Familiarity Bias and the Cautionary Tale of the Blockbuster Video
Sometimes the thing with which we are most comfortable present the greatest risk
By: Philip O'Toole
How Netflix Disrupted Blockbuster into Bankruptcy
It is October 1, 1999. My wife (then girlfriend) and I are engaged in a favorite Friday night pastime of running up to Blockbuster Video to get our hands on one of the hottest VHS rentals that week, The Matrix starring Keanu Reeves and Laurence Fishburne. However, Blockbuster is so packed that we feared we might have to settle for Big Daddy starring Adam Sandler (which we loved by the way) instead.
Little did we know that on that very same day, entrepreneurs Marc Randolph and Reed Hastings were trying to take advantage of this newfangled DVD technology and were slowly building their new movie rental by mail venture called Netflix. The legend is that Hastings, disgruntled over $40 in late fees on an overdue copy of Apollo 13, came up with the idea of creating a convenient movie rental service with NO LATE FEES. The two biggest questions they had to answer at the time were:
- Can these new DVD’s be shipped safely through the US mail?
- If so, will consumers sign up on Netflix.com and forever change the way they rent their movies?
Today it is easy to look back and say, “of course Netflix displaced Blockbuster”. In hindsight, it seems inevitable, however, at the time growth was initially slow when the website first launched in 1998. The biggest early move perhaps was when Netflix switched from a per rental to a monthly subscription model in 1999. By 2000, they had 300,000 subscribers in a country of 300 million and would reach 1 million subscribers in 2001. Although Blockbuster was aware of this new startup, they delayed reacting, and in arguably one of the greatest business missteps of the 21st Century, they refused an opportunity to acquire Netflix for a $50 million asking price in 2000.
From 2003 to 2005, Blockbuster would lose half of its value. By 2010, Blockbuster was forced into bankruptcy. Shortly thereafter, the first Blockbuster stores began closing. Mass closings began in earnest after Dish Network acquired the brand, and by 2014, the final corporate-owned locations were closed. Today, Netflix has around 325 million subscribers globally, and a market capitalization over $300 Billion, while BB Liquidating Inc, formerly Blockbuster Inc, has zero subscribers and a market capitalization under $3 million.
This is a cautionary tale about a business and a brand with which millions were intimately familiar and comfortable. In October 1999, could we have known that one of our favorite Friday night rituals would be disrupted forever? How can an unknown company with no stores using only technology and the US mail (at least initially) displace one of the most popular brands with over 9,000 bricks and mortar locations globally?
And it didn’t stop there. Netflix continues to disrupt other industries, including Sports and Hollywood. Many of us probably watched Major League Baseball’s Homerun Derby on Netflix earlier this month, previously a long-time staple of the “World-wide Leader”, ESPN. We may have also noticed that Netflix is showing up increasingly more at The Oscar and Emmy Awards shows. The point is that sometimes the things we know best, the things that are most comfortable are the things in our lives that are most at risk. Blockbuster video is a story of familiarity bias blinding us to a risk that was right in front of our face the whole time.
Familiarity Bias and the Risk of What is Most Comfortable
My introduction to Behavioral Finance came early in my career when the dot com bubble burst beginning in March 2000. I felt what we were experiencing as an industry at that time was unprecedented. Then somebody handed me a book titled Extraordinary Popular Delusions & The Madness of Crowds by Charles Mackay, first published in 1841. One of the chapters was titled The South Sea Bubble which told the story of another financial bubble which destroyed the fortunes of many in the 1700’s. It was a great reminder of the Mark Twain quote that “history often rhymes”.
What I learned from Mackay was that the Dot Com Bubble was not unprecedented, nor would be the Global Financial Crisis of 2008 nor The Covid 19 Pandemic of 2020. The other thing I learned was the dates, the causes, the duration and the magnitude of crises are always different, but the way humans react is remarkably consistent. That is when it first occurred to me that dedicating time and energy to trying to manage the next when, why, how and what of the next economic and/or market crisis is much more difficult then learning how to manage how my clients will react. Is it possible that Behavioral Psychology provides more answers to Wealth Management questions than any other field of study, including Finance, Economics and Capital Markets? I decided then that understanding biases, behaviors and their associated risks would be as valuable to my clients, and maybe even more valuable, than understanding economies and markets.
