benefits did not justify the cost.
From Clayton Christensen’s How Will You Measure Your Life.
Blockbuster looked at the DVD postal business using a marginal lens: it could only see it from the vantage point of its own existing business. When viewed like this, the market Netflix was going after did not look at all attractive. Worse, if Blockbuster did go after Netflix successfully, this new business was likely to kill Blockbuster’s existing business. No CEO wants to tell shareholders that he wants to invest to create a new business that’s going to be responsible for killing the existing business, especially if it’s much less profitable. Who would go for that?
Blockbuster needed to view Netflix through a total cost lens.
Instead, Blockbuster should have been thinking: “If we didn’t have an existing business, how could we best build a new one? What would be the best way for us to serve our customers?” Blockbuster couldn’t bring itself to do it, so Netflix did instead. And when Blockbuster declared bankruptcy in 2010, the existing business that it had been so eager to preserve by using a marginal strategy was los anyway.
This is almost always how it plays out. Because failure is often at the end of a path of marginal thinking, we end up paying for the full cost of our decisions, not the marginal costs, whether we like it or not.
Weakening Consumer Experience
With the rise of Harry’s and Dollar Shave Club is the razor blade industry having its Netflix moment?
Gillette and Schick dominate the razor blade market. Procter & Gamble (PG) owns Gillette and Edgewell Personal Care (EPC) owns Schick.
For years Gillette would add another blade to their razors and raise prices. Consumers begrudgingly paid up and Gillette’s margins remained fat.
At the same time, the buying experience worsened. Higher razor prices enticed people to steal them.
Stores responded by putting the cartridges behind locked cases. Or they put cards on the shelves that you then took to customer service to redeem for a cartridge after paying for it.
High margins and inconvenienced consumers opened the door for new competitors.
Harry’s and Dollar Shave Club The Netflix of Shaving?
Harry’s and Dollar Shave Cub are subscription services. Both send razor blades to you through the mail on a regular schedule. Both offer their blades at a much cheaper price than Gillette. Both of their business models are much lower margin than Gillette’s. But both companies are OK with that, they’re starting from zero.
Like Netflix, both Harry’s and Dollar Shave Club focus on a small niche and provide a much better experience. It’s a similar shaving experience at a lower cost without the hassle of buying new razors.
To be fair, buying razor blades is not the same hassle as returning movies. Returning a DVD to Blockbuster meant getting in your car and going out of your way to get it done.
Buying razor blades is an add-on to your shopping list. You’ll be at the store anyways. It will take a few extra minutes to deal with the security precautions.
However, it is enough of an inconvenience that the subscription razor blade business model has taken off. Harry’s and Dollar Shave Club have a combined 12.2% market share in 2016 up from 7.2% in 2015.
Procter & Gamble Finally Taking Total Cost View?
Is Procter & Gamble finally taking the total cost view?
For the last 6 years Gillette has lost market share. Gillette had more than 70% market share in 2010 and now it is down to 54% at the end of 2016.
A couple years ago Gillette launched their own subscription service. This month Gillette did something more drastic. They announced they are cutting prices by 20%.
Procter & Gamble finally recognizes the existential threat the new razor subscription services pose. Procter & Gamble could have gone the Blockbuster route. Procter & Gamble could have continued to ignore Harry’s and Dollar Shave Club but Procter & Gamble would continue to lose market share. Eventually its razor blade business would hit a tipping point.
The question we have to ask as investors with Procter & Gamble is it too late? Has Procter & Gamble waited too long to make its move? In going after Harry’s and DSC what does that mean for the profitability of Procter & Gamble’s grooming division? The most profitable division, based on profit margins, for Procter & Gamble (PG).
