COMPANY TOWN : Nearly a Blockbuster : Music Retailing Still Poses a Big Problem for the Video Chain

Rewind the story of Blockbuster Entertainment by a little more than a year, and here’s what you see: a company generating more cash than it knows what to do with, spending a lot of it dabbling in Hollywood but lacking a long-term diversification plan and hesitating to use the clout accumulated in climbing to the top of the video rental industry.

But with its $7-billion marriage to Viacom Inc. now more than a year old, all of that has changed. Spelling Entertainment, Blockbuster’s stepping stone into Hollywood, is on the block, and about 20 to 30 potential buyers are looking over the books. Pumping money into video stores is again the priority--especially in foreign markets, where Viacom has reversed a gun-shy attitude about the global market that Blockbuster acquired when an earlier foray failed.

Viacom published its quarterly numbers earlier this week, and two things are clear about Blockbuster. First, it still hasn’t figured out music retailing, a dismal industry that is being killed by price-slashing compact disc sellers such as Best Buy, Circuit City, Wal-Mart and Target. Cash flow in the third quarter for its Blockbuster Music stores dropped from an already anemic $5.9 million on $118.5 million in sales to just $3.3 million on sales of $125.8 million.

Second, those blue-and-gold video stores continue to generate tons of cash, which is what Viacom wanted out of 10-year-old Blockbuster in the first place. Despite a lack of exciting video titles this summer and a slowdown in the video game rental business, cash flow from the stores soared 26% in the quarter to $191.9 million on sales of $615.4 million. Viacom’s $10-billion acquisition of Paramount--made possible in part by Blockbuster’s cash--has relieved the video chain of the pressure to diversify into production and other areas, so it is now focusing again on its retail operations.

What the numbers don’t say is that Blockbuster also is quietly blossoming into the kind of 800-pound gorilla it always had the potential to become. As a company with 4,300 stores that it says puts it “within a 10-minute drive of virtually every major neighborhood in the United States,” Blockbuster wasn’t exactly a wallflower. But it was careful not to alienate Hollywood studios by using its clout too much, because it needed their products to thrive.

Now the Ft. Lauderdale, Fla.-based company doesn’t hesitate to remind entertainment companies that Blockbuster, in video and music sales combined, is their biggest single customer. Blockbuster Chief Executive Steven Berrard has been shocking music executives by suggesting that they help the company battle the discount CD sellers, many of whom chop prices to below $10 as a way to lure customers into their stores to buy other things.

Berrard readily admits he’s expressed his concerns to the industry, saying that selling hit CDs cheaply at some stores ultimately creates an expectation among music buyers that all CDs should be priced that way.

“If you pay $9.99 for Hootie & the Blowfish, it’s going to be hard for you to pay $13.99 for Peter, Paul & Mary. Those catalogue sales are the stuff the companies have lived off for so long,” Berrard said.

Music executives, however, are baffled at the attempt to enlist them in the fight.

“We can’t control what a retailer does. They are looking at us to come up with a remedy to their inability to compete in the marketplace,” a music executive said.

Similarly, Blockbuster today is also pushing harder to extract more favorable terms from studios, with revised price structures that are linked to how much studios spend marketing particular titles. In particular, Blockbuster doesn’t like paying the same $55 price for a box office turkey such as “Cabin Boy” that it does for “True Lies” or other hits.

“It’s not like Blockbuster hasn’t done this before,” said an entertainment executive who knows the company well, “but the intensity has certainly increased.”

Berrard denies that Blockbuster is suddenly being heavy-handed, but it’s clear he doesn’t hesitate to remind people about Blockbuster’s importance.

“I don’t think it’s so much us throwing our weight around,” Berrard said, “but we are good customers and like to be treated as such.”

Some Hollywood executives are skeptical that Blockbuster will maintain an arms-length relationship with sister company Paramount Pictures. Those suspicions weren’t helped by comments Berrard made shortly after the merger, suggesting that Blockbuster stores could give better display to Paramount videos--comments he has since backed away from.

“It’s a 100% arms-length relationship,” Berrard insisted.

Viacom Chief Executive Frank J. Biondi Jr. also discounts talk that Paramount may get favorable treatment from Blockbuster: “I see it as a lot of paranoia,” he said.

Berrard, 41, is an accountant by training who served a long apprenticeship under H. Wayne Huizenga, the Florida businessman who built Blockbuster. Since taking over the operations from Huizenga, who remains a Viacom vice chairman but is expected to leave the company eventually, Berrard has taken a tougher approach to the business, revamping much of the company and its executive ranks in an effort to match the high expectations of Viacom Chairman Sumner Redstone and Biondi.

One area of concern has been Blockbuster’s investment in Discovery Zone, an indoor kids’ play area, which has been plagued by losses and bad management. Blockbuster is now taking a hands-on role in running the operation, and Berrard believes it has a lot of potential, since 30 million children and their parents visit a Discovery Zone annually.

But fixing the problems in music is clearly Berrard’s top priority. He denies speculation that Blockbuster may abandon music retailing by selling its stores, or even taking on a partner. He says internal problems--the company had major distribution snafus and made a number of missteps in buying records--are being fixed.

For now, Redstone and Biondi are giving Berrard the free hand and time he needs to fix the music problems.

“Steve and his managers still believe they can make it work. It is very much a work in progress,” Biondi said.

Then there’s the question of whether video rental stores have a future in the face of emerging technologies that could provide homes with video on demand. Both Berrard and Biondi consider the technology to be the subject of much hype, and are buoyed that phone companies and others are scaling back some of their ambitious video distribution plans. Still, Berrard said, Blockbuster will adapt, possibly providing a Blockbuster video-on-demand channel.

“We’ll be a chameleon when it’s time to change colors,” he said.

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Growing Market

The home video market has grown rapidly, but may face threats from new technologies. Consumer home video spending, in billions:

1995: $15.2

Source: Blockbuster