Adjusting the Focus at Blockbuster

I can be fairly sure of three things in life.

One, a musical act named Urinal Cake will never achieve mainstream success.

Two, any basketball team that allows Allen Iverson to take so many shots -- and miss -- will never win an NBA championship.

Three, whenever I write something even mildly bearish about Blockbuster (NYSE: BBI  ) , I will get some emails accusing me of having an agenda because I own a measly 200 shares in online rival Netflix (Nasdaq: NFLX  ) .

I know what you're thinking. You're thinking I'm wrong. Iverson's got game. He was the MVP at the NBA All-Star Game over the weekend and routinely leads the league in scoring. But I stand by my words. He's a ball hog whose lousy field-goal shooting percentage will undermine any team's chances to reign supreme in the finals.

What's that? You also have no problem with my taking shots at Blockbuster? I guess it's easy to see why these days. Blockbuster faces a cutthroat pricing war online, struggling operations offline that are the target of venom from fraud-averse state attorneys general, and a debt-heavy balance sheet as a result of a ridiculous lump-sum penalty in buying its independence from Viacom (NYSE: VIA  ) . Blockbuster's biological clock is ticking, and it can't be too long before it runs out.

Yikes! Blockbuster has gone from emulating the waves crashing on the shoreline love sequence in From Here to Eternity to the last few go-for-broke frames of Thelma and Louise. What would you make of Blockbuster over the last few months? There's apparently a fine line between ambitious and desperate, and I'm not entirely sure that the offline rental giant is making a good move in either direction.

Yes, Netflix started the price war when it lowered prices to keep Amazon.com (Nasdaq: AMZN  ) out of the mail-delivered loaner market. Blockbuster had little choice but to follow suit, yet it raised the ante with an unnecessary second price cut that sorely damaged the value proposition of its bricks-and-mortar business. Then it got into a bidding war for its largest real-world rival, Hollywood Entertainment (Nasdaq: HLYW  ) , as it continues to muddy up the model with its questionable "No More Late Fees" marketing campaign.

At this point, everything comes down to mind over matter. And by that, I mean that Blockbuster is losing its mind in a valiant attempt to matter. It wants to be everything, even if it means making promises that its already leveraged balance sheet can't keep.

Hope is a four-letter word
As down as I am on Blockbuster's chances to emerge unscathed, the contrarian in me wonders how cool it would be if the company actually got it right. Since I'm an optimist by nature, it doesn't take much to rattle Mr. Bright Side out of his nap. Now that he's awake, he'd like to go over the four things that Blockbuster needs to do if it wants to come out of this episode alive, smiling without wrecking its finances.

1. Slap on your game face. Blockbuster was never the cheapest offline option. The discounters were the department stores, pharmacy chains, and grocers that tried their hand at practically giving away rentals to ensure repeat traffic. It didn't work for them, and it won't work for Blockbuster if its only claim to fame is that it's the cheapest alternative online. It has to stand out. It has to be unique. It has to lead. It has to justify a premium. Offering coupons for free in-store rentals isn't going to be much of an incentive for those spoiled by home delivery. That's why it needs to go where Netflix has not -- video game rentals. Blockbuster already rents the games from its stores. Games pose many factors to consider, like the higher cost of video games over DVDs and the limited shelf life of hot game titles, but there are ways to overcome these shortcomings.

2. Try a cap on for size. Amazon entered the UK rental market with a cap on the number of monthly rentals. That's the sober way to shoo away the heavy users that contribute to operating losses, given the revenue-sharing payments, fulfillment costs, and postage fees that accrue with every delivery. If Blockbuster wants to remain the cheapest game in town, it should follow suit and cap rentals at a reasonable number as a way to lower its costs while increasing the value proposition of its offline operations.

3. Say goodbye to Hollywood. Let Movie Gallery (Nasdaq: MOVI  ) have Hollywood Entertainment. Blockbuster has its own brand to resurrect and a questionable marketing campaign to repair. Pitched properly, its new policy of extending grace periods is a dagger to the heart of its offline competition. So let Movie Gallery and Hollywood Entertainment dance. Blockbuster will be able to acquire them both -- for less -- later.

4. Sleep with the enemy. Everyone's curious about how Amazon will enter the stateside mail-delivered disc rental market. Amazon would rather face one juggernaut than two, and that's why I can see it either teaming up with Blockbuster, as it has with other bricks-and-mortar retailers like Target (NYSE: TGT  ) , or making a bold move in acquiring Netflix. Staring down Netflix is hard. Staring down Netflix and Amazon would be dreadful. That's why Blockbuster has to walk into the sock hop with Amazon on its arm. It has to be the one to propose the branded strategy. That would be the right way to introduce rental caps while appeasing its franchisees by not marketing its online business as a lone wolf. Most retailers come to Amazon lacking online fulfillment expertise, and Blockbuster has invested in its distribution centers to lick that problem already. So Blockbuster doesn't really need Amazon, but that isn't the point here. Blockbuster has to realize that either it or Netflix will swallow the Amazon grenade. It can't afford to let Netflix do it. Absorbing some of Amazon's hipness along the way wouldn't hurt, either.

Can Blockbuster do more? Sure. These four steps are just the beginning. But first, the company has to realize that it can't be the juggler it's making itself out to be these days. It needs to focus. And it needs to focus on the future.

Over in the "New Stock Ideas" discussion board that is part of our interactive Rule Breakers newsletter service -- yes, our collection of premium newsletters offers more than just the monthly issues -- no one has ever suggested that we take a closer look at Blockbuster. I think it's because everyone realizes that the company is trying to play tomorrow's game while still holding yesterday's cards. While the company has made some radical changes in recent months, I believe they've been the wrong kind of changes.

There's still hope for Blockbuster. You know, there may still be hope for Iverson, too. I'm not ready to head out to a Urinal Cake concert, though.

Want more Blockbuster stories?

Longtime Fool contributor Rick Munarriz can't remember the last time he made it a Blockbuster night. He owns shares in Netflix.The Fool has a disclosure policy. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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