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ANALYSIS: A Banner Year for Video

28 Dec, 2001 By: Thomas K. Arnold

Students of home entertainment will one day look back at 2001 as the year when the pie—which studio executives and retailers for years have been slicing, dicing and, at times, throwing at one another—really did get bigger.

The home video sellthrough market fairly exploded in 2001, with total sales to consumers projected by Adams Media Research to clock in at $12.5 billion—up a substantial 14 percent from 2000's $10.8 billion The beleaguered rental market, meanwhile, once again stunned analysts by remaining strong, with total rental revenue estimated by Adams to be up slightly from the $10.3 billion reported the year before.

As Universal Studios Home Video president Craig Kornblau says, "This is the year we hoped would never end."

The twin catalysts in what some are calling a renaissance were the soaring success of DVD and the post-Sept. 11 so-called "cocooning" of America.

"We hit new peaks," says Joe Pagano, senior v.p. of enterprise entertainment for consumer electronics powerhouse Best Buy, based in Eden Prairie, Minn. "In a soft economic period, this category not only maintained, but grew, and that's a phenomenon. It's one thing to be hot when everything else in the world is hot, but the environment in which [home video] skyrocketed was not the most robust."

DVD Engine Powers the Market

"It was an amazing year for DVD," adds Paul Ramaker, v.p. of movies and more at Wherehouse Music, an audio-video combo chain based in Torrance, Calif. "The release schedule gave us some wonderful product to work with throughout the year, not just in the fourth quarter."

By the end of the year, DVD was projected to be in nearly 25 million U.S. homes, and just as the CD reinvigorated the music industry, DVD caught the fancy of both the movie-buying and the movie-renting public.

Mass merchants like Kmart reported the addition of DVD led to double-digit gains in video sales, while Blockbuster Inc.—a late entry into the digital format—adopted a new ad slogan: "The best way to DVD is Blockbuster." The rental chain dumped 25 percent of its VHS inventory to make more room for DVD, and by the fourth quarter was also selling DVD players in more than 4,300 corporate stores.

Benjamin S. Feingold, president of Columbia TriStar Home Entertainment and the Columbia TriStar Motion Picture Group, says 2001 "was the first year in which consumers started renting as well as purchasing DVD in significant quantities."

"Americans have a love affair with buying DVD," Feingold says. "Before, it was a courtship, but 2001 is when we got married."

"DVD is the most successful consumer product to roll out since the television set itself," adds analyst Tom Adams of Adams Media Research. "That became obvious 12 to 18 months ago, and now everybody's geared up to take advantage of that fact."

Indeed, according to VideoScan data, October 2001 marked the first time that consumers bought more DVD units than VHS units. That month also saw the first in a series of press releases from the studios, trumpeting out-of-the-gate DVD sales for hot new releases. Universal was first, boasting that consumers had bought 2 million DVDs of The Mummy Returns in one week. Disney fired the next salvo, claiming Snow White moved 1 million units in a single day.

Fox subsequently proclaimed Star Wars: Episode I—The Phantom Menace the "fastest-selling DVD of all time" with sales of about 2.2 million units in one week, only to be one-upped by DreamWorks' Shrek, with sales of 2.5 million DVDs in just three days. Within a month, consumers had snapped up 5.5 million DVDs of Shrek, making it the biggest-selling disc ever. The latest volley came from Disney, touting first-week sales of 3.7 million DVDs of Pearl Harbor, a new industry record.

Kelley Avery, president of worldwide home video for DreamWorks Home Entertainment, credits much of Shrek's phenomenal success on DVD to the growing family market for DVD.

"One of the most significant developments in 2001 was that DVD broke out of the early-adopter, DVD-collector phase and moved into the mainstream, especially families," Avery says. "Shrek was both a driving force and a beneficiary in this market expansion."

For the year overall, DVD is projected to account for nearly 50 percent of all sellthrough video sales, according to several sources, while on the rental side consumers—as the year was drawing to a close—were spending nearly 20 percent of their money on DVDs, according to Video Store Magazine market research.

VHS Not Going Quietly Into the Night

VHS, meanwhile, has proven itself remarkably resilient—thanks in no small part to mass merchants like Wal-Mart and Kmart, who cushioned the format's fall by stepping up as others—including Best Buy—stepped out. Indeed, Wal-Mart in the fourth quarter unveiled a new merchandising campaign that takes aim at the rental market, erecting huge bins in high-traffic aisles filled with budget-priced cassettes under the tagline, "No Late Charge!…You Own It."

"We are not yet ready to give up on VHS," says Steve Beeks, president of Artisan Home Entertainment. "We still do incredible business with VHS. Even the most aggressive projections showed maybe 25 million DVD players in homes by the end of 2001. Compare that to the 90 million-plus VCRs and it becomes clear that VHS still has a lot of life left in it."