As mentioned in the first section, familiarity bias can blind us to the biggest risks right in front of our faces every single day. These risks go undetected because our comfort level causes us to tune out outside information, especially information that runs counter to our current thinking. Daniel Kahneman in his book Thinking, Fast and Slow said the “familiarity principle” is when repeated exposure to something makes it feel more truthful, safer, and more likable. In the book Nudge, Richard Thaler takes it further by explaining that familiarity “reinforces inertia” or the status quo. In other words, we feel so comfortable with something that we subconsciously ignore outside information.
We see this all around us every day in every walk of life. From the relatives who only buy a certain brand of car because they have “never had a problem” to the friends who go to Texas Roadhouse for dinner while on vacation, to the co-workers who resist an upgrade to the new state-of-the-art software system. Each of these is an example of familiarity bias at play to some degree and each illustrates a certain level of comfort which reinforces inertia or the status quo.
While adhering to the status quo may feel good and makes decision-making easier, having only one side of the story (your side) can be risky. When it comes to buying a new car or choosing a restaurant on vacation, the risk of leaning into familiarity bias is low. However, when it comes to ignoring the new software system upgrade at work, or investing a chink of our retirement dollars in a single business in which we feel intimately familiar, the risks increase significantly.
How Familiarity Bias Reveals Itself in Wealth Management
We often say that we do not manage performance, we manage risk. In other words, our job is not to outperform some arbitrary benchmark. Our job is to get to know our clients so well that we can identify the biggest risks in their financial lives, and one by one, help them take the necessary steps to mitigate those risks. Sometimes those risks are investment related. Sometimes they are related to planning. Almost all the time, they have something to do with biases and behavior.
Below are a handful of biases that can lead to risky behavior:
- Confirmation Bias and/or Regret Aversion and Portfolio Concentration Risk
- Loss Aversion and Purchasing Power Risk
- Recency Bias and Sequence of Return Risk
- Herd Behavior and Valuation Risk
- Anchoring and Opportunity Cost Risk
I have covered a couple of these biases in past posts and will reserve diving deeper into the others until future posts. Instead, I will focus on the bias that motivated this blog post, familiarity bias and one of the biggest associated risks, idiosyncratic risk.
Familiarity bias in Wealth Management can present itself in multiple ways. Home country bias is when people tend to overweight investments in the country they live. Sometimes it is simply a matter of convenience as 401k Plans offer more US options than global or international. The research indicates that Americans tend to overweight stocks and bonds from the USA, Canadiens overweight Canada and the Japanese overweight Japan. The familiarity we have with our home country just feels safer.
In a publication titled No Place Like Home: Familiarity in Mutual Fund Manager Choice, authors Pool, Stoffman, and Yonker discovered that even professional money managers display familiarity bias, often overweighting companies headquartered in their home state. Importantly, they also found that this led to overconcentration and underperformance.
But familiarity bias doesn’t just lead to investing in what feels most comfortable. It can also lead to avoiding investments that feel less comfortable. Author Hisham Foad in a 2010 publication noted that “familiarity bias causes investors to avoid investments they don’t understand, even when those investments may improve diversification or reduce portfolio risk”.
We often see familiarity bias create the highest levels of risk when investors have a significant concentrated stock position, usually their employer’s stock. Not only is a large chunk of their wealth tied up in one company, but their salary and benefits are coming from that company also. That is a lot of eggs in one basket, a risk that can only be mitigated through diversification.
However, because of familiarity with company management, products, customers, and the industry, among other things, some investors tend to resist diversifying away idiosyncratic risk because they feel comfortable. Idiosyncratic risk, as highlighted in the Blockbuster story, is risk that only applies to a single company. Netflix couldn’t put the entire US stock market out of business, but they could disrupt Blockbuster. And the same is true for any family that has a large, concentrated stock position. Idiosyncratic risk can turn a comfortable retirement into major pivot. One strategy to reduce or eliminate idiosyncratic risk is to diversify it away by selling shares of the concentrated stock and replacing it with a broadly diversified portfolio, preferably a tax-efficient one.
Blockbuster Video is a perfect example of how a business in which we are intimately familiar can be disrupted and investors negatively impacted. Our number one job is to identify and manage risk. The idiosyncratic risk inherent in concentrated stock positions is one of the biggest challenges we face in Wealth Management because of familiarity bias mostly. Within twelve years of Netflix founding, Blockbuster filed for bankruptcy. Executives and franchisees with a significant amount of their net worth tied to the fortunes of the company, were decimated. Fortunately, many of us were merely loyal customers of Blockbuster Video, and not significant owners. Although it took a while, my wife and I eventually migrated over to streaming. While we still miss our Friday night trips to the video rental store, pivoting to the “Netflix and chill” model has worked out just fine.