Netflix and Blockbuster

When one talks about home movies, two companies come into mind. There is Netflix, Inc., which provides online movie rental subscription services. The other one is Blockbuster Inc., which offers in-home movie and game entertainment.

While Blockbuster had the initial advantage of being established in 1985, it was quickly overtaken by when Netflix entered the scene in 1999. Unlike Blockbuster where you had to go to a store to rent movies, Netflix instead opted to offer the same services online. Aside from having customers borrow movies online, Netflix also used a system wherein they charged a regular monthly fee to renters. In doing so, the problem of customers paying additional fees as a result of returning rented movies late was removed. Blockbuster had no choice but to implement the same strategy of not making customers pay late fees. Despite this, Blockbuster still lagged behind Netflix and in 2004, started its own online retail system.

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The competition between Netflix and Blockbuster was beneficial to customers since it enabled people to have choices. However, for the two companies involved, it became a different matter entirely. On April 5, 2006, Netflix filed a lawsuit against Blockbuster with the U.S. District Court for Northern District of California. Netflix alleged that Blockbuster infringed on patents that it owned, specifically U.S. Patent Nos. 7,024,381 and 6,584,450. The lawsuit sought a preliminary or permanent injunction enjoining Blockbuster from any further acts of infringement of the two patents. Further, the suit sought unspecified compensatory damages, reasonable costs and expenses, and such other relief as the court deems proper.

According to the United States Patent and Trademark office, patent ‘450 was filed by Netflix on April 28, 2000 and titled “Method and apparatus for renting items.” Patent ‘450 in essence is a computer-controlled method wherein the customers get to choose what movies to rent and how the movies chosen are delivered. This patent was eventually issued on June 24, 2003.

Patent ‘381 on the other is titled “Approach for renting items to customers,” and was filed on May 14, 2003. Unlike patent ‘450, this patent was more specific when it came to the process of renting movies. This patent covered the method wherein Netflix would use ranked preferences in the list of movies to send to customers. Furthermore, this computer-implemented method also allows the customer to update the list. The ‘381 patent was issued on April 4, 2006.

In response to the lawsuit, Blockbuster filed a reply on June 13, 2006. In its reply, Blockbuster said that while it admitted that Netflix was the assignee to the two patents, it believed that Netflix did not have sole and exclusive ownership of the said patents. Blockbuster denied the allegations claimed by Netflix and said that the patents asserted was actually existing technology that was not only widely known but also generally used. The patents, Blockbuster claimed, were not actually new technology but instead just described how existing technology can be used in the business of renting movies to customers.

Aside from denying the allegations of Netflix, Blockbuster further said that Netflix failed its duty of candor to the patent office. Under this provision, Netflix was legally bound to disclose and inform the Patent Office of previous patents, as well as business methods of other companies. Netflix however did not do. Blockbuster also questioned the timing of the lawsuit since it appeared that it was filed mere hours after patent ‘381 was approved. Blockbuster said that it only learned of the existence of the said patent when it was approved and issued on April 4, 2006.

Blockbuster went one step further and filed a counterclaim claiming that Netflix violated Section 2 of the Sherman Antitrust Act. By procuring either or both of the patents, Netflix was engaged in monopolization. With the lawsuit and the counterclaims, one would have expected the case to be a long one. However on April 30, 2007, Blockbuster decided not to pursue its antitrust counterclaim against Netflix but continued to contend that failure of Netflix to make the proper disclosures made its patents unenforceable.

Two months later, on June 25, 2007, Blockbuster and Netflix entered into a settlement agreement. On June 26, 2007, Judge William H. Alsup dismissed the case with prejudice without the terms of the settlement being disclosed. One curious note is that in a regulatory filing by Netflix, specifically its Annual Report for the Year-Ended December 2007, Netflix said that during the second quarter of 2007, it received a one-time payment of $7 million from Blockbuster as part of a settlement agreement. Blockbuster for its part said that the settlement did not materially affect its operations. Another observation is that while it may or may not be connected to the settlement, it is also crucial to know that after entering into a settlement agreement with Netflix, Blockbuster said that modified its Total Access service. Blockbuster’s Total Access service is a system that enables customers to order videos online.

Prior to settling with Blockbuster, it is important to note that on Jan. 31, 2007, a putative class action against Netflix was filed by Dennis Dilbeck. In his complaint, Dilbeck alleged that by filing the lawsuit against Blockbuster, Netflix violated antitrust and unfair competition laws. Like Blockbuster’s counterclaim, Dilbeck also cited the way Netflix failed to disclose proper information to the Patent Office. Two other consumer class action suits were also filed after Dilbeck’s. The three suits were consolidated and were eventually dismissed on October 22, 2007.

