Financial Statement Analysis of Blockbuster and Netflix

Financial Statement Analysis of Blockbuster and Netflix

Introduction

In this memorandum, I will analyze the competitive environment that Blockbuster and Netflix face. In addition, I will identify the key income statement and balance sheet accounts for both companies using their vertical statements. Lastly, I will use ratios to assess and compare the liquidity, solvency, profitability and efficiency of the two companies.

Competitive Environment

Blockbuster is a chain of VHS, DVD and video game rental stores. It mainly sells new and used DVDs and video games. In 2004, it launched its online rental services to compete with market rivals such as Netflix. Blockbuster's headquarters is in Dallas, Texas but it has 7400 retail stores in 21 countries. Before 2004, Blockbuster's competitive strategy focused on retail ventures to increase in-store traffic. For instance, it used the "store-within-a-store" concept that put Radio Shack kiosks inside Blockbuster stores. However, as the rise of online rental service providers such as Netflix greatly reduced Blockbuster's market share, Blockbuster also established its online rental services to adapt to the shift in demand. One risk that Blockbuster faced was the huge drop in DVD prices in the past decade, which led to the increasing trend of customers buying DVDs rather than renting them. Another risk was its high advertising costs because these expenses are not strongly correlated with sales revenue generation. In fact, its no late fee initiative resulted in a costly buildup of inventory, which is another risk factor. In addition, Blockbuster's massive infrastructure adds to its risks because it is unable to react swiftly to the rapidly changing technological environment to stay ahead of its competitors. However, its success lies in the fact that it is a well-known brand and it has relationships with movie studios that rely on it as a major distribution channel and source of revenue.

Netflix is a subscription-based movie and television show rental service that offers media to subscribers via Internet streaming and via US mail. Netflix does not have any retail stores and mainly operates via the Internet to cater to the US market. Its strategy involves personalizing customers' online rental experience to create customer loyalty. To achieve this, it used customers' rental history to develop a movie recommendation system. Its competitors consist of traditional brick-and-mortar rental stores such as Blockbuster and other online rental stores such as Wal-Mart. Nonetheless, it is successful because it adopted a low cost, online DVD rental model that is popular in this technological age where movies can be downloaded online. It also has a patent to protect its business model from potential imitators. However, one of the risks Netflix faces is the significant loss of "late fee" revenue that could be used to improve or expand its business. Another risk could stem from the marketing efforts of its collaborations with other companies such as Sony and Nintendo because these costs could go to waste if the collaborations are not successful.

Key Income Statement Accounts

Sustaining rental revenue is one of the critical risks of Blockbuster thus rental revenue is a key income statement account. The vertical analysis reveals that rental revenue is 61% of total sales in 2008. The impairment of goodwill account for Blockbuster is also important because it may overshadow any improvements in sales or reduction of expenses if the number is too large, as shown in 2004, where it was 25% of total operating expenses and it resulted in a net loss.

On the other hand, Netflix's marketing account is a key account because marketing costs is one of its critical risk factors. Furthermore, vertical analysis reveals that it constitutes about 20% of total operating expense. Similarly, Netflix's subscription cost account is also important because it helps people analyze the expenses that the company incur to generate its revenue. In addition, it represents more than half (56%) of total sales.

Key Balance Sheet Accounts

Maintaining inventory levels is one of the risk factors of Blockbuster thus rental library is a key balance sheet account. Furthermore, inventory represents 17% of total assets in 2008. Another key account is the property and equipment account because Blockbuster operates