Founded in 2002, Redbox pioneered the DVD-rental kiosk market. Prior, the brick-and-mortar rental model dominated, giving customers significant selection but charging high prices and late fees. As volume decreased, retailers increased prices to offset high fixed costs in a \u201cdeath cycle\u201d that opened up the market to disruption. Redbox entered with small-footprint kiosks located in high traffic areas (e.g., grocery stores) that limited selection to newer titles and only charged $1 per night for each DVD.<\/p>\n
This innovative approach to fixed-point rentals, along with the rise of the Netflix subscription model, crushed brick-and-mortar providers, with Hollywood Video declaring bankruptcy in May 2010[2]<\/a> and Blockbuster closing its remaining stores in November 2013[3]<\/a>. At that point, Redbox owned ~50% of the physical DVD market[4]<\/a> \u2013 we will see below why this Pyrrhic victory was short-lived as the operational decisions \u2013 juxtaposed with Netflix \u2013 made by Redbox set it up for failure:<\/p>\n Asset Utilization \u2013 To Centralize Inventory or Not to Centralize<\/u><\/p>\n Netflix took a centralized inventory approach \u2013 it spread a couple dozen distribution centers throughout the United States, so for a given N of a particular DVD the supply could service overall demand variations with less friction.<\/p>\n Redbox took the opposite approach \u2013 tens-of-thousands of individual distribution points each with a set supply of DVDs. For the same N of a particular DVD, the required precision to match supply and demand at an individual box to maintain high asset utilization was too title, demographic, geographic, etc.-specific. Therefore, in order to fulfill customer availability expectations, excess inventory \u2013 depreciating quickly after release \u2013 would have been required. Any inability to perfectly manage title permutations at a given location would exacerbate each other within the broader system, compared to the Netflix pooled approach. With limited ability to economically shift titles across kiosks, the utilization of an individual DVD would be \u201cset\u201d at the initial procurement and allocation decision; likely resulting in lower per-DVD utilization due to various levels of excess inventory. When inventory levels ran low, Redbox sent employees to purchase emergency DVDs at retail prices in Wal-Mart and Target. Up to 40% of overall purchases were done in this inefficient way.[5]<\/a><\/p>\n Fixed \/ Variable Costs \u2013 Costs to Scale<\/u><\/p>\n Due to its centralized inventory management, Netflix incurred very little cost beyond acquisition costs for an individual new subscriber. Instead, its model was burdened by high variable costs \u2013 namely postage costs for mailing DVDs. While this limited profitability in the short-term \u2013 the company expected to spend $600M on postage in 2010[6]<\/a> \u2013 it created a flexible operating model, enabling growth.<\/p>\n Redbox growth required expanding its kiosk distribution network. This approach created a two-fold fixed cost bind: first, it required significant capital to grow; second, each kiosk was burdened by both on-going servicing costs (e.g., locally optimizing inventory) and maintenance capex (e.g., replacing screens, upgrading interfaces). As Redbox kiosks proliferated, it is not a stretch to believe that the incremental kiosk was likely a.) less desirable and b.) cannibalized nearby kiosks. If you combine this with the shift away from physical rentals toward streaming (see graph), the volume decreases create a \u201cdeath cycle\u201d of fixed assets and lower per-asset profit that is no different than the pinch Redbox initially created for Blockbuster, et al.<\/p>\n Swimming Upstream on Streaming<\/u><\/p>\n With perfect hindsight, it\u2019s not hard to imagine the industry shift toward streaming content. Additionally, when Netflix began streaming content in 2007, few appreciated the first-mover advantage and network effects associated with developing the dominant streaming content source.<\/p>\n Redbox was disadvantaged from the start \u2013 it not only had to use its cash flow to service and invest in the physical infrastructure of its kiosks (discussed above) but also to support similarly capital-intensive coin-processing[7]<\/a> and material-recycling[8]<\/a> kiosk businesses. Furthermore, the company executed around $1B of stock buy-backs from 2010 \u2013 2014 to appease investors.[9]<\/a> Unable to make a \u201cbet the company\u201d plunge into streaming, Redbox finally got around to launching Redbox Instant in 2012[10]<\/a>. At a similar price point to Netflix, with vastly inferior selection, Redbox hoped its partnership with Verizon would allow it to make up ground. However, it not only had to contend with Netflix but also Hulu, Amazon, et al. spending billions in aggregate on content (see graph below). At this point content acquisition costs were being bid up far above what Netflix had locked in as a first-mover. When combined with data infrastructure costs to support streaming, the new venture faced significant viability questions. Less than two years later, Redbox Instant was shut down in October 2014[11]<\/a>, leaving the company with only its legacy kiosk business and accompanying challenges described above.<\/p>\n Redbox attempted to provide cheap, convenient content to the masses. A shift toward streaming content should have been a \u201cno-brainer\u201d but its legacy operating model decisions and failure to move first doomed its ability to compete in an industry increasing turning away from physical content distribution.<\/p>\n Sources<\/span><\/p>\n [1]<\/a> http:\/\/www.nytimes.com\/2015\/12\/09\/business\/daily-stock-market-activity.html?_r=0<\/p>\n [2]<\/a> http:\/\/www.wsj.com\/articles\/SB10001424052748704608104575220370429528864<\/p>\n [3]<\/a> http:\/\/www.usatoday.com\/story\/money\/2013\/11\/06\/blockbuster-closing\/3456271\/<\/p>\n [4]<\/a> http:\/\/www.sec.gov\/Archives\/edgar\/data\/941604\/000119312513173688\/d524783dex992.htm<\/p>\n [5]<\/a> https:\/\/www.techdirt.com\/articles\/20100204\/1222178053.shtml<\/p>\n [6]<\/a> http:\/\/techcrunch.com\/2010\/10\/04\/quora-netflix\/<\/p>\n [7]<\/a> http:\/\/www.outerwall.com\/brands\/coinstar<\/p>\n [8]<\/a> http:\/\/www.outerwall.com\/brands\/ecoatm<\/p>\n [9]<\/a> http:\/\/www.capitaliq.com<\/p>\n [10]<\/a> http:\/\/money.cnn.com\/2012\/12\/12\/technology\/redbox-instant-price\/<\/p>\n![\"Video](\"https:\/\/d3.harvard.edu\/platform-rctom\/wp-content\/uploads\/sites\/4\/2015\/12\/Video-Rental-Spending-300x255.png\")
<\/u><\/p>\n![\"Competitor](\"https:\/\/d3.harvard.edu\/platform-rctom\/wp-content\/uploads\/sites\/4\/2015\/12\/Competitor-Spending-300x229.jpg\")
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