Blockbuster Pricing Strategy
Blockbuster Video| Pricing Strategy| Tejas V 1114054| Executive Summary – Blockbuster Video Blockbuster Inc. is an American chain of rental stores that offers movies, video games, and other forms of media entertainment on a subscription or a rental basis to consumers.
The case highlights the implications of a revenue sharing business model in the Video Rental Industry where the Movie Studios are the upstream players (Suppliers) and the Video Rental Stores constitute the downstream players (Retailers).Under the revenue sharing model, the Video Rentals Stores such as Blockbuster procure tapes at a reduced initial cost from the Movie Studios and share a percentage of their rental revenues with the Studios. The following are some of the key benefits of a Revenue Sharing business model- Effective demand management The Video Rentals business is impacted by significant fluctuations in demand. First, it is difficult to predict the success or popularity of a movie prior to its release.Second, the demand for a video tape is at its peak when a new movie is released and declines continuously thereafter (30-60 days post release date).
The rental stores are often in a scenario where they have to decide on the number of copies of the video tape for a movie prior to knowing its success in the box office. Higher upfront cost to procure the tapes would make the video rental stores to stock conservatively leading to increased stock outs.Partial financing of the inventory costs by the movie studios incentivizes the retailers to keep sufficiently higher number of video tapes thereby increasing the availability and copy depth. This in turn leads to better demand realization and increased rental transactions. Leveraging value chain synergies The movie studios and the video rental stores have combined stakes in the success of a movie. A successful movie ensures higher returns from exhibitions in theatres and increased rental revenues by increased rental transactions.
The studios and rental stores hence work together in the marketing and advertising of individual movies, sharing the promotional expenses and jointly reaping the benefits of successful marketing campaigns Risk Mitigation by reducing operating leverage Revenue sharing model reduces the Degree of Operating Leverage (DOL) by reducing the fixed cost (upfront tape procurement cost) and increasing the variable cost (royalty to studios). The higher the degree of operating leverage, the more volatile the EBIT figure would be relative to a given change in sales, all other things remaining the same.Thus by reducing DOL, the rental stores can mitigate the business risk due to volatility in rental sales by having a more stable EBIT. The video rental sector is highly volatile, with contraction and expansion closely pegged to the business cycle. Operating leverage measures the proportion of fixed costs to variable costs in the operations of the firm. When the economy is growing rapidly, demand for discretionary products like Video tapes, DVDs and video games increases, whereas in a downturn demand plummets.
Any weaknesses in the U. S. economy, will translate to Blockbuster suffering from lower store traffic and witnessing drops in store revenues. A Revenue sharing model will mitigate suck risks by reducing DOL. Prevents destructive price competition at retail level Retailers who have the optimal inventory for peak demand periods might be tempted to price inefficiently low in subsequent low demand periods. Revenue sharing is valuable because it prevents destructive price competition in these low demand times.
Thus it achieves the dual objective of softening retail price competition without distorting retailers’ inventory decisions. Double edged sword for the movie studios The Video rental stores such as Blockbuster invariably store titles from multiple studios. Non-availability of a particular movie from a given studio might lead to the customer choosing an alternative movie from another studio. Increasing copy depth through revenue sharing will reduce customer churn and switching to movies from alternate studios. However, a studio might have to produce several movies before hitting upon a blockbuster.
By reducing the upfront procurement cost on the video tapes, the studios could be losing revenue particularly on the vast majority of movies which will not become a blockbuster. Conclusion Overall a revenue sharing model promotes collaborative behavior in the value chain by the various players involved. It provides a framework for sharing of risks and rewards on a proportional basis between the Movie Studios and the Video Rental Stores such as Blockbuster by encouraging heuristically optimal inventory levels at the Rental Stores.