The market reacted with surprise today when it emerged that Blockbuster has offered about $1 billion to purchase electronics retailer Circuit City. The potential deal threatens to distract both companies from the unenviable task of wrestling with disruptive forces affecting their respective core business models.
Over the past few years, online video rental pioneer Netflix has used its no-late-fees model to pummel Blockbuster. After dragging its heels for a few years, Blockbuster started fighting back in 2004. It now has a reasonable share of the online market but has never figured out how to be as profitable as Netflix. And Netflix is moving on to the next act--developing a strategy to win in the video on demand market.
Circuit City has had to contend with Best Buy, whose larger stores and lower prices have allowed it to dominate the electronics retailing market. Circuit City is also trying to play catch up in the emerging market for services to small businesses and individual consumers, where its Firedog service trails Best Buy's Geek Squad service.
Behind Blockbuster's bid is a bold plan to expand its retail footprint and transition its business from video retailing to become in the words of CEO James Keyes a "one-stop shop with solutions for the consumers." Keyes said the combined entity could model itself after Apple's popular stores. Consumers could rent videos from Circuit City locations, or buy hardware from Blockbuster locations.
Combining Blockbuster and Circuit City seems like a pretty bad idea to me (Circuit City doesn't seem to be convinced either--the company is refusing to give Blockbuster access to its books). Each company has distinct strategic issues to address. A merger could very well distract them from the task at hand at the exact worst time.
When disruption strikes an industry, market incumbents can use acquisition as a strategic way to remove increasingly redundant capacity from a market. For example, Arcelor Mittal has become a powerhouse by acquiring integrated mills that struggled to respond to the disruption of steel minimills. Mittal has become a giant by acquiring assets cheaply and taking advantage of massive scale economies.
The combination of Blockbuster and Circuit City would be a different beast. A reasonable analogy could be the combination a couple of years ago of K-Mart and Sears. Like Circuit City, K-Mart had decisively lost the discount retailing battle to Wal-Mart and Target. Like Blockbuster, Sears was sagging under the pressure of disruptive attackers like Wal-Mart and Amazon.com.
Eddie Lampert, the investing wizard who fashioned the Sears/K-Mart deal and is the Chairman of the reconstituted Sears Holdings, has seen the business continue to spiral downwards over the past few years.
Unless there's a non-obvious way to combine Blockbuster's and Circuit City's assets to create a new growth business, a merger could serve as a way to hasten the demise of two former high-flyers.
This post first appeared on Harvard Business Online.
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