2010: A Year in Transition

27 Dec, 2010 By: Thomas K. Arnold

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After a calamitous 2009, which saw the nation’s recession deepen and home entertainment spending drop 5% from the previous year, 2010 wasn’t all that bad.

Sure, total consumer spending is likely to be down again, as Blu-ray Disc and digital delivery growth continues to lag behind the decline in DVD sales — which as of the end of the third quarter were running about 12% behind the previous year, according to an analysis of numbers provided by DEG: The Digital Entertainment Group.

But a new reality has settled on Hollywood, rooted in the acceptance that the double-digital growth the industry experienced in the early 2000s will never happen again, at least not for packaged media — and that Netflix and Redbox have altered the landscape for not just the rental sector, but for the entire business.

“Consumer confidence is coming back but will never return to 2006 levels in this generation,” said John Marmaduke, president, chairman and CEO of Hastings Entertainment, a chain of 147 multimedia superstores headquartered in Amarillo, Texas.

“People are living without what they can live without, as they discovered it wasn’t such a big sacrifice,” he said.

Complicating matters is the fact that thanks to Netflix and Redbox, renting a movie has never been easier or cheaper, and that’s bound to have an effect on consumer purchases, particularly in these still-troubled economic times. At the same time, Netflix has become one of the power players in digital delivery, to the further detriment of packaged-media sellthrough.

Steve Beeks, president and co-COO of Lionsgate, calls 2010 “the year of transition.”

“We saw explosive growth for Blu-ray sellthrough and on-demand platforms, each of which will approach or surpass $2 billion in spend,” Beeks said. “It’s the year in which consumers had more choices than ever, from standard-definition DVD to streaming. It’s also the year in which studios forayed into burgeoning new media platforms, such as social games and apps, which offer a new growth opportunity, as well as the year the industry truly embraced the idea of looking at the whole pie when referring to home entertainment.”

Indeed, every aspect of the home entertainment industry experienced transition during 2010. There was a transition from physical media to digital delivery, from brick-and-mortar rental to alternatives such as Netflix and Redbox, from 2D to 3D. Perhaps most significantly, 2010 saw a transition from what had always been a consumer product to a consumer experience — the experience of watching a movie or TV show where, when and how you wanted to. And the cheaper and more convenient, the better.

“Given the weak economy, it’s no surprise that there has been a secular shift to rental, chiefly subscription and kiosks, over the past year,” said Craig Kornblau, president of Universal Studios Home Entertainment. “Looking ahead, one of our biggest challenges will be finding lucrative ways to offset this loss in sellthrough by aggressively growing our VOD and iVOD [Internet video-on-demand] businesses. Additionally, marketing will continue to be very critical to our success in educating consumers about their options.”

In terms of offering cheaper and more convenient home entertainment, no one did it better than Netflix, the subscription rental service that pushed past Blockbuster to become the No. 1 renter of pre-recorded media. By the end of the year, Blockbuster had filed for bankruptcy while Movie Gallery, the nation’s No. 2 brick-and-mortar rental chain, had liquidated. At the time of Blockbuster’s September bankruptcy filing, Netflix’s share of the rental market was not only significantly bigger than Blockbuster’s, but rivaled that of the entire brick-and-mortar sector. By then, Netflix had an estimated market share of 36%, according to Home Media Magazine market research. Redbox, with its chain of more than 20,000 rental kiosks, had 25%, Blockbuster had 22% and other retailers, mostly independents, had 17%.

The studios’ attitude toward Netflix and Redbox changed from outright hostility to grudging acceptance. Indeed, as 2010 began, much of Hollywood was embroiled in litigation with Redbox, on the grounds that the proliferation of dollar-a-day rental kiosks was cannibalizing the sellthrough business. By the end of the year, however, most major studios had deals in place with both rental services that called for a 28-day delay in new release rentals in return for vastly discounted prices. Netflix also accelerated the streaming component of its Blu-ray, DVD and streaming subscription service.

Hastings Entertainment’s Marmaduke takes a cynical view of Hollywood’s dealings with the non-traditional rental dealers.

“2010 is the year the studios’ favorable prices to Netflix and Redbox came back to bite them,” he said.

Indeed, delaying the availability of new releases to Netflix and Redbox hasn’t had much of an effect on the sellthrough business. DVD sales continued to suffer as 2010 progressed. But on the bright side, Blu-ray Disc sales soared, posting a healthy year-over-year increase of 80% as of the end of September, according to DEG figures. In December, Inception generated 65% of its first-week sales from Blu-ray, a new record for a high-profile new release. And during the Black Friday consumer shopping frenzy, Blu-ray Disc players, many of them selling for well below $100, were the sleeper hit, with sales of more than 400,000 units, a 50% increase from Black Friday 2009.

“It’s undeniable that DVD sales have softened, but Blu-ray will remain a growth area into the future,” said David Bishop, worldwide president of Sony Pictures Home Entertainment. “As HDTVs increasingly become a staple in worldwide households, the hunger for high-definition content will continue to feed strong growth in the Blu-ray market.

“The industry is adapting to change as consumers’ options for rental transactions, rather than sale, continue to expand, and their economic concerns remain,” he added. “But Blu-ray continues to be a bright spot, with units nearly doubling over last year.”

