How Online Video Killed Blockbuster

Blockbuster filed for Chapter 11 bankruptcy protection this morning, as part of a pre-arranged recapitalization that it has negotiated with its bondholders. With the filing, Blockbuster has wiped out nearly $1 billion in debt and given most of its bondholders equity in the company instead. The filing marks the end of an era, in which Blockbuster dominated the home entertainment space with thousands of local stores throughout the U.S.

So how did it end up staggering toward bankruptcy?

For many Blockbuster watchers, the bankruptcy filing was a long time coming. Its biggest issue was an eye-popping $930 million in debt that the firm had amassed, which left it hamstrung as smaller, more nimble firms nipped at its heels. But Blockbuster’s bigger problem was a fundamental change in the way consumers viewed and consumed home entertainment.

Blockbuster’s early value proposition when it opened its first store 25 years ago was relatively revolutionary, as it provided consumers local access to thousands of movie titles all in one place. It was by no means the first video rental company, but it achieved scale in a way no one else did, using its vast reach to dominate the video rental landscape and drive hundreds of local mom-and-pop video stores out of business. For many, Blockbuster provided the convenience of a one-stop shop for nearly any video title one would hope to watch.

But over the years, viewers and viewing habits have changed in a way that made Blockbuster less relevant. It’s no longer enough to provide users with a way to get content from a store down the street; nowadays, they want access to that content in their living rooms. At first the mail, and then online video gave them that access.

Blockbuster has been reeling for years, in part because Netflix (s NFLX) and Redbox (s CSTR) provided a better value proposition for many users. With Netflix, users no longer had to leave the house to rent a movie, as it had DVDs literally delivered to them. On the other hand, Redbox (s CSTR) kiosks in grocery stores did their part to whittle away at Blockbuster’s local market share as well. The trade-off was clear; while users wouldn’t have access to the thousands of titles they would get from a Blockbuster store, the price — just $1 a night — was right. The fact that Redbox kiosks were in places like Wal-mart and consumers didn’t have to drive to another store made its rentals a no-brainer.

But it was online video that provided the final blow. Netflix had been successful with its DVD-by-mail service, but never has it been more successful than with the expansion of its streaming video service. Over the past year alone, its subscriber numbers have grown more than 40 percent, driven primarily by users that have logged into its streaming service. Now, more than 60 percent of subscribers have streamed Netflix content to their PCs and other connected devices.

And it was that — the low-cost, instant access to video content — that really did Blockbuster in. It might have had a wider selection, but the convenience of choosing a movie to be streamed online or on VOD made it so that users no longer had to leave the house to be entertained. The rise of Netflix and other online video services on various connected devices — like TVs, Blu-ray players and game consoles that users already own — just made it that much easier to watch video without ever leaving the house.

Blockbuster is poised to leave bankruptcy protection a much leaner and more nimble organization. But its ability to compete in the long term will depend primarily on how close it can get to the consumer to provide its content. It’s no longer sufficient to provide a video service down the street when users could already get their content in the living room. Blockbuster’s future will depend primarily on how well is can leverage broadband, its relationship with distributors and maybe even its real estate in this brave new world.

Photo courtesy of Flickr user Andrew Levine.

Related content on GigaOM Pro: (subscription required)

Cord-cutting? Hold the Phone

Google TV: Overview and Strategic Analysis

New Business Models For Pay TV Services