For some time we have been hearing about the woes of the US consumer electronics high street chain Circuit City. Now it has decided that a full liquidation is the best that it can hope for.
There are a number of reasons for this, some incidental and some classic to our chosen subject matter, the transition from analog markets to full blown digital markets in entertainment technology.
On the incidental front Blockbuster, a classic bricks and mortar interim answer to digitization, thought it might extend its retail reach by buying Circuit City but pulled out. This would allow it to either reach more customers, with a flawed DVD lending business, or move its businesses into slightly more profitable areas, cheaply, by harnessing the captive real estate of Circuit City. Had it bought the business, it would be bankrupt itself now and spinning its own original business out of the mess this made. So luckily it decided to pull out of the deal.
We call Blockbuster an interim business because it was only ever viable for as long as people were happy to pay late fees on a piece of precious technology ‘ the DVD. It was first hit by the slight improvement from Netflix, which did away with the late fees, and opened up the concept to much broader content choices. In turn the Netflix idea is only viable for as long as it is difficult to download films, which itself would only be worthwhile until it is cheap to stream films, which finally give the ingredients of instant choice alongside instant gratification. Most of these other models have a delay in either the choice or the opportunity to enjoy the entertainment.
Blockbuster really had a natural 15 year life span and its business model’s time has come and gone. It’s management, instead of guessing what was coming next, needed to apply the Faultline concept, the idea that entertainment markets are shifting to another fault, and a radical re-adjustment in thinking is what is required to take the same need and supply it differently in a digital world. Rented retail leases are an encumbrance, and as much as Blockbuster has tried to use these as an advantage, it has led to yet another short term interim fix. In the light of that, buying another large retail operation would have been clearly and obviously terminal, and a case of doing the ‘knee jerk’ thing. Executives may have asked ‘what is it we have done to build business in the past?’ and they would have answered themselves ‘ ‘we have broadened our retail platform,’ which in this case would have been ruinous. In the Faultline the knee jerk reaction is never the right one.
Throughout technology development, and especially during the past 30 years, it has always been best to ‘eat your children’ as we call it in the business, which is to develop new businesses which will undermine your old and existing business, before someone else does. Culturally this is almost impossible, because the ‘big’ products in an old business, those which have been responsible for the most revenue in the past, are run by the more trusted people in the organization. If you give someone else in a company the power to undermine this strong business, then internally they become pariahs, and are in turn personally undermined by those who are deemed most trusted.
Take a company like Sony. The strong players would be the people who ran the electronics business, because it was a $40 billion business, so eventually they will undermine the games area, and the entertainment area, and they would have cut off the lines of supply to new business areas like the Connect music service, because it wasn’t to their benefit.
The inevitable always happens, at some point the company is doing badly and the board kicks out the old boss and promotes someone, and that promotion is usually from the biggest division. Their job is to drive the entire business (not the case in Sony as it happens). From that moment on, this new trusted leader drives the company unerringly in the wrong direction, doing the things that have worked in the past, but doing them harder and faster, and taking the company towards oblivion.
What is always needed in order to set up new businesses which will eventually undermine the old established order, is to put them at arms length, with separate management drawn from outside the company. Then when the friction begins no-one from the old order holds sway over the new order.
So when Netflix embraced online film downloads and streams, it appeared to undermine the old order of online DVD rental which was its own personal revolution. But the fact that it took three years to come to market with these offerings, and that they are bundled into the company’s existing service, means that it has not taken this advice, and instead has used the new online service to bolster and retain its old business. So in the same way that Netflix proved poison to any company that had to sustain an enormous number of retail real estate properties, so too will a pure online service (such as Amazon or iTunes) undermine Netflix, which has to offer online but uses it only to sustain an existing inventory of millions of new DVDs.
What happens when content is made for online consumption, as it increasingly is, how does Netflix continue to confuse the issue between its two services ‘ physical DVDs and digital streams ‘ when a rival simplifies both the cost, delivery and proposition. The answer is that if it had two sets of management, pushing two sets of services, one side of the business would wax and the other would wane in step with the market. But now it won’t. So the Netflix bundle approach is flawed, although we totally understand why it is so structured. If Reed Hastings, Netflix CEO, continues to have his wits about him, he might avoid this being a problem, by separating out the services at a point in the future, but culturally he will be swimming upstream and this may reduce his reaction time, and sink the company.
How did Apple manage to grow its entertainment business in the shadow of its old PC business? Well there are a few strands to the answer. It had invested in software that supported the entertainment industries for some time, so had a basis for understanding its needs. But the most important point was that an extraordinary CEO, with clear vision, can create digital devices and services alongside an older moribund business, by the pure power of his personality, by bold strokes which involve crushing internal opposition to what were unpromising projects like the iPod and iTunes Music Store. He must do this either by brooking no discussion about overlaps with the PC business, or by getting buy-in company wide behind an exceptional vision. That’s not something the average public company can rely on, and it’s best not to try to be Apple.
