Sit down, please. This is a scary story.

Once upon a time, seemingly in a galaxy far, far away, there was a video rental chain that ruled its home entertainment domain with an iron fist. Blockbuster (NYSE:BBI), as the enlightened despot was known, was making a lot of money, and a big portion of that came from late fees on rented materials.

Along came gallant Sir Netflix (NASDAQ:NFLX), intent on saving the consumer from limited selection, inconvenient stores with underpaid and undertrained staff, and those abominable late fees. Sending DVDs by mail to those thirsting for entertainment, Netflix started small but -- in just a couple of years -- put a serious dent in Blockbuster's armor.

As Netflix' subscriber count climbed into the millions -- it's at 5.7 million today -- the industry consolidated in response. Blockbuster cast a lecherous eye at rival chain Hollywood, but Movie Gallery (NASDAQ:MOVI) beat our villain to the punch and snapped up the prize. As Movie Gallery now undergoes serious indigestion from that meal, and is staving off creditors with nothing but some moxie and a broken bottle, Blockbuster must feel like it dodged a bullet.

Thing is, there are so many bullets flying these days that this miss might not matter much. Blockbuster's margins are deteriorating, the balance sheet isn't very balanced, and the company's credit rating sunk from a B+ to CCC (the lowest rating possible) over the past year, making it very difficult to take on further debt to shore up that bank account.

In short, the old king is lying on his deathbed. Now, there will probably always be video stores in our neighborhoods, because sometimes you just want to walk in and see what grabs your eye on those shelves tonight. But the company could very well go belly up and disintegrate through bankruptcy into a gazillion privately owned and operated mom-'n'-pop stores. Blockbuster can't afford to hemorrhage red ink for much longer.

Netflix has a virtual lock on the most-convenient market segment, at least until video on demand or direct downloads become viable business models with proper studio support. When -- not if -- that happens, all bets are off when it comes to crowning the new ruler. It could be Netflix, (NASDAQ:AMZN), Apple (NASDAQ:AAPL), or maybe even the studios themselves. Sony (NYSE:SNE) at the very least has some incentive for creating a usable downloading solution to go with its imminent PlayStation 3 console, which is highly capable of high-definition display and high-bandwidth networking.

I'd be shocked if Blockbuster rates anywhere near the top in that sweepstakes. Its copycat effort to mimic the direct-mail success of Netflix has been anemic, and lacks the usability and customer focus that makes Netflix such a joy to behold. Blockbuster just doesn't get it. And that will be its downfall. Hail to the victor, and cheers on a battle well fought.

The End?

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Fool contributor Anders "Orange Mocha Frappuccino" Bylund is a Netflix subscriber and shareholder but holds no other position in any of the companies discussed here. You can check out Anders' holdings if you like.

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