"I think the biggest challenge facing our business is that retailers are positioning themselves to be cutting edge and are trying to move too quickly into DVD while sacrificing VHS," adds Universal's Craig Kornblau. "Look at Shrek and The Grinch—I think the biggest surprises in each case were the amount of copies that were sold on VHS."

Indeed, while consumers may have bought 2.5 million DVDs of Shrek the first three days the video was in stores, they also bought nearly 4.5 million cassettes in that same period. And of The Grinch's first-week sales tally of 8.5 million units, an estimated 5.5 million were cassettes.

The "cocooning" of America in the wake of the Sept. 11 terrorist attacks is certainly a factor, industry observers say. Video rental experienced a brief uptick in the weeks immediately following the attacks, while video sales remained on an upswing through the end of the year.

"In a social element, movies have provided a very healthy form of escape from the trials we faced in the last few months," Best Buy's Joe Pagano says. "And that's something we should all be proud of—continuing to make people's lives more enjoyable in difficult times."

DreamWorks' Kelley Avery believes even bigger things are in store for next year.

"The phenomenal success of Shrek has really laid the groundwork for the next big movie, Harry Potter, to break through the 30 million-unit mark next year," Avery says. "I think that's a distinct possibility, with the expansion of the market and the strength of both VHS and DVD."

The rise of DVD and the cushioning of VHS's fall may be the dominant news stories of 2001, but they certainly weren't the only ones.

Chain Retailers Fortunes Return

As the year got underway, the publicly traded video chains began to see their fortunes rise. Blockbuster's broader world view paid off handsomely: The chain achieved a 40 percent share of the video rental market, became the nation's second-biggest DirecTV dealer and opened 94 company-owned and 80 franchised stores.

Blockbuster also continued to reach out into other businesses, cutting a deal in March with Radio Shack to operate 600-square-foot hardware departments and, in the fourth quarter, introducing DVD players into its stores.

Movie Gallery of Dothan, Ala., in May reported double-digit gains in first-quarter sales from the previous year and announced it would open 75 more stores by year's end. The chain also bought bankrupt Video Update's bank debt and took control of the former competitor's 350 stores [THIS HASN'T HAPPENED YET. WE'LL SEE THIS WEEK]. And by May, its stock price had doubled from what it was the year before.

The biggest turnaround, however, happened at Hollywood Entertainment Corp., the country's No. 2 rental chain, which at the end of 2000 appeared to be on the brink of collapse. Hollywood's stock price, which sank below a dollar a share in late 2000, rebounded and by November 2001 was trading for more than $12 a share.

"They finally got their business figured out," says one high-ranking studio executive. "They rationalized their purchasing process, stopped opening new stores and focused on the fundamentals of the business."

Independent video specialty retailers, fewer but stronger, were heartened by the burgeoning DVD rental market. "We've never been able to buy hot rental product for less than $20 before DVD," says one store owner. Accordingly, several vocal indies, including Tom Hannah of Video Quest in Joliet, Ill., and Dave Stevenson of Big Picture Video in Liverpool, N.Y., were making plans to go all-DVD.

Indies' spirits were further boosted by the decline of studio-direct revenue-sharing and the advent of flat pricing, for which they had long been clamoring. In what many saw as a harbinger of things to come, Blockbuster failed to renew its VHS revenue-sharing deal with Disney.

Other revenue-sharing deals between the studios and the big rental chains are reportedly near collapse, in large part "because the big chains don't need them anymore," according to one observer. "With everyone going DVD, it's no longer a case of he who has the most cassettes wins."

Rising, in revenue-sharing's stead, is flat VHS pricing. MGM Home Entertainment was the first major studio to scrap complicated copy-depth programs in favor of single pricing, beginning with the August title Hannibal, a $164 million theatrical grosser retailers could buy on cassette for $48. In December, Columbia TriStar announced it, too, would move to flat pricing on five secondary titles streeting in January, and observers believe other studios will make similar moves as 2002 progresses—joining the ranks of indies like Artisan, Lions Gate and USA that have also gone to flat pricing.

Another highlight for packaged entertainment retailers this year was the emergence of two new video game consoles to do battle with the Sony PlayStation (one and two) juggernaut. With the November launch of Microsoft's Xbox and Nintendo's GameCube, some analysts also speculated that the video game rental business might also improve as consumers tried out the new players and/or rented game titles at least once before buying new games for their (now) multiple player homes.

If there was one segment of the industry for which 2001 was not a good year, it was traditional distribution. In February, wholesalers shut out of Universal Studios Home Video's streamlined distribution network filed suit in federal court, accusing the studio and its chosen distributors of conspiracy and anti-trust violations.

By the end of the year, ETD, one of the litigants, had exited the video business to focus on its core magazine and book lines, and another distributor, Valley Media, had filed for bankruptcy.

Ironically, Valley Media was one of only three wholesalers who had made the cut with Universal a year before, albeit only for sellthrough and DVD product.

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