So what has all this to do with Circuit City? Circuit City’s business was also an interim business. In the 1980s, in middle class American and European extended households, you could find lots and lot of devices. A TV set, a second set, a set top, a stereo. As we have traveled through the 1990s into the 21st century that household may have added a games console, telephones, portable gaming devices, GPS mapping systems, portable music players, portable TV sets, portable DVD players, headphones, electronic books and picture frames, DVRs, cellular handsets, PCs, laptops and netbooks and the odd Blackberry or two, a DSL or Cable modem and some source of Wi-Fi.
The proliferation of devices leads to the proliferation of device choice, which in turn leads to the need to go and see each device and seek the advice of an expert, and to try it hands on. That is what led to the idea that Circuit City would be a good thing. The continued proliferation of technologies means that each of these areas not only offers brand choices, but also many individual choices and prices levels within each brand.
CRT TVs give way to rear projection, give way to Plasma, to LCD and then to super flat LCDs and finally to OLED screens of scintillating clarity. When they are all on the market, and visible in every brand, there is a proliferation of device types and differentiation and price points. Underneath all of this there are wars about formats, DRM and software, which are fought within the CE brands, but also within the general purpose technology areas such as PCs and cellular handsets. Form factors are also toyed with and fashion plays a hand. Content fragments and becomes initially a basis for differentiation, and finally even that goes.
The reasons for going and seeing devices, and trying them begins to fall into the background, and instead an homogenization of software layers comes through standards, and a quality expectation forms for each technology type and prices fall on technologies which are favorites and the whole devices area becomes less interesting. In different markets we are at different stages here.
Taking the wider view and looking longer term, we will see the death of devices. Think how many devices the PC replaced as it became the de facto desktop device in use, it ousted the word processor, the calculating machine, the accounting machine, the inventory management system, the photo album and is well on its way to replacing the diary, the personal TV set and countless others. The handset automatically takes on the same role with the added word portable and the TV set takes on the same role for large scale shared viewing. This proliferation of function, this software driven capability is only possible once all services are digital.
Look at an older consumer industry, the one for domestic vehicles. Just go back to the number of cars there are on the road and the amount of profit car companies are making? Garages still make money fixing cars, but the companies that make cars only make money when they have clear and strong brands and make only a handful of designs. The rest is about logistics chains and pricing.
The consumer electronics industry is going down the same route. As a device becomes a piece of software running on a general purpose device, why would you go and see it at a retail store. Why wouldn’t you simple download it. And that’s the Faultline effect all over. Who ever thought that devices per se would become downloadable, but gradually their characteristics are going that way. Companies which make one or two devices types, under the same simple clear brand, which is configurable to be whatever you want it to be, will the future winners. Stores cannot help that process and CE stores will evaporate.
It’s all very well knowing this, but know when this all becomes a reality is much tougher, and for that companies like Circuit City have our sympathy. If it had not been for this recession, as a business entity it might have had a longer life and the opportunity to change into something else for the sake of its shareholders. But the recession simply accelerates the market forces that have already come into play.
What it brings into question is the effect of the internet on retailing. We have always said, even through the dotcom years that the internet was ‘under hyped’ and that it would prove to be bigger and more than we all thought it was at first sight. During dotcom everyone thought retailers would all die and then when they realized that although this might be true, it could be a 30 to 40 year proposition, the excitement went out of the web business. But Amazon and its ilk have been sustained and have continued to build.
But as this affect reaches more and more retail areas, what will happen to retail rents everywhere? Today we may continue to go to the store to buy food, furniture and other physical ‘atom’ based products. We only do this because it is more convenient and quicker than ordering it online and that may not always remain true. The ‘go and fetch’ business model is fine for now for those products, though it isn’t set in stone.
But going and fetching at a time when any given device does more, stores more, and is more connected, has lost and will continue to further lose, its appeal.
The device is not dead, but it is wounded, and as the Faultline unravels, it becomes a set of best of breed visual and control interfaces and a specific size format, and numerous pieces of software, and service provision. So long term the device is dying, and that means device shops were on borrowed time.
If we can leave you to reflect on what that does to retail premises everywhere. As there is less retail desire in devices, the slack will be taken up by other services, but as people are busier and less prepared to take time out of their day to ‘go and fetch’ the internet as a retail market becomes stronger and stronger and business property values not only fall, but plummet. Retail properties will slide off to other uses, as piers and river warehouses were converted to modern city living during the 80s and 90s, so might shopping malls.
As for Circuit City, it will liquidate its assets because no-one wanted to buy it. Dumping 30,000 employees onto the street, and offering up 567 stores for others uses, and rivals will be hurt by seeing all that liquidation priced inventory on the streets.
And as companies like Best-Buy do the predictable thing and buy the best placed leases from the liquidator, the underlying themes of digitization will be ignored for the time being. But not forever.