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Tickers in this Article: BBI, NFLX, AMZN
When looking at the comparative chart between Blockbuster (BBI) and Netflix (NFLX), it is clear to see that these are two companies headed in opposite directions. Over the last year, shares of Blockbuster have been hit hard losing half their value, while Netflix shares have doubled over the same period.

It is not bold to suggest that Blockbuster is now operating in tough times, especially after four straight quarters of revenue decline. Not to mention the combined $500 million they have lost over this time period.

The fact of the matter is that the video rental industry has clearly changed as consumers are shifting more and more towards online renting in favor of the traditional brick-and-mortar renting -- a trend which Blockbuster clearly underestimated.

Since its operations began in 1999, Netflix has seen its subscription base grow from nothing to an estimated 5.5 million and is the clear leader in online renting. And as you can imagine, significant revenue growth has come with these subscribers.

The company has seen its revenue grow at an annualized rate of 55% from $75 million in 2001 to $683 million in 2005, and has done so profitably for the last three years.

Blockbuster after seeing this significant growth at Netflix, while its sales remained stagnant growing at an annualized rate of 2.6%, decided it was time to enter the online market. In August 2004, the company launched Blockbuster Online, a service that is almost the carbon copy of Netflix, which has resulted in a patent infringement lawsuit from Netflix. Blockbuster's online service has seen success as it now has 1.3 million customers. But it has been growing at a slower rate with only 100,000 new subscribers in Q1 compared to the nearly 700,000 Netflix added over the same period.

This does not mean that Blockbuster is at its end and will lose its leadership position in the industry. While the road ahead is a difficult one for Blockbuster, and requires management's focus on cost cutting, such as the continued reduction of its store count, it is still the major force in the industry. Blockbuster still has every chance to compete against Netflix in the online market place and be a very strong competitor.

However, looking at the economics of the industry it might just be best to avoid an investment in either. Two major concerns standout for me and should for anyone looking to invest in either company.

The first concern is the almost certain increase in competition. It is the classic situation in which success breed's competition, and Netflix has been very successful. Online retailers such as Amazon (AMZN) have long been rumored to be a potential entrant into the market, along with other smaller start-ups. And while Netflix has a dominating share of the online market, with low switching costs for consumers, there is little they can do to protect this share without destroying margins.


The other concern lies further in the future dealing with a potentially destructive technology changes that could make Netflix and Blockbuster obsolete, at least their current business models. The advancements of broadband, allowing a greater amount of data to transfer at a faster rate, will only lead to a situation in which we no longer use discs to watch movies. How long will it be before cable companies and movie studios get together to deliver movies straight to our home entertainment centers? This is a question in which Blockbuster, Netflix and their investors should carefully consider.

There may still be some more room for Netflix shares to go higher, but with it trading at 54 times consensus 2006 earnings it seems that all of the most optimistic growth projections are already priced into this stock. And as was mentioned before the present situation at Blockbuster is not looking good. So I would suggest one think long and hard before investing in either company.

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