Studio optimism for Blu-ray Disc is fueled by the arrival in 2010 of 3D for the home, utilizing the Blu-ray Disc platform to recreate the 3D theatrical experience that has been such a bonanza for Hollywood movies on the big screen.

“The biggest story of 2010 for our industry was certainly the launch of Blu-ray 3D,” said Lori MacPherson, EVP and GM of Walt Disney Studios Home Entertainment. “The opportunities that it presents for creative and immersive in-home entertainment are immense.”

Bishop added, “The launch of Blu-ray 3D has certainly been impactful at a time when consumers have demonstrated a demand for high-quality 3D content, both in theaters and in their living rooms. With the success of recent theatrical 3D films and with many more high-profile 3D releases on the horizon, now is the ideal time to bring that experience into the home.”

Digital delivery, like Blu-ray, posted impressive gains in 2010. The download-to-own market, which rose 37% to $432 million in the first three quarters of the year, is still dominated by Apple’s iTunes. But the streaming, or video-on-demand, market — which posted a 20% increase, to $1.2 billion, during the same time frame — has flourished on both cable and the Internet. Netflix has solidified its position as one of streaming’s biggest drivers, chiefly through an inexpensive monthly plan that lets customers stream movies as well as rent physical discs. In November, Netflix launched a streaming-only plan in the United States, two months after bowing a similar plan in Canada. Netflix maintains more than 60 million consumer electronics products have been sold this year featuring Netflix streaming, ranging from Xbox consoles to Blu-ray Disc players — a total of more than 200 different third-party devices.

But these impressive gains certainly don’t mean the disc is dead, or even dying.

“A business that serves its customers well and remains flexible during times of transition or technological innovation does not just evaporate,” said Disney’s MacPherson. “Through our various product offerings and distribution partners, we are focused on providing our consumers with what they want — when and how they want it.”

As an example, she cites the “combo pack,” which Disney pioneered. Combo packs include a DVD, Blu-ray Disc and digital copy of the same movie, “providing greater value and usage opportunities for families,” MacPherson said.

“This type of cross-platform usage will only continue and grow,” she said. “And the flexibility of the Blu-ray format makes it a critical slice in the ever-expanding home entertainment pie.”

Universal Studios’ Kornblau added, “Packaged media still reigns supreme in the home. It is clear that consumers continue to remain highly engaged in our category, as evidenced this year with the enormous success of several tentpole titles like Despicable Me.

“Total transactions across both physical and digital are up slightly from last year, continuing the upward trend we’ve been seeing for the last several years,” Kornblau said. “Equally telling is the fact that physical discs accounted for more than 80% of consumer dollars spent this year — a number that we don’t expect will shift substantially in 2011.”

Lionsgate’s Beeks agrees. “The ‘death’ of packaged media has been greatly over-exaggerated,” he said. “Packaged media spending will account for more than 85% of all home entertainment spending this year, so it is still the platform that the vast majority of consumers choose when viewing home entertainment product. Consumers are still willing to purchase compelling content in all platforms — especially higher-margin Blu-ray, as witnessed from its tremendous growth over the past year. We released The Expendables this quarter and the conversion rate (box-office-to-home-entertainment revenue) was one that we would have expected to see back in 2008.”

Steve Nickerson, president of Summit Home Entertainment, added, “Packaged media is not dying. It is simply a very large, but mature, product category that is being affected by newer consumer options that are in their early stages of adoption.”

Looking ahead, one clear-cut forecast is that market fragmentation will continue. There’s Blu-ray Disc and DVD, digital downloads and streaming, Hulu and YouTube, Facebook and Twitter — all competing for consumer eyeballs. Consumers have more home entertainment options than they’ve ever had, and industry leaders realize they have a difficult task ahead of them, keeping their products and their programming front and center.

“We view our challenges as opportunities, and among those for 2011 is ensuring the success of Ultraviolet (the ‘cloud’-based movie storage and retrieval system being worked on by a consortium of studios) and keeping intact the very attractive value proposition of owning content, whether that platform is Blu-ray, [electronic sellthrough] or a value-priced, standard-definition catalog title,” said Lionsgate’s Beeks. “There is tremendous revenue being generated in all home entertainment, with a large chunk of this revenue on the digital and new media side of the business. And our challenge is to leverage this growth over our new releases and library and create even more value to our customers and stakeholders.”

Hastings Entertainment’s Marmaduke is looking ahead at 2011 with cautious optimism. He predicts “continued slow recovery and increasing penetration of Blu-ray.” And, yet, he warns that studios and retailers alike must work together to make sure that “streaming does not commoditize and diminish rental and sellthrough.”

“I’ve been told by an increasing number of consumers, ‘I don’t rent or buy anymore now that I can get it for free streaming,’” he says.

Marmaduke also suggests the studios “focus on finishing the expansion of Blu-ray before jumping on the 3D bandwagon,” echoing the “too much, too soon?” questions posed by some industry analysts.

Disney’s MacPherson believes consumer education and messaging will be increasingly critical, as entertainment options continue to expand.

“A key challenge in 2011 will be consumer education regarding 3D in the home and the value proposition that digital ownership represents,” she said. “Consistent messaging that resonates with our core consumers will be key as we strive to tackle the ever-present issue of marketplace fragmentation. We need to make good on the promise of interoperability, and the driving force has to be, ‘How do we best serve our consumers?’”

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