It has not been a great year for Blockbuster (BBI). The movie rental company may have to close 1,000 stories. To offset the drop in its bricks-and-mortar operation, it does have a system for ordering DVDs over the internet. But “Total Access,” as the program is known, only has 1.6 million subscribers. Netflix (NFLX), the dominant company in this part of the video distribution business, has over 9.4 million subscribers.

Blockbuster has explored other ways to build its business, as consumers move away from renting premium entertainment from stores. The first is to go into the movie rental kiosk business, which has been successful for Redbox. Redbox operates automated kiosks that allow consumers to rent movies at the rock-bottom price of $1 per night.

Blockbuster has made a start in the kiosk business with about 500 units. Redbox has 15,000. Blockbuster may be able to improve the size of this business, but the odds are very high that Redbox has such a big head start, Blockbuster won’t be able to catch up.

Blockbuster has also added a movie download business to its product mix. Through this online service, consumers can rent or buy movies. Either way, the movies are then downloaded to a PC.

But again, Blockbuster is late to the game. Its system is primitive compared Roku, the Netflix set-top box for streaming videos to a television screen. The Netflix product offers 17,000 premium films and TV shows and does not require that the consumer watch the movie on a PC.

The Netflix set-top competes with Video on Demand (VOD) from cable companies and fiber-based telecom services like Verizon FiOS. It has the ability to offer the consumer a one-stop option for getting a movie to the TV instantly. Blockbuster does not.

Blockbuster Late to the Party

It’s not that Blockbuster hasn’t kept pace with the changing nature of at-home movie viewing. The company has a toe in each major delivery system for premium video content, with the exception of owning a chain of theaters.

But Blockbuster’s problem is that it has been late to adopt each of the new models and has been flanked by competitors that staked out their positions early in the age of broadband-delivered digital content. And ironically, in the case of Redbox, Blockbuster was too late getting into a primitive and inexpensive way to distribute DVDs.

The stores Blockbuster plans to close represent only 20% of its total outlets. That leaves the question of what it does with the nearly 4,000 locations it will have left. How long will they last? Each of these stores has employees. Each has rent. The company will continue to have trouble getting out of long-term leases, and its balance sheet obligations will continue to weigh on the firm.

Netflix is a reasonable example of a company that has taken the option of evolving in the hope of continuing to have a reasonable position in the industry.

The Netflix DVD rental business may be the largest in the industry, but it is still up against a relentless movement on the part of the consumer to download or stream feature content to TVs, portable devices like the Apple iPod, and smart phone handsets. That field is now remarkably crowded, with competitors ranging from e-commerce operations like Amazon (AMZN), which have millions of customers, to the traditional cable companies. Netflix will need to expand its Roku business rapidly if it wants any chance of being a significant part of the digital broadband delivery future.

Like Blockbuster, Netflix has the problem of having a legacy business, DVD rentals through the mail, which still contributes most of its revenue. Its cost structure is based on that system. It has not made any move to become a largely virtual company, which sends content over the internet from inexpensive servers that need very few people to operate. Netflix still has over 1,500 workers and significant physical delivery systems to support.

Wall Street continues to love the Netflix, which trades near its $50 52-week high. But the fact of the matter is that it will have to go through a transformation to remain competitive with digital video on demand. Its prospects are based on whether it can time that move correctly and execute the transformation flawlessly. If not, Netflix will find itself in a position not unlike Blockbuster’s five years down the road.

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