We can gain useful insights by winding business models back in time to see how they emerged and evolved. In the case of competing business models, we can analyze the different outcomes and perhaps assign some cause and effect analysis to interpret why one model variant performed better than another. How do we do that? Through the technique of entrepreneurial business history.

Alan Payne conducts just such a historical business model re-enactment in his excellent book, Built To Fail: The Inside Story of Blockbuster’s Inevitable Bust (Mises.org/E4B_116_Book). It’s the dynamic story of two competing business models in one industry, a comparison of outcomes, and the resulting emergence of a new, third model.

Key Takeaways And Actionable Insights.

Business models are discovered by experimenting entrepreneurs.

The video cassette recorder (VCR) and playback device was a technological emergence in the 1970s. Movie studios saw the opportunity for new sales but worried about diverting revenues from the theater channel and therefore priced movies-on-cassette quite high from a consumer perspective (about $65). The experience of viewing movies at home was valuable to consumers but the exchange value was not aligned with the price. A few enterprising entrepreneurs discovered the rental option (don’t buy the cassette, rent it, and return it). The unit rental price emerged at around $3. The video rental business was born. Individual rental stores were profitable and some of the entrepreneurs started to open multiple stores and build small chains.

Capital-advantaged shareholder value-focused owners recognize emergent business models that are scalable.

Alan Payne’s story of business model evolution in the video rental industry describes a great leap in industry growth led by another kind of entrepreneur. Wayne Huizenga was an entrepreneur experienced in a certain kind of growth model. He had built Waste Management, a Fortune 500 company, from a one truck garbage collection route, largely through acquisition and subsequent expansion of local operators. He knew how to finance and run high growth expansion of a templated operating system. He bought Blockbuster for $18.5 million and sold it nine years later for $8.4 billion. That’s a huge amount of shareholder value generation.

Under Huizenga, the consumer value experience did not get better. It was frozen. We know that consumer experience is dynamic, not static; Huizenga’s Blockbuster let more and more consumers into a static experience (through geographical expansion) but was not generating new value for those or any other consumers.

More consumer-oriented businesses evolve more responsive business models.

In Alan’s story, HEB Grocery was a different kind of entrepreneurial business that approached consumer value in a different way. Alan describes the company as “obsessed with being the best” at meeting the ever-changing preferences of food shoppers. An effective grocery retailer must be highly responsive to changing consumer needs and adept at providing selection and value at low cost, with operational excellence in inventory management and customer service.

HEB decided they could offer video rental service in-store and brought their grocery operations skills to bear on designing a consumer-preferred experience. They tested different value propositions – Alan called their stores laboratories for the video rental experience – and let the consumer decide which were the best. They experimented with inventory (number of movies available), the in-store selection of new releases versus classics, different pricing schemes for different movies, different return dates for different products, and offering snacks alongside movies, among other variations. The result was a differently-tuned business model, one that built a more satisfied and loyal user base and generated more revenue and more profit per store than Blockbuster.

Business models are tools for economic exploration and advancement, so long as there is managerial and organizational flexibility to learn and improve.

When Alan Payne went to work for Blockbuster as an executive to run a panel of franchised stores, he transferred the learnings from the HEB video rental business model. He demonstrated that the model could be applied successfully in this new environment, achieving similar levels of growth, profitability and consumer satisfaction and loyalty in his panel of stores.

The issue for Blockbuster was not business model transferability, but the managerial, organizational and decision-making environment into which it was transferred. Blockbuster was a top-down hierarchy in which knowledge flowed one way — from the top of the hierarchy to the stores in the form of commands. When there was learning at the store level about new and better ways to organize, to manage, to operate, to please consumers and to make profit, it was impossible to transmit it upwards and share it. Blockbuster lost money and entered bankruptcy even while a significant number of stores in Alan’s franchised panel were operating profitably and were growing.

Alan eventually raised the money to buy the franchised stores from Blockbuster and operate them independently, which he did successfully and profitably for over 20 years. Blockbuster never was able to learn any of his techniques, nor modify its business model to the more successful version that was in plain sight.

Sometimes, an outsider from the industry comes along to seize the opportunity of the next business model evolution.

Alan makes it clear that technological change did not kill Blockbuster or the video rental model. When DVDs were introduced to (eventually) replace video cassettes, Alan’s franchised stores thrived by offering both side-by-side and thus appealing to two sets of consumers in one store.

Netflix was able to anticipate a future in which the digital data stored on DVDs became streaming data downloaded at home by consumers. This was not so much an act of prescience as one of exploration. The next new video-at-home experience began to emerge and Netflix captured much of the consumer value.

There is more value to be captured today because the consumer finds new experiential benefits in streaming, and the accompanying data analytics deliver insights that a consumer-centric firm like Netflix can utilize to further improve the experience. The same opportunity would have been available to Blockbuster, but their lack of business model agility and their failure to build learning channels from the consumer back to the corporation meant that they could not take it.

Additional Resources

Built To Fail: The Inside Story of Blockbuster’s Inevitable Bust: Mises.org/E4B_116_Book

“Consumer Value vs. Shareholder Value Models” (PDF): Mises.org/E4B_116_PDF

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