The battle of the two companies over the patents and its eventual settlement raised a concern for some sectors. Aside from the disclosure the Netflix made, no one knows what other provisions are included in it. News reports on the settlement said that even the judge in charge of the case refused to oversee the settlement since even he was not allowed to see the terms.

The question that still remains is that why did the two companies agree to settle? Clearly, Blockbuster had a point in its defense. Netflix already had the lead when it came to online rentals of home movies. It is obvious from the way the lawsuit was timed that Netflix intended to gain the advantage over Blockbuster in the best way possible. The possibility that Netflix was aiming for a monopoly in online retail was seen not only by Blockbuster but even by consumers. Aside from allegations that Netflix violated antitrust and unfair competition laws, the Dilbeck class action suit also alleged that subscribers were paying artificially inflated subscription prices as a result of the patents.

From the way the arguments and counter arguments were presented, it was clear that Blockbuster had a chance of winning the case. As mentioned earlier, Netflix filed the ‘381 patent May 14, 2003, a few weeks before the ‘450 patent was issued which was on June 24.During this time up to the date of the lawsuit, Netflix not only took no move to enforce the ‘450 patent but also did not divulge that patent ‘381 was pending. This alone made Blockbuster’s defense more reliable.

So to ask the question again, why did Blockbuster agree to a settlement? One reason could be financials. With the entry of Netflix, Blockbuster was already having problems and a protracted litigation could have been bad for Blockbuster.

On the other hand, what benefit could Netflix have in going for a settlement? While Netflix received a sum from Blockbuster, it was a measly amount compared to what the company has. Regulatory filings show that for the year ended 2007, Netflix reported net income of $66 million. Blockbuster meanwhile experienced an $86 million net loss for the fiscal year ended January 6, 2008. Netflix probably agreed to settle in order to prevent more lawsuits against it from coming to light. Blockbuster is arguably the largest competitor of Netflix. If Blockbuster, a home movie retail giant, was unable to pursue a case against Netflix, then what chance would a small retailer have? If we assume that the modification Blockbuster made on its Total Access service was part of the settlement, then again Netflix gained an advantage. By modifying it, it is possible that the subscription price for Blockbuster could go up. Blockbuster however said that through the modification, it managed to decrease the number of unprofitable subscribers who availed the Total Access service.

If it had continued with its counterclaim, Blockbuster could have won the case. But with agreeing to the settlement, Netflix managed to gain an advantage over its rival. Blockbuster should have continued the fight as it stood to gain a lot if it won. Nevertheless, with the lawsuit out of the way, the competition on who will reign supreme in the online retail market between these two companies has once again started. Though Blockbuster has managed to gain a number of customers, it is still a long way off from overtaking Netflix. With Blockbuster becoming involved in the online retail market, chances are not all the money will go to Netflix.

Still, with the terms of the settlement not being made public, it remains to be seen if the competition between these two companies is real or not. In the latest Internet Retailer Top 500 Guide, Netflix was ranked at 18 while Blockbuster stood at 51.

For now, consumers will just have to put faith in the idea that the rivalry between these two companies is real. If indeed there is something amiss with the settlement, then consumers will just have to do what has always been their power to do. Choose another retailer.

References

 “Netflix, Inc. v. Blockbuster, Inc.” Justia.com. 18 April 2008. < http://dockets.justia.com/docket/court-candce/case_no-3:2006cv02361/case_id-178629/>

“NETFLIX INC.” U.S. Securities and Exchange Commission. 18 April 2008. < http://www.sec.gov/Archives/edgar/data/1065280/000119312508040378/d10k.htm>

“BLOCKBUSTER INC.” U.S. Securities and Exchange Commission. 18 April 2008. < http://www.sec.gov/Archives/edgar/data/1085734/000119312508048757/d10k.htm>

“United States Patent 7,024,381.” United States Patent and Trademark Office. 18 April 2008. < http://patft.uspto.gov/netacgi/nph-Parser?Sect1=PTO2&Sect2=HITOFF&p=1&u=%2Fnetahtml%2FPTO%2Fsearch-bool.html&r=2&f=G&l=50&co1=AND&d=PTXT&s1=7,024,381&OS=7,024,381&RS=7,024,381>

“United States Patent 6,584,450.” United States Patent and Trademark Office. 18 April 2008. < http://patft.uspto.gov/netacgi/nph-Parser?Sect1=PTO2&Sect2=HITOFF&p=1&u=%2Fnetahtml%2FPTO%2Fsearch-bool.html&r=3&f=G&l=50&co1=AND&d=PTXT&s1=6,584,450&OS=6,584,450&RS=6,584,450>

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