C. Gopinath

BLOCKBUSTER is the largest video rental chain of stores in the US with a market capitalisation of about $1.9 billion and there is a battle on between investor Carl Icahn and Chairman John Antioco. At the company's annual meeting last month, Icahn, the largest single investor controlling 8.6 per cent of the shares challenged the management's slate of three directors (which included Antioco) and got his group elected.

Mr Antioco resigned and you would think Icahn would be relieved to be rid of him. But his contract with the company calls for a severance payment of $54 million so the new Board prudently reappointed him!

The issue runs deeper. Mr Icahn wants the company to step up its dividend payment to the shareholders while Antioco wants to retain earnings in order to invest in different areas of the business. Hence the fight goes to the core of strategy, namely, resource allocation.

The market for video rentals has undergone major changes both due to changes in technology and aggressive competitors. Transmission and distribution technologies have allowed cable companies to offer video-on-demand. That is, you can call the video company and pick from a selection of movies that they will then play for you to watch on your television for an additional fee.

Technology has also allowed people to download movies over high-speed cables and watch them on their personal computers.

New competitors such as Netflix have made it easier to rent DVDs. For a monthly subscription fee, Netflix allows you to choose three movies at a time from a list of 40,000 titles, which are delivered through the mail (along with reply-paid envelopes for return) that you can keep as long as you want. When you return one, it is replaced from your personal pre-selected list.

Another entrant in the industry has been giant retailer WalMart. By pricing DVDs really low, it went from offering a substitute to being almost a rival in the video rental business. On top of that, the retailer also began a video-rental service, directly challenging stores such as Blockbuster.

The result of these developments in the market place has put a squeeze on Blockbuster's growth although it has stayed cash-rich.

In early2005, Blockbuster was cut loose from its parent Viacom Inc, an entertainment giant. The company sought to expand horizontally by buying a rival video rental store called Hollywood Entertainment but the bid was not successful.

Mr Antioco's view of the future of video rental is not very bright. He believes that the market would decline about 3 per cent a year and, therefore, wants to reinvent the company. They have begun renting and selling video games, buying back used movies, and have even started a membership-based rental service. In a shrinking market, they have also sacrificed revenue by scrapping late fees.

Mr Antioco has also invested significantly to start a mail rental service, just like Netflix, and is even offering a lower monthly subscription, $14.99 as against Netflix's $17.99. Netflix, by itself, is barely profitable after six years of operation, and Blockbuster's various moves make one wonder if it is just firing in too many directions hoping that at some time they may hit paydirt. Companies often have to make a choice between the short term and long term when it comes to making investment decisions. For example, Toyota is quietly plugging away to unseat GM and emerge the global leader with a share of 15 per cent. It has been investing heavily in increasing its global production capacity, by building new plants and adopting new technology to offer hybrid vehicles. At the same time, it is battling rivalry in the US through discounts. All this has taken a toll on its profitability and depressed its share price.

The pressure on Blockbuster to pay out the money now rather than invest in its future challenges our assumptions about what strategy is about and who is responsible for it. A management that takes a long-term view is willing to give up an immediate return to put the company in a better position for the future. Tweaking decisions to show a return in the short term is only tactical, and not strategy.

If Mr Icahn was a long-time shareholder of the company, one can view his motives at Blockbuster as being a challenge to the status quo and look forward to a debate with the management about a new vision for the company. But that is not his reputation. He is popularly seen as a `raider.' He acquired the stock recently at the time of Blockbuster's effort to buy Hollywood Entertainment, in which also he acquired stock and was in favour of the merger, which would have netted him a nice quick return on his holdings. Soon after that effort failed, he started his challenge of the strategy of Blockbuster. Therefore his motives are suspect. Mr Icahn's track record of actions at other companies such as, Texaco and RJR Nabisco, shows his penchant for acquiring stock in companies and forcing decisions that drive up the share price so he can profitably exit. Having been cheated of a profit arising from the merger, one can guess that he now sees control of the management of the company as the way to pay out Blockbuster's cash as dividend. No matter if the company stays as a big player but in a shrinking market and without a well thought out strategy for the future.

In a similar situation, investor groups, not too long ago, challenged Kodak's efforts to diversify into imaging technologies and move away from its stagnant film business, by going to court to make them pay higher dividends. Investor groups usually have their eye on the short term. Blockbuster's other big shareholders are hedge funds who are backing Mr Icahn's moves. With returns among hedge funds down and with hedge fund managers claiming almost 20 per cent of investment gains as their personal compensation, they also keep up the pressure for quick returns.

Meanwhile, the environment continues to be in a state of flux. WalMart has just announced that it is getting out of offering rentals and will stick to just sale of DVDs.

It is striking an alliance with Netflix to whom it will transfer its subscribers. Blockbuster, in a feisty move, has responded by two free month's service and a free DVD player to those who will switch to them from WalMart/Netflix. With Mr Icahn and Mr Antioco now sitting on the board of Blockbuster, your guess about the future of the company is as good as mine. Wonder who is going to be around to pick up the pieces when the dust settles.

(The author is professor of international business and strategic management at Suffolk University, Boston, US. He can be contacted at gopinat@suffolk.edu)

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